Reported PMLs for Canadian and Foreign insurers (Spring 2016 Q27 b.)

potatorambo

Hello,

I can't seem to wrap my head around the concept of how the PMLs should be reported for Canadian and foreigns insurers when there is exposure outside of Canada.

BattleCards says:
BoD, senior management would report PMLs to OSFI as follows:
- Canadian insurers report PMLs based on worldwide exposure
- foreign insurers report PMLs based on Canada-wide exposure

Does it simply mean that the foreign insurer (either Canadian in another country or foreign in Canada) should adjust its PML based on exposure in the said country to reflect the earthquake risk there?

Thanks!

graham

This is something that isn't very well explained in OSFI's earthquake paper.

The answer I included in the BattleCards is directly from the examiner's report, and the answer in the examiner's report is directly from Section 4 of OSFI's earthquake paper under the subsection: Exposures to Multiple Regions

Ok, here's what they're trying to say. Let's first look at part (a) of that question. In the past, PMLs have been based on the greater of the exposure in BC versus QC. Obviously, this is dumb! It will understate the true PML for the following 2 reasons:

• some insurers will have exposures in both regions (BC & QC)
• some insurers will have exposures completely outside of BC & QC

Then in part (b), they are essentially asking how this understatement can be mitigated. They don't ask the question like that, but that's really what they're getting at. In other words:

• what requirements can OSFI impose so that earthquake exposure is not understated.

The general answer is that insurers should consider all of their earthquake exposures, whether it's in Ontario, or Peru, or Japan or wherever. And that same rules hold for both Canadian and foreign insurers. That seems like an obvious and sensible thing to do, and that's the way I would have explained it if I had written the OSFI earthquake paper.

But the explanation in the paper is confusing. It almost seems backwards to say that a Canadian insurer should consider their worldwide exposure and a foreign insurer should consider only their Canadian exposure. When I first read that, I was like, huh? I had to think about it for a while before it made sense to me:

• The part about Canadian insurers considering their worldwide exposure makes sense. That just means they should consider all material earthquake exposure in their book of business wherever in the world it may occur.

• The part about the foreign insurers considering only their Canadian exposure assumes their Canadian business is "walled off" from their business elsewhere in the world. For example suppose the parent is based in China, but has a Canadian subsidiary in Winnipeg. When this Canadian subsidiary calculates their PML, they would only need to consider Canada-wide exposure. Earthquakes in China are irrelevant for the subsidiary.

So that's the way I understand it. Again, the whole point is consider all material earthquake exposures in the book of business. That's a simple concept and it applies to all insurers, both Canadian and foreign. But the way they explained it made is seem like there was some kind of fundamental difference between Canadian and foreign insurers.

potatorambo

Thanks Graham for the thorough explanation. The concept is much clearer to me now!