Policy Position Paper Non-life Solvency Standard Oct 2011

Policy Position Paper Solvency Standard for Non-life Insurance Business Calibration of Catastrophe Risk Capital Charge Insurance Policy Prudential Supervision Department October 2011

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1. This paper accompanies the Solvency Standard for Non-life Insurance Business (“the standard”) released by the Reserve Bank on 7 October, 2011. It sets out and explains the Reserve Bank’s intentions regarding the calibration of the loss return period, as referenced in paragraph 70(b) of the standard, for dates on or after 8 September 2015. Future loss return periods for earthquake risk
2. Paragraph 70(b) of the standard states as follows: For financial reporting periods commencing on or after 8 September 2015: the greater of the maximum amount of catastrophe reinsurance (expressed in New Zealand dollars) held by the licensed insurer before 8 September 2015, or an amount equivalent to the licensed insurer’s projected insurance losses calibrated to a specified loss return period to be published by the Bank in a formal Policy Position Paper which will set out the Bank’s future loss return period requirements, (moving progressively to a maximum calibration of 1 in 1000 years).
3. It is the Reserve Bank’s intention that the specified loss return period referenced in paragraph 70(b) of the standard will be as follows: a. For financial reporting periods commencing from 8 September 2015 to 7 September 2016: 1 in 750 years; and b. For financial reporting periods commencing on or after 8 September 2016: 1 in 1,000 years Rationale for calibrating the Catastrophe Risk Capital Charge in this manner:
4. The recent Christchurch earthquakes have underlined the importance of earthquake risk for New Zealand. Insurers typically manage the risk either by holding adequate capital themselves against such losses, or by reinsuring a large proportion of these potential losses.
5. The stated purposes of the Insurance (Prudential Supervision) Act 2010 (“the Act”) are to “promote the maintenance of a sound and efficient insurance sector” and to “promote public confidence in the insurance sector”. The Act seeks to minimise the likelihood of insurer failure, but not to totally eliminate this possibility.
6. The financial impact on non-life insurers and the emerging systemic impact across the country of the recent Christchurch earthquakes have highlighted the need to ensure that insurers operating in New Zealand have sufficient financial resources to withstand major earthquakes. The adequacy of reinsurance and capital resources becomes vital for the country at a time of serious natural disaster. This means that the capital and/or reinsurance requirements on non-life insurers must be set at a level that gives the required degree of comfort that any similar future events should not cause insurer failure.

4550218 7. We consider that insurers, reinsurers and property owners should rightly bear the risks of a catastrophe, rather than government whose costs are ultimately borne by all taxpayers. Recent events may also have increased moral hazard in the market. That is, insurers may believe that government intervention in the case of another catastrophe may occur in the future. These factors further support the need for robust solvency requirements in respect of earthquake risk. 8. However, it is also recognised that the establishment of the proposed catastrophe risk capital charges takes place during a period of significant uncertainty for the New Zealand insurance market. For this reason we have calibrated the capital charge to a loss return period of 1 in 500 years, or the maximum level of catastrophe reinsurance held by the insurer prior to full licensing if this is higher, for financial reporting periods commencing until 7 September 2015. This is to enable the new “normal” market and seismic conditions to emerge clearly as a more stable context for further decisions in respect of this measure. At present we are clearly flagging our intention to ultimately increase this to 1 in 1000 years for the reasons outlined above. 9. Based on industry response to our recent Quantitative Impact Study we understand that the initial calibration at the greater of a 1 in 500 year loss return period, or the maximum level of catastrophe reinsurance held prior to full licensing, will not cause most insurers significant concern. In addition, by flagging our intentions early we are giving adequate time for industry to plan its path toward any indicated future calibration levels that may require additional reinsurance. 10. We will continue to monitor developments during the period to September 2015, and beyond, and reserve the right to reconsider our approach in the context of any further significant factors that emerge.

Website http://rbnz.govt.nz/finstab/insurance/ Email insurance@rbnz.govt.nz Telephone +64 471 3591 Mail Reserve Bank of New Zealand Prudential Supervision – Insurance Policy PO Box 2498 WELLINGTON 6140