AFRICAN RISK CAPACITY INSURANCE COMPANY LIMITED

Transcription

1 AFRICAN RISK CAPACITY INSURANCE COMPANY LIMITED POLICY HANDBOOK Version 1.2 Effective: 1 May 2014 African Risk Capacity Insurance Company Ltd Registered Office: Canon s Court 22 Victoria Street, PO Box HM 1179 Hamilton HM EX, Bermuda

2 FOUNDING POLICY STATEMENT The African Risk Capacity Insurance Company Limited ( Company ) will operate under best practices for international finance institutions. In order to help fulfil Company s purpose to provide insurance coverage for African Risk Capacity Agency Member States against Extreme Weather Events and Natural Disasters ( Purpose ), Company will operate so as to serve its Members with transparency and ethics, under a zero tolerance principle for corruption by the Company or its service providers, and with an emphasis on sharing lessons learned and its development impact with the global development community. The Company Board of Directors (the Board ) will reconsider these Founding Policies on a regular basis and will make recommendations to the Company Members annually, or more frequently if the need arises, regarding their amendment and modification to help ensure that the Founding Policies are well- suited to governing Company operations. ii

3 TABLE OF CONTENTS Founding Policies are listed under paragraph 13.5 in the Company Bye-Laws ( Bye-Laws ) and appear below in the order in which they are listed therein. Founding Policy Statement... ii 1 Anti-Money Laundering General Principles Procedures Anti-Fraud, Anti-Corruption and Anti-Bribery, Complaints and Whistleblowing General Principles What are Fraud, Corruption and Bribery? Company Principles Relevant Company Policies Responsibilities Complaints and Whistleblowing Investment General Principles Procedures Underwriting and Insurance Risk Management Introduction Purpose Confidentiality Revisions and Updates Underwriting Authority Statutory and Legal Requirements Underwriting and Risk Management Strategy Development and Implementation Insurance Underwriting, Drought Policies Availability of Coverage Type of Insurance Cover Country-specific Underwriting Parameters Premiums Use of ARV in Underwriting Policy Wording Capital Preservation, Risk Retention and Risk Transfer Introduction Capital Preservation...17 iii

4 4.4.3 Risk Transfer Claims Identification & Settlement and Loss Reserving Identification of Claims/Losses Management of Payouts and Reinsurance Recoverables Loss Reserving Transparency, Disclosure and Data Protection General Principles Information Company will Routinely Make Publicly Available Exceptions to Information Disclosure Accessing Information Data Protection Procurement General Principles Procedures Permitted Deviations Ethics Evaluation of Service Providers Tax Service Provider Travel and Expense Policy Conflicts of Interest General Principles Procedures Compliance Monitoring General Principles Procedures Borrowing General Principles Sanctions General Principles Procedures Enterprise Risk Management General Principles Procedures Director and Officer Travel and Expense Reimbursement General Principles Procedures...38 iv

5 12.3 General Travel Requirements and Reimbursable Expenses Non-reimbursable Expenses Director Appointment, Evaluation and Remuneration General Principles Procedures Terms and Conditions of Appointment Evaluation of Directors Environmental and Social Budget Tax General Principles Procedures Development Impact General Principles...48 List of Annexes...49 v

6 1 ANTI-MONEY LAUNDERING 1.1 General Principles (c) Company will comply with Bermuda and international law and will operate with reference to specified Financial Action Task Force ( FATF )) recommendations as described in this policy to guard against money laundering. Company will not participate, directly or indirectly in money-laundering activities, including without limitation any act of converting money or other monetary instruments gained from illegal activity into money or investments that appear to be legitimate. Company is accountable for the way it earns, utilises and manages funds and is therefore responsible for, among other things, ensuring that those with whom Company does business ( counter-parties ) are not listed on any prohibited list published by the United Nations or the African Union and that every counter-party in any transaction with the Company enters into and performs such contract according to law whether in Bermuda or elsewhere. 1.2 Procedures (c) (d) (e) (f) Consistent with FATF Recommendation 10, Company will conduct reasonable due diligence on its counter-parties before issuing contracts and while minimising the compliance burden and impact on such counter-parties. Consistent with FATF Recommendation 11, Company will obtain and maintain for five years after the business relationship has ended certified or verified identification records from all counter-parties. Consistent with FATF Recommendation 11, Company will maintain detailed records of all financial transactions to ensure that financial receipts and disbursements are only received from or made to bank accounts matching the information on file for the applicable counter-party or recipient, in the case of an Insurance Policy payout, expense reimbursement or other financial transaction. Company will neither accept cash nor disburse cash and Company reserves the right to refuse to engage in any financial transaction if it believes the transaction may to be connected in any way to money laundering, the proceeds of crime or terrorist activity. Consistent with FATF Recommendation 20, any Company Member, Director, Officer, staff member or service provider who becomes aware of suspicious financial activity within or related to the Company must promptly notify the Bermuda Monetary Authority with reasonable detail regarding the matter. The Company will monitor trends in money laundering risks in Member countries, including by regularly checking the FATF grey warning list and other evaluations of international money laundering. 1

