Indemnity based Nat Cat insurance covers for sovereign risks Example: FONDEN, Mexico

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1 Indemnity based Nat Cat insurance covers for sovereign risks Example: FONDEN, Mexico Workshop World Bank / Munich Re Washington: 23 April 2013 Dott. Ing. Paolo Bussolera Head of Claims - Europe and Latin America

2 Indemnity based Nat Cat insurance covers for sovereign risks Example: FONDEN, Mexico FONDEN = Fondo de Desastres Naturales The Mexican Natural Disaster Fund is a financial instrument within the National Civil Protection System whose purpose is to help the Mexican public authorities to deal with and to recover from the adverse effects of natural catastrophes, whose magnitudes exceed the financial capacity of federal institutions, state agencies and public bodies. 1:

3 FONDEN, Mexico: History of the insurance program 2006: The world s first government catastrophe (Cat) bond with a parametric trigger. 2009: Multi-peril Cat bond which covers hurricane and earthquake risk in specific regions and has a parametric trigger. Renewed in : Excess of loss insurance coverage for costs arising from the reconstruction of public assets and low income housing after natural catastrophes. MXP 4.5 billion (ca. US$ 400 million) in excess of MXP 12.5 billion (ca. US$ 1 billion) in the annual aggregate. Lead reinsurer Munich Re. 2012: Excess of loss Cat Insurance coverage is renewed for MXP 5.5 billion in excess of MXP 12.5 billion in the annual aggregate. 3

4 FONDEN Cat Insurance Program: Assets and sums insured Assets insured: more than 136,000 kilometres of roads (sector SCT); more than 7,000 bridges (SCT); more than 200,000 schools (SEP); more than 16,000 hospitals (SS); more than 200,000 low incomes houses (SEDESOL); 4,000 water distribution installation and infrastructure points (CNA). Sums insured: more than US$245 billion 4

5 FONDEN Cat Insurance Program: Risks insured and disaster declarations Risks insured: Avalanche, volcanic eruption, collapse, seaquake, landslide, tsunami, earthquake, subsidence, severe hailstorm, hurricane, rainwater flood, river flood, severe rain, severe snow, severe draught, tropical storm, tornado, forest fire and other natural hazards Declaration of Disaster: The Damage Assessment Committee (CED), a Civil Protection Committee, meets after the occurrence of a Destructive Natural Phenomenon and issues a Natural Disaster Declaration which allows the Federal entities to access FONDEN's resources. 5

6 FONDEN Cat Insurance Program: Excess of loss layers structure From June 10 th, 2012 to June 10 th, 2013 Lead Reinsurer: Munich Re MXP 5,500mio MXP 18,000 Mio MXP 12,500 Mio AAD = FONDEN s retention AAD = Annual Aggregate Deductible FGU But sub-limited Others different than SEDESOL SEP CNA SS SCT SEDESOL FGU Underlying insurance policies 16/04/2013 6

7 FONDEN Cat Insurance Program: Structure Geo-referenced database with all the locations of the assets insured Database with Cat Loss statistics Seismic / meteorological models for assessing the exposure to natural catastrophes and for calculating the premium (models available at Munich Re). Insurer: Agroasemex (owned by the Mexican Federal State). Consortium of brokers to manage the placement of the cover on the international reinsurance market. Munich Re as the lead reinsurer directly involved in calculating the premium and in structuring the program, including the claims management processes. Claims protocol (the heart of the insurance program). 7

8 FONDEN Cat Insurance Program: Claims protocol Characteristics of the program: Indemnity based insurance programme, providing compensation for damage actually incurred. Challenges: Most possible detailed evaluation of thousands of claims incurred as a result of a high number of natural disasters Need to control the erosion of the AAD as well as of the excess layer Availability of a sufficient number of qualified loss adjusters Effective criteria for the performance of loss site inspection and the evaluation of damage. 8

9 FONDEN Cat Insurance Program: Claims protocol Role of Munich Re in the definition of the loss adjusting processes Loss adjusters: Establishment of a consortium of loss adjusters: A lead adjuster responsible for the coordination of the consortium and the issue of summary periodical reports Other teams of adjusters according to their specialities, for example experts in adjusting road claims supported by professional quantity surveyors. Inspections of claims and adjusters' reports: Establishment of form and structure of adjusters' reports Definition of the ways of collaboration between FONDEN's Damage Assessment Committee and the adjusters Agreement on deadlines for the performance of inspections and the issue of official reports in order to comply with FONDEN's rules and objectives. 9

