Evolution of Catastrophe Models at the Canadian Institute of Actuaries Seminar

1. Aon Benfield AnalyticsEvolution of Catastrophe Models Canadian Institute of Actuaries Seminar for the Appointed ActuaryToronto – 21st September, 2012

2. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

3. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

4. History of Catastrophe Models and Usage in a Canada • Risk Management Solutions (RMS) • Founded in late 1980’s • Largest catastrophe modelling firm globally • First offered Canadian earthquake model in 1991 • Currently offers the widest array of catastrophe models for Canada

5. History of Catastrophe Models and Usage in a Canada • EQECAT • Founded in early 1990’s • ranked 3rd in catastrophe modelling firms globally • Currently offers earthquake catastrophe model for Canada • First model: • scenario-based DLM • hazard module based on 1985 Geologic Survey of Canada (GSC) • Third (minor) update: • postal code revision including geographical boundaries • Platform migration • from desktop to WorldCATenterprise • Second (minor) update: • soil classification based on detailed differentiation by type • First (major) update: • stochastic with time dependence • includes fire following • hazard module based on 1996 GSC • latest science on attenuation, soils, vulnerability • Latest (major) update: • hazard module based on 2005 GSC • soil-based attenuation • updated spectral accelerations • updated vulnerability • -guidelines for regulatory (OSFI) reporting

6. History of Catastrophe Models and Usage in a Canada • AIR • Founded in 1987 • Ranked 2nd in catastrophe modelling firms globally • Currently offers earthquake and severe thunderstorm catastrophe models for Canada • First Canadian model: • Stochastic DLM for Severe Thunderstorm • Exposure data update: • EQ • Severe Thunderstorm EQ model update Severe Thunderstorm update • Introduction of EQ model: • Stochastic DLM

7. History of Catastrophe Models and Usage in a Canada • Early 1990’s: • individual risk brokers and underwriters involved in Canada’s large commercial lines segment • accumulation exposures modeled on more of a deterministic basis by 3rd party modelers and reinsurers • Mid-1990’s: • accumulation exposures modeling shifting to stochastic basis by 3rd party modelers and reinsurers • B-9 Earthquake Exposure Sound Practices (1998): • BC and QC exposures • Minimum 250-year PML increasing to 500-year by 2022 • Risk characteristics: year built, height, occupancy, construction and soil conditions • Encouragement of models versus conservative, deterministic Default Loss Estimates • 2000’s: • Industry consolidation • Increased model dependency to facilitate greater spread of risk and avoid overconcentration • Increased scepticism in model outputs due to excessive, unanticipated “model miss” (e.g. Hurricane Katrina)

8. History of Catastrophe Models and Usage in a Canada • E-18 Sound Business and Financial Practices Stress Testing (2009): • Testing the financial stability of federally regulated Canadian P & C (re)insurers under various areas of risk including accumulations exposures • Eventual May 2012 EQ stress test modeling four specific events: 2 peak (BC M9.0 & QC M7.0) and 2 non-peak • B-9 Earthquake Exposure Sound Practices (2012 revised draft): • (Re)insurers required to further develop prudent, company-specific approach in using catastrophe models and associated uncertainties including: • Scrutiny and oversight by senior management • Integrity and verification of exposure data • Sound, demonstrable knowledge of assumptions, methodologies and uncertainty in PMLs • Non-modeled exposures - contingent BI, auto PD, claims expenses, ITV, GRC, increased seismicity, blanket/coverage extensions and model miss • EQ PMLs based on EP curves on Canada-wide versus peak of BC or Quebec

9. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

10. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

11. Recent Global Cat Events: How Could They Affect Canada’s Models? M9.0 Tōhoku, Japan - March 11, 2011 M6.3 Christchurch, NZ – February 22, 2011 • Following an EQ event, modelers send teams sent to: • assess actual ground shaking versus modeled estimates • collect empirical data on physical damage to the property and infrastructure within the impacted region • to measure tsunami height estimates (if applicable) M8.8 Maule, Chile – February 27, 2010

12. Recent Global Cat Events: How Could They Affect Canada’s Models? • Lessons Learned: • Building Codes • Lower degree of damage versus magnitude • Benefit of successive improvements after subduction EQs Maule, Chile • Facts: • February 27, 2010 • Magnitude (M) 8.8 • Offshore subduction event • Depth of 35km • ~450 km ruptured along the Nazca and South American plates • Loss calibration demonstrated private-built infrastructure issues • Other Observations • Geographical concentration of highly interdependent industrial risks leading to unexpected, disproportionate time element losses • Unanticipated tsunami losses

