Catastrophe Reinsurance Program and Risk Appetite
A regional homeowners insurer has $1.2B in insured value concentrated in a single hurricane-exposed state. Its risk appetite statement says the company must survive a 1-in-250-year hurricane without needing new capital. Statutory surplus is $550M. The current reinsurance program has a $250M per-occurrence retention, a $500M first-event limit, and one reinstatement at 100% additional premium. The catastrophe model shows a 1-in-250-year gross loss of $1.1B and a 1-in-100-year gross loss of $450M. Reinsurer credit quality is A-, and 30% of the limit is collateralized. The CFO wants to buy a second-event cover because the reinstatement premium would strain liquidity. The CRO is concerned that the model underestimates demand surge and that the reinsurance recoverable is concentrated with two reinsurers. The CEO asks whether the program meets the stated appetite and what changes are needed.
1. Assess whether the current program meets the 1-in-250-year survival appetite, showing the net loss calculation.
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For the 1-in-250-year event, gross loss is $1.1B. The program retains $250M and covers 100% of the next $500M, so the reinsurance recovery is $500M. Net loss is $1.1B - $500M = $600M. Statutory surplus is $550M, so the net loss exceeds surplus by $50M before any reinstatement premium or credit-risk haircut. The program therefore does not meet the stated appetite. The 1-in-100-year event produces a gross loss of $450M, a recovery of $200M above the $250M retention, and a net loss of $250M, which is within surplus. The failure is at the tail event, not at the 1-in-100-year return period. The reinstatement premium would make the 1-in-250-year outcome worse on a liquidity basis.
2. Evaluate the CRO's concerns about model risk and counterparty concentration, and recommend risk-mitigation actions.
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The CRO's concerns are material. A catastrophe model can understate demand surge, secondary perils, and claims inflation, so the 1-in-250-year gross loss of $1.1B may be a central estimate rather than a conservative one. I would stress the model with a demand-surge load and show the net loss under a 10% to 20% gross-loss increase. Counterparty risk is also material: two A- reinsurers, only 30% collateralized, and a $500M limit mean the recovery is not risk-free. I would diversify reinsurers, require more collateral or trust arrangements, monitor concentration limits, and apply a credit haircut in the risk-appetite calculation. The program should be tested on both a gross and a collectible-recovery basis.
3. Recommend whether to buy second-event cover and how to structure the program to meet the appetite.
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Second-event cover does not solve the first-event problem. The current first-event net loss already exceeds surplus by $50M, so the priority is to increase first-event protection. To keep the net loss at or below $550M with a $250M retention, the insurer needs at least $550M of first-event limit. Increasing the limit from $500M to $600M would produce a net loss of $500M on the 1-in-250-year event, leaving a $50M cushion. Alternatively, reducing the retention to $200M and buying a $550M limit would also cap the net loss at $550M. Once first-event protection is adequate, a second-event cover can be considered for liquidity and reinstatement-premium risk, but it should be priced and modeled separately. I would not buy second-event cover as a substitute for fixing the first-event shortfall.