7 2 ANTI-FRAUD, ANTI-CORRUPTION AND ANTI-BRIBERY, COMPLAINTS AND WHISTLEBLOWING 2.1 General Principles (c) Company is committed to complying with all applicable laws, both in Bermuda and in all other jurisdictions where Company operates. It is a core aspect of the Company s mission to act with integrity in all aspects of the Company s operations, and the Company Board of Directors expects all staff, contracted service providers and Company Members to comply with both the letter and spirit of the law. Company s policy on fraud, bribery and corruption is one of zero tolerance; no level of fraud, corruption or bribery will be accepted. Fraud and corruption against Company funds by Company staff, contracted service providers or member countries including their representatives will not be tolerated. Those found to have been involved in fraudulent or corrupt activity or to have been negligent in the exercise of supervisory duties will be subject to disciplinary and, where appropriate, civil or criminal proceedings. The Company will take action to recover any funds or assets that have been lost. 2.2 What are Fraud, Corruption and Bribery? (c) Fraud: Fraud is a deceit or trickery; an abuse of position or confidence; a failure to disclose relevant information; the possession, making or supplying of articles for use in fraud; or a misrepresentation to gain unfair or dishonest advantage. Corruption: Corruption is the abuse of power for private gain. Bribery: Bribery is the offering, promising or giving an advantage; the requesting, agreeing to receive or accepting an advantage; the bribery of a public official; the failure by an organisation to prevent a bribe being paid for or on its behalf. Bribery can take the form of gifts, hospitality or commission for a contract, and may also be paid by agents or third parties working on the Company s behalf. 2.3 Company Principles (c) Company will carry out its business fairly, honestly and openly (e.g. transparent payment terms, and maintenance of clear records). Company will not make bribes, nor condone the offering of bribes on its behalf so as to gain a business advantage (e.g. no bribes to be paid by staff or agents). Company will not accept bribes, nor will it agree to them being accepted on its behalf (e.g. careful management of commission payments). 2

8 (d) (e) (f) (g) (h) Company will avoid doing business with others who do not accept these values and may harm Company s reputation (e.g. careful selection and contracting of business partners). Company will keep clear, accurate and updated records (e.g. recording how a conflict of interest was handled, and recording the selection process for contracted agents or service providers). Company will set processes for avoiding direct or indirect bribery (e.g. Company will set rules on dealing with gifts and entertainment). Company will make sure that everyone in its business and all business partners know Company s principles (e.g. publication and communication of policy handbook, inclusion of requirement to comply with Company policies in contracts). Company will periodically review and update its processes as needed. 2.4 Relevant Company Policies Procurement (Policy 6), including Gifts and Entertainment (section 6.4) Conflicts of Interest (Policy 7) 2.5 Responsibilities (c) (d) The Company Board of Directors is responsible for establishing and maintaining a robust system of internal controls that mitigate the risk of fraud, bribery, corruption or other activities that harm the ability of the Company to achieve its objectives. Company staff, service providers and members of the public must immediately report any suspicions of fraud, bribery, corruption or other breaches of law to the Company Internal Auditor, the Board of Directors or via the mechanisms set out in the following section (Company Complaints Policy). All complaints will be treated in the strictest confidence and will be dealt with as outlined in the Complaints Policy. All Company staff are responsible for acting with propriety in the use of Company resources and for reporting details immediately through the appropriate channel if they suspect that fraud or corrupt activities have been committed. All Company Directors, staff, service providers, Members and agents are responsible for protecting the Company s funds and other assets from misuse, mismanagement or misapplication. Contractors and insurance policy holders are also responsible for fraudulent / corrupt acts committed by their sub-contractors and sub-grantees. 3

9 2.6 Complaints and Whistleblowing Company takes all complaints regarding its compliance with this Policy Handbook and Bermuda and international law seriously and will follow the procedures set forth below to help ensure a transparent and expeditious review and resolution of all complaints. Procedures for complaints handling are as follows: (c) (d) (e) (f) (g) (h) (i) (j) Company will provide a mechanism on its website ( Complaints Hotline ) for any individual to report any allegations of a breach of Bermuda or international law (for example fraud, corruption, bribery) or a material breach of this Policy Handbook. All complaints or allegations, however raised, will be treated in the strictest confidence. Company encourages all company staff, service provider staff and members of the public to raise any concerns or allegations that are made in good faith and on reasonable grounds, to the Company Internal Auditor directly or through the Complaints Hotline. Complaints may be made anonymously; however, the complainant must provide at least an address for the Company to contact the complainant for additional information or clarification. Company will promptly investigate each complaint and, if deemed appropriate by the Company Board after reasonable investigation, seek a solution that addresses the complaint as quickly and efficiently as possible. Company will use good faith efforts within 10 business days and will then review whether a complaint requires further investigation. Company will strive to inform each complainant within 30 business days whether a further investigation will be undertaken or how the matter has been otherwise addressed. If a complaint has been accepted as eligible for investigation, Company may contact the complainant to cooperate with Company to provide the information necessary to help Company conduct its investigation of the matter. Company s Board, excluding any Director named or implicated in a given complaint, may decide not to investigate such complaint if the Board reasonably believes the complaint is frivolous or malicious. Once any Company investigation is concluded, the outcome of the complaint, including decisions, reasoning, and any remedial action taken shall be published in the Company Annual Report. The Company will not reveal the identity of the complainant without the complainant s consent. Company s decisions will be final but may be reviewed by a Bermuda court or any other court of competent jurisdiction where the complaint implicates a violation of Bermuda or international law. 4

