For those who are wondering ‘What is this Event Limit (EL) and why was it required?’ Normally under a proportional treaty (Quota share or surplus), a CAT event can impact various policies ceded to it and the ultimate loss can thus be multiple times of the treaty limit. A participating reinsurer is thus unable to gauge the maximum exposure that he may have from the treaty in the unfortunate scenario of a huge catastrophe. International Reinsurers are constantly under pressure from Rating Agencies as also under Regulatory pressure to comply with Risk Based Capital (RBC)/Economic Capital and gradually move towards Solvency II compliance. Arising from these pressures, the reinsurers are now required to accurately define their exposures. This is rather difficult under a proportional treaty unless there is a cap for exposure from a CAT event. Reinsurers were thus compelled to impose an EL on all proportional treaties as an aid in capping its exposures in the adverse situation. The EL pegs a reinsurers maximum exposure from a single event and thus helps in assigning a finite figure to an otherwise infinite one.
The last straw on the camel’s back was the (un)memorable year of 2011. The year saw the highest economic losses in history, the highest insurance earthquake losses, and also the highest insured losses ever for a single flood event. Earthquakes in Japan, New Zealand, and Turkey, as well as floods in Australia and Thailand brought about massive destruction and loss of life. The economic losses totaled USD 370 billion and of that, insured losses were to the tune of USD 116 billion. There were 325 catastrophic events in 2011: 175 were natural catastrophes and 150 were man-made disasters. 2011 year thus once again brought to centre stage the concept of EL in proportional treaties. Given the peculiar nature of the Thailand flood event which lasted for an enormously long duration, the non-life insurance companies got the chance to claim from their reinsurers, multiple times (number of reinstatements plus one) from technically the same event. This event which resulted in humungous insured losses was an eye opener to reinsurers.
Thus learning from the above events of 2011, the management of most reinsurers came down heavily and began insisting on EL on all proportional programmes, barring a few countries, not traditionally classified as CAT prone. The concept of EL was not new to the Indian market which has witnessed Cat events in the past. Few companies had an EL on their erstwhile programmes which were then discontinued as the Indian market was not conceptually tuned for this, further the market did not want any kind of restriction on the recoverable loss. However, we cannot lose sight of the fact that insurance and reinsurance business of a country goes beyond its boundaries and thus it goes without saying that quite often the insurance terms and conditions followed by a market are dictated by the international market scenario.
At various forums, International Reinsurers had cautioned GIC Re and also various Indian Insurers that subscription to proportional programmes without EL may become challenging. GIC’s retro programme would have been the worst hit if the underlying proportional programmes of the Indian Insurers were without EL. This coupled with the fact that the surplus treaties of most companies do not have positive results, which otherwise also makes the placement difficult, the Indian Insurers at the 2012 renewal were not in a dictating position and had to give in to the demands of the International market to introduce the EL.
Being convinced that EL is the writing on the wall and that the same is unavoidable for the 2012 renewals, GIC Re in its role as the Indian reinsurer began its efforts to prepare the market for accepting this new concept. It was a well-known fact that the introduction of the EL would bring in competition for GIC Re from reinsurers who were avoiding the market. Despite this, GIC Re, in the interest of the market, took up job of preparing the market, which was a challenging one as initially there was a resistance for change, further, as mentioned subsequently, commercially, the concept was in favour of the reinsurers – Insurers would have to pay proportional premium and get restricted cover and also live with the fear that the cost of the CAT XL programme would go high due to spill over coverage. The only fact in favour of the Insurers was the oral (unproven) assurance that having accepted the EL the subscription to the surplus treaty programme would be smooth.
For a new startup company and relatively smaller sized Insurers the automatic capacity offered by the surplus treaties is a necessity. These Insurers cannot give up this capacity because of the threat of the EL.With an EL on his surplus treaty, an Insurer in case of a large Catastrophe will be in a position to recover from his reinsurers only to the extent of the EL (i.e. a restricted recovery) despite having paid proportional share of the premium. The spill over (unrecoverable portion) over and above the EL, if any, would fall back on the Insurer, who would need to cover it under his non proportional Catastrophe programme, at an additional price.
Two major ramifications that the EL would have on the Insurers would be the added cost and the fear of adequate coverage. As regards cost it boils down to the fact that the original pricing of the insurance policy has to be adequate. Taking a cue from this, the Council came out with a minimum rate for AOG (Act of God )Perils. Further, to ensure that the spill over is minimum, the Insurer needs to have a good quality data base of his exposures and bring in discipline to map, monitor and control his accumulation.
Bearing in mind the moral responsibility to the market, GIC Re formulated the wording for the EL for the Indian market based on the mere objective that it has to serve only to cap the reinsurer’s liability in the unfortunate incidence of a CAT Event and not to deprive an Insurer of getting his recovery. Following were the salient points of EL clause imposed at the 2012 renewals and continued for the 2013 renewals:
- Limits were fixed liberally, guided by RMS modeling output for 1 in 250 years return period for the aggregation data and assumptions submitted by them. This worked out in the range of 2 to 3 times Treaty Limit for most companies
- The EL was made applicable only to NAT/CAT perils
- Fire conflagration risks and RSMD were excluded from the scope of the EL
- Being the first year of introduction, the ELwere made applicable only to policies incepting on or after 1st April 2012. This was to give the Insurers time to get in place the aggregation control mechanism.
- Coverage for the spill over portion, if found necessary, was offered under the CAT XL programme.
- Companies were guided to move to a healthy P:L (premium to Liability ratio) and to achieve this the unused capacity was truncated. This also made the EL quantum more acceptable to reinsurers thus garnering their support.
Now on hind sight, it can be stated with conviction that the introduction of the EL did ensure that reinsurers who were avoiding the Indian market due to the absence of the EL did take sight of the programme and then based on the performance of the treaty; proposed terms and conditionsand confirmed their support ensuring smooth placement of the 2012 and also 2013 surplus treaty programmes for most Indian Insurers.
The only comforting fact is that the original policy holder would not be impacted by the EL as the contract between a Policy Holder and his Insurer is independent of the contact entered into by the Insurer with his Reinsurer. Thus the EL which appears on the Reinsurance contract would have no bearing on his claim.
To add to the above, at the 2013 renewals, the EL was further supplemented by the Interlocking Clause. This clause merely states that should more than one Underwriting year of a proportional treaty be open when a CAT event occurs, a single EL applicable to the current underwriting year would be applicable to all open years in the ratio of the losses given by each such year to the total losses for all the open underwriting years combined. This once again emphasizes the need for discipline and improvement in the quality of aggregation data.
Reinsurance, like all other business is governed by the principles of economics of demand and supply. Whether an Insurer likes it or not, the EL concept that got introduced last year amidst all hue and cries is now here to stay. An Insurer thus has to gear up to tackle this (unwarranted) feature technically by monitoring and controlling his aggregate exposures and buying sufficient spill over cover. The Indian Non-Life Insurers however, seem to have got comfortable with the concept of EL, thankful to the fact that 2012 was a good year with no major CAT event. A cautionary advice – complacency should not catch the Insurers on the wrong foot as the EL has as yet not got tested real time!
Mrs. Madhulika Bhaskar
GIC Re, Asst General Manager, Mumabi