13. Recent Global Cat Events: How Could They Affect Canada’s Models? • Lessons Learned: • Model Miss • Christchurch originally considered modest EQ hazard due to: • Extended distance from closest strike slip and subduction faults areas • Relatively firm soil that would not be subject to shallow depth events • Based on 400 years of diligent records, common understanding of Japan Trench: • to break “in part” generating maximum M7.5 to M8.4 events • required costal areas to have corresponding building codes, zoning by-laws (Fukushima nuclear plant) and tsunami sea walls for events of this scale M6.3 Christchurch, NZ – February 22, 2011 • Liquefaction • Likely combination of ill-effects on Christchurch: • Preceding (09/2010, M7.1, strike-slip) EQ increasing ground subsidence, lateral spreading and reduced thickness of the non-liquefiable crust • Higher groundwater levels (~ 800mm) versus 09/2010 event due to snow melting in the Southern Alps which recharged the Canterbury Plains • Oblique-thrust crustal event with minimal surface bulging M9.0 Tōhoku, Japan - March 11, 2011

14. Recent Global Cat Events: How Could They Affect Canada’s Models? • Lessons Learned: • Model Miss • Christchurch originally considered modest EQ hazard due to: • Extended distance from closest strike slip and subduction faults areas • Relatively firm soil that would not be subject to shallow depth events • Based on 400 years of diligent records, common understanding of Japan Trench: • to break “in part” generating maximum M7.5 to M8.4 events • required costal areas to have corresponding building codes, zoning by-laws (Fukushima nuclear plant) and tsunami sea walls for events of this scale M6.3 Christchurch, NZ – February 22, 2011 • Liquefaction • Likely combination of ill-effects on Christchurch: • Preceding (09/2010, M7.1, strike-slip) EQ increasing ground subsidence, lateral spreading and reduced thickness of the non-liquefiable crust • Higher groundwater levels (~ 800mm) versus 09/2010 event due to snow melting in the Southern Alps which recharged the Canterbury Plains • Oblique-thrust crustal event with minimal surface bulging M9.0 Tōhoku, Japan - March 11, 2011

15. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

16. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

17. Modeling Changes Going Forward - EQECAT Platform & Functionality (revision Fall 2012) • Future Generation (3G) • Multi-layered correlation matrices to dynamically assess correlation • Loss metrics to include Year Loss Tables (YLT) representing uncertainty as captured through multiple loss outcomes from each event • Output of risk aggregation/allocation by region, peril, and business unit allowing integration of catastrophe risk model uncertainty into ERM Vulnerability and Hazard • GPS Technology in Subduction Zones • Applicability in EQ models of current tracking of uplift and warping of leading edges overriding tectonic plates is currently being researched • Two of the highest strained build-ups based on continuous Japanese GPS measurement since 1995: • Epicentral region of the 2011 Tohoku EQ • East coast of Hokkaido • Canada-Specific Updates • Following complete revision in July 2011, none expected

18. Modeling Changes Going Forward - AIR Platform & Functionality (starting Fall 2012) • Next Generation Concept • Broadened as a complete enterprise platform for all segments of insurance industry • Ability to customize certain model assumptions, e.g. frequency and severity, vulnerability functions • Integration of company-specific catalogues for non-modeled perils • Blending of external models with AIR models • Cloud deployment Vulnerability and Hazard • Canada-Specific Updates (2014) • EQ • Inclusion of probabilistic liquefaction module based on high resolution soils and ground water tables • Incorporating latest scientific findings from joint USGS and GSC 2014 update of Seismic Hazard Maps • Severe Thunderstorm (likely changes) • Year-built as a new primary building feature mainly for hail and straight-line wind exposures • Inclusion secondary features for hail, i.e. “roof characteristics” and “environmental conditions” • Addition of straight-line wind/tornado secondary risk features based on modified hurricane methodology • Other • Introduction of Winter Storm and Hurricane modules

19. Modeling Changes Going Forward - RMS Platform & Functionality (transition starting in 2014) • Financial Modeling • Moving toward full ground up simulation modeling for new models • Ability to handle more complex contract types and structures • Cloud Based • Leveraging technology and cost efficiency in cloud computing • Available everywhere, all the time • Open Model Architecture • Ability to use other models within the platform • Potential to include user company’s proprietary models, customized vulnerability curves or other available models Vulnerability and Hazard • Canada-Specific Updates • EQ module to include latest scientific findings from joint U.S. Geological Survey (USGS) and Geological Survey of Canada (GSC) update of Seismic Hazard Maps in 2014 • Update to liquefaction module to be incorporated in the next update • Possible update of time element vulnerability in the next update

20. Modeling Changes Going Forward – Other Considerations • Canada-Specific Eventualities • New understanding of attenuation in stable continental regions resulting in refined definition of earthquake source zones, particularly in eastern Canada • Refined modeling of fire following exposure and vulnerability to account for mitigation efforts such as the retrofit of the aerial transformers throughout downtown Vancouver • Globally • AIR, RMS, Swiss Re and Munich Re currently researching tsunami models for Japan • Swiss Re currently exploring to revise global proprietary models to include contingent business interruption and diminish model miss from super cat events

21. Contents • History of Catastrophe Models and Usage in a Canada • Recent Global Cat Events: How Could These Influence Canada’s Models? • Modeling Changes Going Forward

22. Contents Questions?

23. Contents Thank You!