10 (k) This complaints policy will be periodically evaluated and reviewed by the Company s Internal Auditor. 5

11 3 INVESTMENT 3.1 General Principles (c) (d) Company will manage its resources to help maintain Company s financial viability and with regard to staying above the threshold stipulated in the Bye-Laws to ensure that Company does not become Financially Unsustainable as that term is defined in the Bye- Laws. Company may create one or more funds as separate investment pools as necessary to stay within Company s risk parameters, including short term operating, and short and long term reserve funds and in each case to further conservative operating and investment objectives intended to maintain the Company and transition its ownership to the mutual Class A Members as and when possible. Company will only invest in fixed-income instruments, until the Members modify the types of permissible investment instruments. Company should invest in a manner that is socially responsible and sustainable. 3.2 Procedures (c) (d) (e) (f) The Board will review this Investment Policy annually together with any service providers performing as Investment Manager to the Company and advise the Members of such changes, if any, as may be desirable or necessary, for the approval of the Members in accordance with Bye-Law The Board, in consultation with the Members, will determine the currency amounts to be held in the Company s operating fund and reserve funds and the applicable mix of investment instruments, subject to any Bermuda Monetary Authority requirements. The purpose of Company s operating fund is to provide sufficient cash to meet Company s day- to-day obligations with the following objectives: the preservation of Company s capital and liquidity, and to optimise the investment return within principles of this Investment Policy. The purpose of the short and long term reserve funds are to help ensure that Company can meet its obligations to all Company Members in connection with Insurance Policies and the return of capital to Class C members (including consideration of the currency of such capital) as provided in the Bye-Laws Investment of Company funds will be diversified so as to minimise the risk of substantial losses. Within three months of appointment by the Company, an Investment Manager shall develop a detailed investment programme, consistent with this Investment Policy and with suitable monitoring and evaluation criteria of the programme performance. Once 6

12 approved by the Company s Board of Directors, such investment programme shall form an integral part of the contract for that Investment Manager. 7

13 4 UNDERWRITING AND INSURANCE RISK MANAGEMENT This Company Underwriting and Insurance Risk Management Policy ( Policy ) provides highlevel guidance for underwriting and risk management activities undertaken by African Risk Capacity Insurance Company Limited ( ARC IC or Company ) and with particular regard to the taking on of sovereign parametric weather risk from African Member countries and the management of that insurance risk once underwritten. This Policy has been approved and adopted by the Members of ARC IC in line with requirements laid out in the Bye-laws of the Company. It provides a framework for underwriting and risk management which ensures that ARC IC is in compliance with Bermuda regulatory requirements, the Company s internal requirements (as laid out in its Bye-laws and in Capital Contribution Agreements signed between the Company and its Class C Members) and that the Company is operating sound and sustainable insurance business practices. This Policy requires that the Company s senior executive officer ( CEO ), with support from technical advisors (including the senior executive of the appointed provider of underwriting services or officer/staff of the company with underwriting responsibilities, herein the Underwriter ), seek and obtain approval from the Company s Board of Directors ( BoD ) for the annual underwriting and risk management strategy prior to inception of the annual underwritten programme. Each annual strategy must be in compliance with this Policy, and will include (at least) the details of risk characterisation for the insurance policies to be issued, rationale for primary policy pricing, analysis of options for risk management, and recommended risk retention/transfer strategy with suitable justification. At the first meeting of Members of the Company after approval of the underwriting and risk management strategy, the strategy must be presented to the Members of the Company for information. 4.1 Introduction Purpose The purpose of this Policy is to establish the principles and the procedures that must be applied by ARC IC s Underwriter for the assessment and underwriting of inward business and the management of its outward risk transfer in order to develop and maintain a book of business in line with ARC IC s business objectives and in compliance with its regulatory and legal requirements. The Policy contains the high level rules and procedures adopted by ARC IC in the management of its underwriting and risk management operations. It is also intended to provide the framework within which the BoD and the Company s executive and technical staff must operate. The management and staff of ARC IC are expected to be fully conversant with its contents and to apply the policies contained herein. This Policy is effective from its date of adoption by the Members of ARC IC. 8