10 FONDEN Cat Insurance Program: Claims protocol Methodology of the adjusting process Verification of weather / seismic station readings to cross check whether the conditions for a Natural Disaster Declaration are fulfilled Use of standard formats for surveys and reports Verification of the sums insured agreed in the policy Comparison of own evaluations with the claims notifications presented to FONDEN Loss site inspections in conjunction with government agency personnel in order to reconcile the amount of damage in the field Exclusion of betterments and of repairs to pre-existing damage. 10

11 FONDEN Cat Insurance Program: Claims protocol Exclusion of pre-existing damage and betterments The quantification of insured losses excludes pre-existing damage. Upgrading or betterments of the existing infrastructure after natural catastrophes are also to be excluded. Example: roads Loss event damage Photos copyright: Quorum International, Mexico Pre-existing damage 11

12 FONDEN Cat Insurance Program: Claims protocol Lessons learned from the program Very high number of Cat events: It was a challenge to manage all of them and to deal with all parties involved. The basis of calculation of sums insured was unclear, whereas the indemnifications had to be evaluated on the basis of replacement costs. Necessity to comply with FONDEN's deadlines for compensation of the affected parties, put the loss adjusters under high time pressure. Approval of indemnifications by FONDEN not in accordance with the principles of insurance cover (i.a. inclusion of pre-existing damage and betterments). The loss adjusters had to inspect a very large number of loss sites, to assure that only indemnifiable claims were taken into account 12

13 FONDEN Cat Insurance Program, Final figures AAD erosion : Priority not exceeded 51 Cat events included hurricanes, tropical storms, floods, earthquakes, severe rains, landslides and drought. 1,370 individual claims inspected and verified in detail by the adjusting teams

14 FONDEN Cat Insurance Program: June 2012 renewal Introduction of event deductibles in order to reduce number of applicable Cat events and therefore utilize more efficiently the adjusting resources Increased number of adjusters Introduction of linear/volumetric unit prices as basis for the evaluation of sums insured as well as for claims evaluation Shortened, pre-agreed response and reporting time from the adjusters (better management of expectations) Photographic samples for easier identification of pre-existing damage. 16/04/

15 Comparison of advantages / disadvantages of Cat Insurance vs. Trigger Based Products Cat Insurance vs. Trigger Based Products Trigger Based Cat Insurance Price Volatility High Moderate Trigger of payment Parametric Value Actual Loss Incurred Speed of liquidity release High Moderate Complexity of Claims Management Very low / none High Costs of Claims Management Very low / none High Due to their lower complexity, trigger based products seem to be more advantageous than traditional Cat insurance products. So, why should a Government buy a traditional Cat Insurance product?

16 Comparison of advantages / disadvantages of Cat Insurance vs. Trigger Based Products Why should a Government buy a traditional Cat insurance product? The advantage is mainly in the management of indemnifications after the occurrence of a natural disaster. A proper assessment of the incurred claims gives transparency on their actual amount. This guarantees that the funds are not dispersed and are really spent for repairing the damage occurred. The loss adjusters and the insurers/reinsurers, that have to approve their reports, are additional guarantors of transparency on the allocation of the indemnifications. A detailed damage assessment can help the Government to reduce the own costs for the indemnification of losses within its self-retention (e.g. Annual Aggregate Deductible). 16

17 The role of Munich Re in the development of Cat Insurance products for sovereign risks Munich Re has the necessary know-how for developing Cat Insurance products for sovereign risks (parametric as well as traditional insurance solutions). Munich Re has recognized that governments do not only need financial security through insurance products. They need also a claims management infrastructure for a proper assessment of claims and for the correct distribution of the indemnifications. The capability to build-up and manage such an infrastructure is the key of success for such products. When developing innovative products like the FONDEN's insurance coverage, Munich Re advocates close collaboration between Underwriting and Claims Management. In both areas we can provide the necessary expertise and skills.

18 Would it be possible to duplicate the FONDEN Cat Insurance cover in other countries? Key success factors of the FONDEN Cat Insurance cover: Mexican risk management infrastructure particularly advanced in the areas of civil protection and insurance. Databases of geo-coded risk locations, insured values, Cat loss statistics. Conclusions: In other countries a Cat Insurance Cover would have to be adjusted to local conditions and may require a step to step development to build-up awareness for the needs of the insurance industry geo-referenced lists of asset locations, insured values Cat exposure data / Vulnerability of the insured locations Cat loss statistics. Such a process could be facilitated by a combined approach of supranational organizations like the World Bank and Munich Re. 18

19 THANK YOU FOR YOUR INTEREST! Paolo Bussolera