OSFI.Eqk

Reading: “Earthquake Exposure Sound Practices,” Guideline B-9

Authour: Office of the Superintendent of Financial Institutions Canada (OSFI)

Forum

BA Quick-Summary: OSFI Earthquake Managing earthquake risk includes data management, PML estimation practices, understanding the model and Senior Management overseeing and ensuring effective implementation. Insurers should use robust earthquake models that account for uncertainty and model limitations. Regular validation and data quality checks are essential to maintain accurate PML estimates and effective risk management. Insurers must maintain adequate financial resources (e.g., capital, reinsurance) and contingency plans to support long-term solvency and regulatory compliance in the event of a major earthquake.

Pop Quiz

Today's Pop Quiz is really from OSFI's MCT reading, but it relates to calculating earthquake reserves. Do you remember how to do it???!!! (I'll give you an easy one!)

Question: If the modeled ERX (Earthquake Risk Exposure) with phase-in is 135,919, and the financial resources are currently 60,000, calculate ERC (Earthquake Reserve Component).

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• key principles of earthquake risk management (analyzing SCENARIOS for improvements to earthquake risk management)
• best practices for earthquake modeling [Hint: DAQKD-UP]
• financial resources supporting earthquake risk [Hint: CREC-it]
• non-modeled exposures that may impact PML (Probable Maximum Loss) calculation
• data testing, model validation, version management

Top Questions ← Questions you absolutely need to know!

Questions held out from Fall 2019 exam: #17. (Skip these now to have a fresh exam to practice on later. For links to these questions, see Exam Summaries.)

reference	part (a)	part (b)	part (c)	part (d)
E (2019.Spring #18)	OSFI.MCT	OSFI.MCT	BCAR.Cat	key principles: - eqk risk management
E (2018.Fall #19)	OSFI.MCT	key principles: - eqk risk management
E (2018.Spring #17)	see OSFI.MCT	eqk modeling: DAQKD-UP - best practices	PML: CREC-it - financial resources
E (2017.Fall #18)	see OSFI.MCT	key principles: - PML (probable max loss)
E (2017.Spring #17)	SCENARIO: - improve eqk risk management
E (2016.Fall #17)	see OSFI.MCT	eqk modeling: DAQKD-UP - best practices	PML: - non-modeled exposures
E (2016.Spring #17)	eqk data: - testing	eqk modeling: DAQKD-UP - best practices	PML: - non-modeled exposures
E (2016.Spring #27)	PML: - multi-region exposures (BC,QC)	PML: - reporting (Cdn v Foreign) 1
E (2015.Fall #16)	PML: CREC-it - financial resources	key principles: - eqk risk management
E (2015.Spring #18)	model version & validation: - sound practices	PML: - non-modeled exposures	PML: - financial resources RESTRICTIONS
E (2014.Fall #15)	eqk modeling: DAQKD-UP - best practices	key principles: - PML (probable maxiumum loss)	PML: CREC-it - financial resources
E (2014.Spring #16)	SCENARIO: - risk management failures	SCENARIO: - improve eqk risk management	PML: CREC-it - financial resources
E (2013.Fall #33)	key principles: - eqk risk management

¹ The answer in the examiner's report isn't clear. Check the forum for a better answer.

In Plain English!

Exam Hack

• Focus on Section 2: Key Principles
• Don't spend too much time on Sections 1,3,4,5. (There are BattleCards for these sections after you've thoroughly learned Section 2.)
• Observation: You may have noticed prior exam problems that ask you to calculate earthquake reserves. Those problems are actually from the insurance risk section of OSFI.MCT, Section 4.5.1

Section 1 & 5: Purpose, Scope, Terms

Just a few basic facts. It's pretty easy.

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Section 2: Key Principles for Managing Earthquake Exposure

You can see from the BattleCards that this section is heavily tested. These are easy points to get on the exam if you take the time to memorize the details. (According to the examiner's reports, most candidates don't learn the earthquake facts thoroughly enough.)

Question: describe the 5 key principles for managing earthquake exposure.

1. Risk Management:
   • earthquake exposure risk management policies are overseen by Senior Management
2. Data Management:
   • data required is MORE than for traditional ratemaking (attention to consistency, accuracy, completeness due to uncertainty in earthquake exposure management)
   • must address data Integrity, Verification, Limitations (IVL)
3. Models:
   • understand (assumptions, methods, limitations) of earthquake models
4. PML: (Probable MAXIMUM Loss)
   • PML = Total Expected Ultimate Cost
   • includes considerations for data quality, non-modeled exposure, model uncertainty, multi-region exposure
5. Financial Resources & Contingency Plan:
   • Financial Resources: quantification of how financial resources cover PML
   • Contingency Plan: how to continue efficient business operations after disaster

These principles have been asked on (2015.Fall #16c), (2013.Fall #33). Note that they don't always ask for all 5 principles, but you should learn all 5 anyway. (All 5 principles have further details that are covered in the BattleCards.)