14 4.1.2 Confidentiality This Policy will be made available to the BoD and any Officers of the Company, the Underwriter (and/or other relevant technical member of ARC IC s staff), the Insurance Manager, and the Loss Reserve Specialist (and/or any other external actuarial function which the Company may utilise) of ARC IC. It contains confidential information and the distribution of this Policy will be controlled and authorised by the BoD. No parts of the contents of this Policy can be made available to any persons outside the organisation without the approval of the BoD. However, this restriction is not applicable to the Bermuda Monetary Authority ( BMA ), legal advisors, auditors and other persons to whom the company is obliged to disclose the information by virtue of law or in accordance with the Bye-laws of ARC IC and any restrictions are subject to the Company s Transparency Policy if not explicitly excluded therein Revisions and Updates This Policy is a statement of ARC IC s current rules and procedures. The Policy will be reviewed regularly to allow for changes in internal and external factors, ARC IC s own needs, and the circumstances prevailing in ARC IC s territory of operation. Any change request can be initiated by the BoD or by any Member of ARC IC. Non-material (e.g. clarification, language) changes have to be approved by the BoD. Material changes must be approved by the Members of ARC IC in accordance with the Bye-laws Underwriting Authority The BoD may authorise the Underwriter to accept inward insurance business on behalf of ARC IC only after approval of an annual underwriting and risk management strategy. The BoD can delegate underwriting authority to the CEO of the Company (if such officer is appointed by BoD), the senior executive of the appointed provider of underwriting services (or specific staff member if one is appointed by ARC IC), (c) the Insurance Manager or (d) a sub-committee of the BoD ( Underwriting Committee ). The Underwriting Committee of the BoD shall consist of three members of the BoD as voting members and the CEO and Underwriter (if not the senior executive) as non-voting members. The Insurance Manager shall be a second non-voting member of the Underwriting Committee should the CEO and Underwriter be represented by the same individual, and the Insurance Manager shall provide Secretariat services to the Underwriting Committee. Underwriting decisions always have to be made by unanimous consent of the Underwriting Committee. The members of the Underwriting Committee will be elected by the BoD. All underwriting decisions have to be documented in writing Statutory and Legal Requirements As a Class 2 licensed insurer in Bermuda, stipulations by the BMA for regulatory purposes in the area of underwriting and risk management are relatively modest. The following is the list of specific requirements that ARC IC must meet to maintain its insurance license: Minimum Solvency Margin - Statutory capital & surplus must exceed the greater of: o i) Minimum Capital & Surplus of USD 250,000 9

15 o ii) Premium Test, 20% of first USD 6 million NPW and 10% of excess of USD 6 m NPW o iii) Loss Reserves Test (not reserves) of 10% Minimum individual reinsurer financial strength rating (AM Best A- or equivalent) Approval for deviations from Business Plan Statutory reporting and meeting of liquidity ratio (assets >=75% of liabilities) Triennial Loss Reserve Specialist opinion. Of course ARC IC must always comply with Bermuda law and any general regulations applicable to the transacting of insurance business, and all underwriting and risk management/transfer activities undertaken by ARC IC must comply with all relevant law. ARC IC has a further specific stipulation in its Bye-laws that it must achieve an Enhanced Capital Ratio ( ECR ) of 150% based on a monthly calculation of solvency in the Bermuda Solvency Capital Requirement ( BSCR ) model. The relevant BMA regulations applicable to ARC IC under both BMA and internal Bye-law requirements are provided in Annexe 4A. 4.2 Underwriting and Risk Management Strategy Development and Implementation This chapter briefly outlines the overall financial strategy for ARC IC as a sustainable mutual insurance company meeting the needs of and ultimately owned by its African Member countries, supporting the overall development goals of the African Risk Capacity Specialised Agency of the African Union ( ARC Agency ) and supported by the global private risk transfer markets where appropriate. It therefore sets the scene for the two subsequent chapters of this Policy, the taking on of risk by ARC IC and the management of that risk. The following section briefly describes the key underpinning elements of catastrophe insurance which dictate the key components of the financing strategy for ARC IC. Insurance in general is the formal sharing of risk between a number of participants such that the financial consequences of an unanticipated event can be spread over time so that the financial burden can be more easily borne by the affected individual(s). If the unanticipated event occurs randomly amongst the members of the pool (i.e. their risk is poorly correlated), which in general is more likely the larger the number of participants in the pool, then the insurance mechanism becomes more efficient from a financial perspective. Take, for example, a pool of 10 risks, each of which has a loss of $10 once every 10 years. The average annual loss ( AAL, the total aggregate loss divided by the number of years over which the losses occurred) of each member of the pool is $1 and the total AAL of the pool is $10. The coefficient of variability ( CoV, the standard deviation of annual loss divided by AAL) for each individual risk in the pool is As the risks become less correlated, the CoV trends towards and can eventually reach 0 (if a different risk gets a $10 loss in each of the 10 years); this lowering of the CoV between the individual and the pool is indicative of the value of an insurance mechanism. 10

