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Chapter 9 Reinsurance market 9/25

Activity
You may be employed by a company that has been ‘rated’ or have clients that have been. You may even work for a
rating agency. Look at a large company that you are familiar with and discover what financial rating agencies have
had to say about it.

Rating agencies have embraced the use of modern technology as an important underwriting tool for
Rating agencies have
reinsurers. In consequence, rating agencies may wish to evaluate a reinsurer’s computer models for embraced the use of
rating and pricing and its ability to model catastrophic events. The agencies would almost certainly modern technology as
an important
assess the actuarial disciplines used in calculating past, present and future claims reserves, and underwriting tool for
premium pricing, if applicable. The ultimate aim is perhaps to configure that reinsurer’s involvement in a reinsurers
particular loss scenario and, in effect, ‘test’ the reinsurer’s retrocession programme. Many actuarial
techniques use stochastic models to produce a range of results.
A stochastic model is a tool for estimating probability distributions of potential outcomes by allowing for
random variation in one or more inputs over time. Based on a set of random outcomes, the experience of
the portfolio or company is projected, and the outcome is noted. This is then done again with a new set
of random variables. In fact, this process is repeated many, many times.

Computer modelling of realistic disaster scenarios (RDS) on an individual event basis has been replaced
or complemented by sophisticated dynamic financial analysis models that stress test the entire
operations of an insurance company or reinsurer.
In 2005 the highest number of tropical cyclones (27) and hurricanes (15) were recorded in a single
season in the North Atlantic, including the strongest hurricane ever recorded in that area (Wilma at 882
hPa central pressure), the fourth strongest (Rita) and the sixth strongest (Katrina) in a single season.
These North Atlantic storms (together with other natural perils events elsewhere) produced record
worldwide insured property losses of US$83 billion. It is probably fair to say that many computer
modelling systems underestimated the loss potential of the areas affected by the brutal succession of
North Atlantic storms and many insurers found that they had insufficient reinsurance protection.
Virtually all of the main rating agencies introduced new and enhanced capital adequacy models and new
methods of assessing catastrophe exposures for 2006 and beyond, especially if the reinsurers were Reference copy for CII Face to Face Training
located in so-called peak zones.

Consider this…
Where do you think these ‘peak zones’ are situated?

The actions of individual rating agencies in stress-testing the analytical models of reinsurers are of great
importance with regard to catastrophic risk. In general terms, we could call this new type of analysis
‘enterprise risk management’ in that it embraces a better understanding of risk assumption and risk
management in all its diverse aspects.

Activity
Rating agencies continue to develop and finalise analytical and modelling systems. Follow activity as it is reported in
the insurance and reinsurance press.

In summary, we could say that these new capital adequacy models are an advanced form of risk-based
capital assessment.

E3 Ratings Chapter

Various phrases are used to describe the ratings depending upon the agency conducting the analysis. 9
Fitch, A.M. Best and Standard & Poor’s favour ‘insurer financial strength rating’ (IFSR). In each case, what
is being provided is an opinion from that agency on the financial strength and ability of the company to
pay under its (re)insurance policies and contracts in accordance with their terms and conditions (or
similar).
All of the rating agencies use a scale of alphabetic indicators – with or without + or – signs – as the mark
All of the rating
of the strength of their rating, with AAA being the best, descending through AA, A, BBB and so on. They agencies use a scale
also provide supporting definitions and make these freely available to all entities operating in the of alphabetic
indicators
insurance and reinsurance market. For example, an insurer rated ‘AAA’ may be said to have extremely
strong financial security characteristics whereas one rated ‘AA’ may only have very strong characteristics
and another rated ‘A’ may only have strong characteristics and be more likely than those with higher
ratings to be affected by adverse business conditions, and so on (Standard & Poor’s).