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Principle 3: Models

Question: what are the best practices for earthquake modeling [Hint: DAQKD-UP]

• This is heavily tested: (2016.Fall #17b), (2016.Spring #17b), (2014.Fall #15a)
• The hint is pronounced Dacked-Up) (It's rude, but it sounds like F**KED-UP, which is what earthquakes do. They f**k you up. Now you'll never forget it!)

Abbreviation	Meaning	Best Practice
D	Docs	document use of model within risk management program
A	Alternatives	explain why a particular model is used versus alternatives
Q	Qualified	qualified staff needed to run in-house models regularly
K	Knowledge	AML (i.e. must have KNOWLEDGE of Assumptions, Methods, Limitations of Model)
D	Data	provide evidence to show that GRANULARITY & QUALITY of data is appropriate
–	----	----
U	Uncertainty	understand how uncertainty affects: (capital adequacy, reinsurance requirements)
P	PML	if PML(model 1) <> PML(model 2): explain (differences, subsequent model adjustments)

The section on earthquake models is very detailed. Consider the following 2 questions:

Q1: What are sound practices for earthquake model versions? (2015.Spring #18a.i)

Q2: What are sound practices for earthquake model validation? (2015.Spring #18a.ii)

The questions sound similar, but have different answers. Answers in mini BattleQuiz.

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Other Top Earthquake Questions

Make sure to click the Top Questions button near the top of this wiki article. (There's a Top Question for every article) There are 2 questions from earthquake key principles that have appeared on several prior exams.

Question 1: identify non-modeled exposures to consider when calculating PML.

Exam reference: (2016.Fall #17c), (2016.Spring #17c), (2015.Spring #18b)

Answer:

• exposure growth between (date of data) & (relevant exposure period)
• consider adequacy of ITV (Insurance-to-Value)
• consider GRC (Guaranteed Replacement Cost) - may be inadequate due to inflation
• increased seismicity after large event

Question 2: identify financial resources that can be used to support the PML for an earthquake. [Hint: CREC-it - sounds like the insect cricket ] Alternate hint.

Exam reference: (2015.Fall #15b), (2014.Fall #15c), (2014.Spring #16c) (See also section 4.5.1.2 in OSFI's MCT paper)

Answer:

abbreviation	meaning	financial resource
C	Capital	use Capital & Surplus from the B/S (max 10% of capital & surplus)
R	Reinsurance	most insurers use cat Reinsurance
E	Earthquake	EPR (Earthquake Premium Reserve)
C	Capital	Capital market financing

ATTENTION: Pay particular attention to (2017.Fall #18a). This was the hardest earthquake calculation question to date, but it isn't from the earthquake paper. The information formulas you need is actually from the insurance risk section of OSFI.MCT, Section 4.5.1. Here, instead of simply asking you to list the financial resources as in the above table, they ask you to calculate the value. That means you have to calculate each component separately using balance sheet and other numerical information.

Anyway, here are few more practice questions...

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Section 3 & 4: Regulatory Reporting & Guideline Administration

As of (2017.Fall) there have not been any questions from these sections of the paper. But there have been questions regarding roles & duties of the Board of Directors and senior management from other papers. If the CAS is searching the earthquake reading for new questions, this is one area that has not yet been touched. (My judgment, however, is that these are lower-probability questions)

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BattleCodes

Memorize:

• Just do the BattleCards (especially from Section 2). Note that the really, REALLY important memory items are:

Memory Item	Hint
5 Key Principles for Earthquake Exposures	Risk Management Data Management, Models, PML, Financial Resources & Contingency Plan
7 Best Practices for Earthquake Modeling	DAQKD-UP
4 Non-Modeled Earthquake Exposures	Exposure-growth.ITV (Insurance-to-Value).GRC (Guaranteed Replacement Cost).aftershocks!!
4 Financial Resources for Earthquake Exposures	CREC-it

Conceptual:

• You should understand that it is difficult to set accurate prices and reserves for earthquakes. This is because they are infrequent and potentially, but not always, severe A good conceptual exam question to review is: (2014.Spring #16ab). (You are given information about a company's earthquake exposure practices then asked to provide a critique and suggest improvements.

Calculational:

• None. (Recall that the calculation of earthquake reserves is part of OSFI.MCT.)

• Expect roughly 2.0 - 2.5 pts from this reading on the exam

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POP QUIZ ANSWERS

• ERC = ERX – FinRes = 135,919 - 60,000 = 75,919