16 While many lines of insurance business operate based on the above-described principle, one line in particular, catastrophe insurance, cannot, because it insures against risks which can affect many people simultaneously (known as covariant risk). Natural disasters are the major source of catastrophe risk; lack of rainfall leading to drought can affect many villages, many regions and even many countries simultaneously. An insurance company with clients in one particular affected region will suddenly be faced with losses to most or all of its clients. Going back to the example above, if each risk in the pool is fully correlated with each of the other risks, then the CoV of the pool is the same as for each individual risk, Thus the pool is no more efficient than each individual in the pool. This leads to a critical element of catastrophe insurance risk financing: while the average annual loss of a portfolio of risk is the sum of the AAL of the individual elements of that portfolio, the standard deviation, or volatility, of the losses will decrease as the diversification of the portfolio increases. In pricing insurance (and in addition to recovering operating costs), an insurer needs to recoup the AAL (pure premium) and charge a cost for assigning capital to cover larger-than-expected loss in any given year. The latter cost may be assigned based on the CoV of the portfolio (or some other metric related to CoV, such as the portfolio loss at a given return period), and a welldiversified portfolio with a low CoV brings optimal efficiency as the total premium collected each year (if charged at pure premium) is at or close to the total loss paid out in even the worst year. For catastrophe risk, then, an insurer must seek either to diversify geographically (so that not all of its insureds are affected by the same natural catastrophe event), hold large liquid reserves (which cannot therefore be used to generate a substantial return via long-term investment) or will require reinsurance (insurance for insurers), which will boost claims-paying capacity when needed. (The reinsurance business model is a global one; reinsurers diversify risk geographically across the world so that the overall correlation within the portfolio is lowered). Drought risk in sub-saharan Africa is catastrophic from an insurance perspective, and therefore the principles briefly highlighted above are key to developing an overall concept for ARC IC s financing strategy. Two factors are, however, somewhat unusual in ARC IC s case, and both are important in considering the financing strategy: ARC IC itself, being a highly specialised entity offering sovereign parametric drought insurance, cannot diversify geographically or by peril (notwithstanding potential future expansion to, say, flood coverage), so it must manage its exposure through use of its own assets and reinsurance. ARC IC is a mutual insurer, and therefore underwriting practices and pricing will be geared towards providing best value to its members which effectively means offering the lowest premium pricing possible for the broadest coverage. As a mutual, ARC IC has no need to make a profit or pay dividends; however, some capital growth and, most importantly, capital preservation is fundamental to long-term sustainability and to the ability to meet obligations to Class C Members after 20 years. These basic principles, and the particular characteristics of ARC IC, are further developed in the following chapters detailing, respectively, the underwriting and risk management processes that ARC IC will follow. 11

17 4.3 Insurance Underwriting, Drought Policies This chapter outlines the overall methodology for underwriting of inward parametric drought insurance. Additional underwriting chapters will be developed for other perils that may be underwritten in the future by ARC IC. As a mutual insurance company serving sovereign government Members, insurance underwriting is relatively straightforward and much of the process can be captured in this highlevel Policy. However, some operational underwriting decisions will be required to be made by the Company s underwriting team and approved as outlined above by the BoD on an annual basis and prior to actual issuance of insurance policies. Under no circumstances are ex gratia payments to be made under or related to any insurance contract issued by ARC IC, and no clause in any insurance policy wording may imply that ex gratia payments can be made Availability of Coverage ARC IC insurance products are available to African states that are (or will become on policy inception) Class A Members of ARC IC. In order to qualify for Membership and in order to have a policy issued, countries will require a valid and in-force Certificate of Good Standing ( CGS ) granted by the ARC Agency Governing Board ( ARC GB ) under powers conferred upon ARC GB by the Conference of the Parties ( ARC CoP ) to ARC Agency member states that have contingency plans approved by the ARC GB, and that have otherwise completed the necessary planning and capacity building activities and customisation of Africa RiskView ( ARV ). ARC IC will require a top copy (or suitably validated electronic copy) of a valid CGS on file prior to issuance of a Policy to any country Type of Insurance Cover ARC IC will initially offer a parametric (index-based) drought insurance product based on the ARV model to member countries of ARC. In the future, ARC IC may offer other insurance products for the protection against natural perils like floods or storms in accordance with the bye-laws of ARC IC; such additional perils will require a separate commentary on insurance underwriting. Africa RiskView is the underpinning modelling tool for ARC IC s parametric sovereign drought product. Annexe 4B provides further information on ARV. Where necessary, ARC IC must document that it has a valid license for ARV in the annual underwriting and risk management submission approved by the BoD. For the drought cover, the insurance contract period is initially limited to risk periods commencing within a single year and can be renewed on an annual basis. Policy inception will be 1 May for all drought policies, and the annual policy will cover growing seasons which start within the policy year. Due to the rolling nature of growing seasons across Africa, ARC IC will be in a position that it will be incepting a new policy for some countries while the old policy is still on 12

