Catastrophe Reinsurance, Risk Appetite and Growth
A UK mutual insurer writes £420m of household and commercial property premium. Its current catastrophe excess-of-loss programme is £60m xs £40m, with a 1-in-200-year gross loss estimated at £310m. The board's risk appetite limits the net 1-in-200 loss to £150m. Reinsurers offer an additional layer of £100m xs £100m at a rate on line of 22%. The insurer's regulatory capital surplus is £55m above its SCR, and the board wants to grow commercial property by 15%. The finance director argues the extra reinsurance is too expensive and the capital surplus is adequate; the chief underwriting officer says the current programme leaves the mutual exposed to a tail event and could constrain growth. The CEO asks for a reasoned recommendation.
1. Evaluate whether the insurer should buy the additional catastrophe layer, considering net risk appetite, capital, cost and growth.
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Calculate the net position. The current £60m xs £40m layer recovers only £60m from a £310m gross loss, leaving a £250m net loss. That is £100m above the board's £150m appetite. The proposed £100m xs £100m layer would recover a further £100m, reducing the net loss to £150m and exactly meeting the appetite. The layer costs £22m (22% of £100m). The surplus is only £55m, and a 15% growth plan will increase exposure and likely the SCR. Without the layer, the mutual is running a tail risk that could consume the surplus and constrain growth. The price is high, but it is buying protection against a 1-in-200 event, not an expected loss. Recommend buying, subject to negotiation of reinstatements, a clear event definition and collateral. Also test a lower attachment or a smaller layer if the board wants to reduce cost.
2. Explain how the purchase would affect the insurer's regulatory capital and what due diligence is needed on the reinsurer.
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Reinsurance reduces the gross underwriting risk and catastrophe charge in the SCR, but it adds counterparty default risk. The net effect on the surplus depends on the premium, the capital relief and the reinsurer's rating. Under Solvency UK the insurer must be able to demonstrate that the reinsurance contract transfers risk and that recoverables are prudently valued. Due diligence should cover the reinsurer's credit rating, jurisdiction, collateral or trust arrangements, and the contract's hours clause, event definition, exclusions and reinstatement provisions. The insurer should also check aggregate recoveries and whether the layer responds to a flood event affecting multiple policies. Document the board's risk-appetite decision and stress-test a 1-in-250 event; if the net loss still exceeds appetite, buy more or slow growth.