Earthquake Premium Reserve

FrancoisFrancois
in OSFI.MCT

Hi,

I'm quite confused about this portion of the Earthquake Reserve in capital required for insurance risk.

First off, the Earthquake Reserve that we use is :

ER = (EPR + ERC) x 1.25

EPR would be a given number, ERC needs to be calculated.

ERC = Earthquake reserve exposure - Financial Ressources

From the text, this is :

ERC = {Country-wide PML500 x (Year - 2014)/8 + MAX [East Canada PML420, West
Canada PML420] x (2022 - Year)/8} - capital and surplus - reinsurance coverage - capital
market financing - EPR

Let's assume that capital and surplus, reinsurance coverage and capital market financing all equal 0.

The equation for ER becomes :

ER = (EPR + ERX2 - EPR) x 1.25

ER = ERX2 x 1.25

If everytime the insurer has EPR as a financial ressource, it is added then substracted in the calculation of ER, why do we even bother ?

Is it because of this section of the text :

Should an earthquake occur and trigger claims, companies would establish an unpaid
claims provision as well as a provision for claims adjustment expenses. The ERC
component would be reduced after the EPR, by an amount equal to the claims reserves.

Does this mean that the EPR financial ressource is only substracted when there is an event ? If there are no event, the EPR is not "used" as a financial ressource, thus not substracted ? "The component would be reduced after the EPR, by an amount equal to the claims reserves"

Thanks a lot

The elements bolded are from the following OSFI text : http://www.osfi-bsif.gc.ca/Eng/Docs/mct2019.pdf

Comments

  • chrisboersmachrisboersma

    It probably best to not dig too deep... If you do you end up here:

    Much of the way things are broken down depend on the financial statements. It often makes more sense if you can find the lines on the P&C docs and follow along.

    The "Earthquake Premium Reserve" is booked on page 92.40 along with a "Earthquake Reserve complement", which appears similar, but could be different to the ERC defined in the MCT guidelines despite comments to the contrary:

    Insurers must refer to OSFI’s Guideline B-9 Earthquake Exposure Sound Practices for details on OSFI’s expectations relating to P&C insurers’ earthquake exposure risk management and the related definitions.

    It defined ERC as:

    earthquake reserve complement, the additional component (if necessary) of ERRO needed to achieve financial preparedness according to the formula. The ERC must always be greater than or equal to 0.

    The only thing I could find that referenced both was:
    http://grahamsegger.com/wp-content/uploads/2013/09/Tweaking-the-Earthquake-Regulations.pdf

    Suggesting ER Complement was replaced with ER Component:

    Earthquake Reserve Component (rather than Earthquake Reserve Complement as in the 1998 Guideline)

    However, the general guidelines continued to use "complement"

    It appears the financials have kept "complement" and even the Earthquake Guidelines (B-9) updated in 2013 also have ERC = "earthquake reserve complement". The financials however, do not have 1.25 x (ERC+EPR) documented anywhere.

    With:
    ERRO = EPR + ERC (as per Page 92.40).

    As per,
    http://www.osfi-bsif.gc.ca/Eng/fi-if/rg-ro/gdn-ort/gl-ld/Pages/b9_let.aspx

    Leaving me with the question:
    1. is ERComponent the same as ERComplement?
    2. Why does the B9-letter use ERRO = EPR + ERC, where as MCT uses Earthquake Reserves = (EPR+ERC) x 1.25?

    In either case, it easiest, just to memorize what they want to know:
    1. ERC = PML - capital and surplus - reinsurance coverage - capital market financing - EPR
    2. ER = (ERC + EPR) x 1.25

    Regardless, no one is using this - so all this complexity isn't that important. The exam may ask for ERC or ER, know the difference. There's no reason to add EPR only to deduct it later, but that's just how it works.

    It doesn't help that:

    The amount of earthquake reserves includes Earthquake Premium Reserve (EPR) and Earthquake Reserve Component (ERC) and is added to total capital requirements for the purposes of the MCT/BAAT as capital/margin required at the target level.

    It doesn't actually state the 1.25 figure in the text portion (but sort of implies it).

  • javidjavid

    Hi,

    Agree with @chrisboersma here. My thoughts are that while EPR does cancel out in the formula, the formula is written as the sum of those two components for a few various reasons:
    1. Each of ERC and EPR are amounts reported on the balance sheet (this is noted on pages 40 and 41 of the document you linked to), making the ER easy to calculate once you obtain these amounts from the balance sheet.
    2. On page 41, it is noted that "Should an earthquake occur and trigger claims, companies would establish an unpaid claims provision as well as a provision for claims adjustment expenses. The ERC component would be reduced after the EPR, by an amount equal to the claims reserves." On page 40, it is also noted that "Should an earthquake occur and trigger claims, companies would establish an unpaid claims provision as well as a provision for claims adjustment expenses. The EPR
    component would be reduced by an amount equal to the claims reserves." What I believe they are saying here is the following: Suppose an earthquake occurs. You will need to set up an unpaid claims provision. To support the claims reserves, use the EPR first and then the ERC.

  • FrancoisFrancois

    Thanks guys, I looked at the previous exam questions and either they mentioned that EPR = 0 or they straight up gave the Financial ressources available, so I'll try not to dig too deep like chrisboersma said.

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