18 risk for a growing season which is ongoing on 1 May. For clarification, the risk will not roll over to the new policy but remains with the old policy until such time as the growing season ends and the appropriate calculations have been made. At that time, and once any eligible payouts have been made, the obligations of ARC IC will be discharged for that policy (and, for the last growing season end date in each annual portfolio, for the full portfolio of policy obligations.) Each policy issued by ARC IC will cover a single growing season in a single country. Countries with multiple growing seasons can purchase policies for each of its growing seasons in any one annual policy issuance cycle, and dual season coverage (to allow for back-to-back droughts potentially having a more significant impact than the sum of the two individual droughts) may also be considered for underwriting by ARC IC. A sample sovereign parametric drought policy is provided as Annexe 4C to this Policy. Annexe 4C should be reviewed annually and any changes to wording submitted as part of the BoDapproved underwriting and risk management strategy. All policies will be denominated in United States Dollars ( USD ) and all premiums and payouts will be transacted only in USD. Any reference to financial values in this Policy is to USD except if explicitly stated differently. Capitalised terms where not defined in this Policy are defined in the insurance policy itself Country-specific Underwriting Parameters Parametric insurance allows easily for the selection of coverage criteria by the policy-holder. This section outlines the nature of those choices and the limits to each choice which should be considered by ARC IC as prudent from an underwriting perspective. All limits to country choices must be applied equally to all participating countries unless otherwise approved by the Members of ARC IC. a) Attachment Point The Attachment Point can be described as the minimum severity of a drought event loss which gives rise to payment and therefore is the loss value at which a policy is triggered. It hence functions like a deductible in a standard insurance policy, with the insured country retaining the amount of risk below the Attachment Point for any event. Payouts are only made on the policy when the estimated loss (according to the ARV model) for a drought event in a covered country exceeds the Attachment Point specified in the insurance policy. ARC IC considers that a minimum Attachment Point at the 1 in 5 year loss level (equivalent to an exceedance probability of 20% in any one year, as measured relative to the historical parametric response cost event set and as measured for the single growing season covered by the insurance policy) OR a maximum rate on line ( RoL, the premium divided by the Coverage Limit) of 20% is most appropriate for this form of parametric sovereign drought coverage. While the above Attachment Point levels are a stated target, the BoD may approve Attachment Points for individual countries/growing seasons outside of this guidance as part of its approval of the annual underwriting and risk management strategy and once appropriately justified and recommended by the Underwriter. 13

19 In all cases, the Attachment Point level will be translated into an equivalent monetary dollar amount which that return period represents in the country s historical risk profile, and the Attachment Point is provided on the Schedule to the insurance policy. b) Exhaustion Point The Exhaustion Point is the drought event loss level at which the maximum payout under the policy is paid. Any drought loss events more severe than the Exhaustion Point loss have a payout of the Aggregate Limit of the policy. While no specific limitations on selection of the Exhaustion Point are provided by ARC IC, the Exhaustion Point must not be higher than the maximum drought loss possible in ARV for that country and growing season. Furthermore, the Exhaustion Point selection (in conjunction, where necessary, with the Attachment Point selection) cannot be such that the Ceding Percentage (see below) is greater than 100%. In all cases, the Exhaustion Point level will be translated into an equivalent monetary dollar amount which that return period represents in the country s historical risk profile, and the Exhaustion Point is provided on the Schedule to the insurance policy. c) Aggregate Limit The Aggregate Limit is the maximum amount that can be paid out under the insurance contract in any one policy period. This Aggregate Limit applies to the full term of the contract; the total amount paid out under the contract during the one-year period cannot under any circumstances exceed the Aggregate Limit. Given that the ARC IC drought policies are single growing season only, the Aggregate Limit is also the event limit. Initially, ARC IC will cap the Aggregate Limit of each policy at USD 30,000,000. A number of factors have been taken into account in setting this cap, including ARC IC s lack of financial capacity to underwrite uncapped per-policy limits initially, and insured countries ability to successfully deploy large sums within approved contingency and final implementation plans. USD 30 million is the cap on disbursements from the UN Central Emergency Response Fund to UN agencies for an individual country/event, which is considered an appropriate benchmark for ARC IC. The Aggregate Limit is provided on the Schedule to the insurance policy. Any increase of per policy Aggregate Limit provided to participating countries has to be unanimously approved by the Board of Directors of ARC IC. d) Ceding Percentage The Ceding Percentage is the share of the losses between the Attachment and Exhaustion points which is ceded to ARC IC, the remainder being retained by the insured country. Ceding Percentage is calculated as [Aggregate Limit / (Exhaustion Point - Attachment Point)] and cannot be greater than 100%. The Ceding Percentage is provided on the Schedule to the insurance policy. 14

20 4.3.4 Premiums ARC IC will need to collect enough premiums each year to cover: Average Annual (or expected) Loss (AAL or EL), which is the average loss expected in a single year from the policies in the portfolio of underwritten risk. In relative terms, this is the largest component in insurance pricing. Costs associated with maintaining sufficient claims-paying capacity to pay large losses to multiple clients in any one year. These costs mainly relate to the cost of reinsurance and the cost of building and holding capital reserves. This element of the premium may be referred to as the catastrophe or capital load. Costs related to operations, research and development and any other costs of doing business. Insured countries should pay the annual insurance premium in advance in a single instalment on or prior to the policy issuance date (or at some fixed date prior to inception if so-stated by ARC IC). If inception is allowed prior to full premium payment being received, the insurance policy must state the time period after policy inception within which ARC IC must receive the insurance premium; if the premium is not paid within that time period the insurance contract will be deemed void ab initio and ARC IC shall have no obligation whatsoever to the subject country under the insurance contract. a) General Pricing Considerations Premiums will be fixed annually and pricing will be risk-based, meaning that the premium cost will be a function of the expected loss (EL) for the contract and possibly (but not necessarily) the standard deviation of the EL (or some other measure of the volatility of loss on the contract). ARC IC must utilise the same pricing metric for every country taking out an insurance policy for the same peril in that policy year, and that pricing metric must form part of the documentation of the annual underwriting and risk management strategy approved by the BoD and provided to all Members. ARC IC is a mutual insurance company and initially no return on capital has to be achieved and hence no profit margins have to be priced when providing insurance cover. From the policyholder s perspective, the goal of ARC IC is to provide the lowest-possible cost of insurance while simultaneously having the ability to select the coverage they want from a broad range of options. On the other hand, the goal to provide the lowest-possible cost of insurance needs to be carefully balanced with the need to protect the Class C returnable equity and build the reserves of ARC IC over the 20-year commitment period of Class C Members. ARC IC s capital provided by donors cannot be easily replenished following a large loss and hence ARC IC should not expose all of its assets at any one time. Being able to deploy its own capital alongside reinsurance is critical in accessing the global reinsurance market in a cost efficient way. Furthermore, holding back capital to deploy in a year following large losses is advantageous for long-term survivability. Thus building and holding reserves provides many benefits, including a lower likelihood for the need to raise premiums after a high claims year, and greater flexibility in buying reinsurance capacity. 15

21 A final relevant requirement of ARC IC s premium pricing is the meeting of the Enhanced Capital Ratio requirement in the Company Bye-laws. As this is an absolute requirement, annual premium pricing must reflect this capital reserve requirement (along with the risk management strategy.) Further details of the Dynamic Financial Analysis ( DFA ) modelling required for successful risk management is provide in the following chapter; the DFA platform is used inter alia to identify the optimal premium pricing each year Use of ARV in Underwriting Average Annual or Expected Loss on a country level is estimated within and defined by the outputs from Africa RiskView. Underwriting (including setting of policy conditions and pricing of contracts) must be undertaken using the exact same version of ARV as is to be used for calculating parametric losses and settling contracts. Prior to the locking of a version of ARV for use in a forthcoming policy year, all countries wishing to purchase policies in that forthcoming policy year must have completed and signed off on any country-specific customisations of ARV required such that it provides an acceptable view of drought risk in that country. Further details on customisation of ARV are provided in Annexe 4B. For the locked version of ARV in any policy year (that is, the exact version of the software which will be used for settling policies in that policy year), the full historical response cost event set must be produced in advance and form part of the annual submission of the underwriting and risk management strategy for BoD approval. Selection of coverage options by each country wishing to purchase a policy should be made based on the historical response cost event set from the locked version of ARV, and pricing of policies by ARC IC must be based on the same dataset. Any simulation of losses for use in risk management strategy planning for that forthcoming policy year must also be underpinned by the same historical loss dataset. Some parts of the ARV calculations in certain circumstances require historical rainfall data from the preceding up to 30 years for setting internal benchmarks and for missing data filling. The necessary historical rainfall dataset must be utilised within the relevant locked version of ARV and this historical rainfall dataset forms part of the insurance policy documentation. Historical datasets are updated after the end of each calendar year (once the full year of rainfall data is available) and, given that the policy year spans parts of two calendar years, the historical rainfall dataset required to calculate and fix certain variables in the locked version of ARV being used to calculate parametric losses in that policy year must be updated while coverage is in force. Such updating must be completed as soon as practical after the end of the calendar year, and the new historical rainfall dataset must be appended to each in-force insurance policy as well as being made available to the BoD and Members as an addendum to that policy year s underwriting and risk management strategy. It is noted that such updating may alter the historical response cost series, which in turn is the basis for pricing the coverage; there is thus particular pricing uncertainty for policies where the covered growing season starts in a subsequent calendar year to policy inception. 16

22 4.3.6 Policy Wording Wording of the insurance policy, including all technical Exhibits, must be reviewed as part of the underwriting process, and any changes presented to the BoD for approval as part of the annual submission of an underwriting and risk management strategy. It is not envisaged that significant changes to policy wording will be required year-on-year; however, any changes to the ARV software to be used for calculating losses must be fully reflected in the policy wording, and updated databases of historical response costs and historical rainfall must be included. 4.4 Capital Preservation, Risk Retention and Risk Transfer Introduction Even though ARC IC can, to a limited extent, reduce underwriting risk by diversification within Africa, very significant residual risk remains in the correlation of severe droughts across multiple countries. A lack of rainfall leading to drought can affect many villages, many regions and even many countries simultaneously. ARC IC as an insurance company with many potential insured countries in one affected region can suddenly be faced with losses to many of its clients at the same time (known as covariant risk). Initially, ARC IC itself cannot sufficiently diversify geographically or by peril, so it must manage its exposure to the low probability high loss events through the use of its own capital plus reinsurance Capital Preservation As part of the annual underwriting and risk management strategy development process, the Underwriter, together with relevant technical staff or consultants to the Company, will develop a risk management strategy which must be based on financial modelling techniques generally embedded in a Dynamic Financial Analysis model. Such techniques should include both probabilistic and scenario approaches to the assessment of risk. ARC IC has developed a DFA model which has been independently reviewed by two separate actuarial experts and deemed fit for purpose. An operational version of this DFA will be used by the Underwriter to establish the level of portfolio risk being taken on by ARC IC given individual insurance policy coverage parameters, and to find the optimal balance between risk retention and risk transfer within the context of achieving the necessary capital adequacy while minimising premium costs to insured countries. In addition to the insurance portfolio to be underwritten, available risk capital and reinsurance pricing are the two key input variables. Other inputs such as investment return and operational costs are also included in the analysis. As previously stated, within ARC IC s Bye-laws is a requirement to remain financially sustainable, with such sustainability defined as achieving 150% Enhanced Capital Ratio based on a monthly calculation of solvency in the Bermuda Solvency Capital Requirement model. The Insurance Manager has responsibility for completing and reporting on the ECR each month, and must provide input to the risk management strategy development process to ensure that the recommended strategy enables ARC IC to meet its ECR requirement throughout the year in question. 17

23 This having been said, ARC IC is a mutual insurance company committed to long-term sustainability for its African Members and committed also to repayment of Class C returnable equity investments before or at the end of the committed term. In this regard, its risk management strategy should look well beyond the minimal benchmark of meeting the ECR requirement on a month-to-month (and therefore year-to-year) basis. While not established as an absolute requirement, ARC IC should seek to achieve claims-paying capacity equivalent to a 1 in 250 year portfolio loss across a forward-looking 5 year window. Given ARC IC s particular status within the public-private nexus, raising of capital to boost reserves is likely to be a challenging and time-consuming task should it be required after a series of high loss events. To allow some time for raising capital, ARC IC should limit its retention (of risk up to the 250-year benchmark portfolio loss) to 35% of its total assets (so that it can fund at least one full year of the same retention and still allow portfolio expansion) and must not exceed a risk retention of 50% of assets without specific authority from the Members of the Company Risk Transfer Within the constraints outlined above, the Underwriter, working with the reinsurance broker and other technical specialists within or consulting for the Company, will test various risk transfer strategies to identify the most cost-effective in both the short term and the medium term. Although the annual risk-adjusted cost of reinsurance will be the primary driver of the cost efficiency calculation, medium-term considerations taking account of reinsurance pricing cycles, business relationships and secondary contributions of risk transfer partners to ARC s overall development aims can also be taken into account as appropriate. The parametric nature of ARC IC s drought policy allows for relatively easy access to both traditional reinsurance and capital markets, and the Underwriter and broker should explore, within reason, the full range of risk transfer options available while developing the annual risk transfer strategy. Except in exceptional circumstances, risk transfer from ARC IC to the reinsurance markets should be on a portfolio basis so that ARC IC is capturing diversification benefits. As part of the annual underwriting and risk management strategy, a risk transfer structure should be presented to the BoD for approval, and said approval should allow some flexibility to the Underwriting Committee (or other authorised person) in securing the final reinsurance terms. a) Reinsurance Contracts Reinsurance coverage (which here includes derivative and other forms of alternative risk transfer) should always be contracted such that there is no basis risk on ARC IC between its inward insurance policy (and potential losses) and reinsurance recoverable amounts (subject to stated retentions and any layering and upper limits in the reinsurance programme). This must include any currency risk, which is best managed through USD-only reinsurance contracts. The term of the reinsurance coverage must mirror the full term of the underlying policies, including those which having a growing season extending beyond the end of the policy year. Appropriate Special Termination Clauses should be included in reinsurance contracts, and no exclusions should be allowed in reinsurance contracts unless they are also in place in the 18