East African earthquake less of a risk then realised

Time and again, the insurance industry claims that one of the problems in pricing risk in Africa is that there is insufficient historical data on which to base the figure. So news of improved modelling for east African catastrophe risk should be welcome. And the good news for insurers is that the new model suggests they have perhaps historically bought more reinsurance cover than they truly needed for earthquake exposure in east Africa. Impact Forecasting, the catastrophe model development center at Aon Benfield, has launched the first catastrophe model for the east Africa region. The model quantifies the financial impact of earthquakes and in turn allows insurers and reinsurers to gain a better understanding of their exposures in this growing market.hideAreas of Kenya, Tanzania and Uganda are seismically active and prone to earthquakes because of their position in the east African rift system. The region is prone to earthquakes as the rift system has two tectonic plates which are separating and diverging. There have been a number of recent earthquakes (Lake Tanganyika, magnitude 6.8 in 2005 and Arusha, Magnitude 6.0 in 2007) which have affected the region. Similar events could more strongly affect Kampala, Nairobi and other major cities, which would have implications for the insurance and reinsurance markets. The model was developed using the latest earthquake data from local and international experts, including the University of Pretoria Natural Hazard Centre Africa. To assess the impact of the hazard against the building resilience, the model analyses more than 500,000 events against three occupancies (residential, commercial and industrial) and 24 structural types including three height and age categories. Portfolios can be modelled using CRESTA and State administrative levels. Aon Benfield claims the model brings the following key benefits for insurers and reinsurers underwriting business in the region: Ability to model loss to both property and life to in turn shape reinsurance buying Model can also be used for underwriting purposes of large commercial and industrial risks The model is available in ELEMENTS, Impact Forecasting’s loss calculation platform, which is transparent with detailed documentation, open and with customisation possibilities for individual clients including custom vulnerability functions, adding new events etc. Simon Chikumbu, Chief Executive Officer of Aon Benfield Africa, explained: “The African economies are growing pretty fast and so will insurance penetration in the region. Insurers and reinsurers in Kenya, Tanzania and Uganda are therefore seeking a greater understanding of the seismic risk in the region. This is to gain greater knowledge and better insights of their exposure and enable better decisions on matters such as capital, risk pricing and reinsurance requirements. Up to now very little scientific research has been put into action in such a model to understand this risk in the region.” In fact, he said, there has been an assumption of an earthquake risk in the Rift Valley, based on work done 20 years ago despite massive movements of population and development of cities since then. The figures used were based on an assumption that, for example, 5% of property in Nairobi would be destroyed in an earthquake but Mr Chikumbu said: “There is no sense behind this figure. It was a guesstimate and there is no independent verification of that kind of figure.” Because of this reliance on old material and guesswork, Aon Benfield decided the only solution was to build its own model. Earthquake exposure exists in eastern, northern and southern Africa, said Mr Chikumbu, so the firm has built three models—South Africa, the Maghreb region and now east Africa. However, he warned: “Earthquake is not the only natural catastrophe exposure. There is a very real risk of drought and also of coastal flooding. In some regions hailstorms also pose a major risk.” While he acknowledged more modelling is needed—particularly on flooding—Mr Chikumbu said the new model is a major step forward which should have some tangible results for those that buy reinsurance, in particular. “The model allows them to know how much reinsurance to buy and how much capital they may need to raise,” he said. The Aon Benfield man said, in fact, the model suggests the risk of, say, destruction in Nairobi, is somewhat lower than previously assumed at around 2%. “It depends on the strength of the buildings,” he said, “but on an average basis we have come up with that as a maximum loss.” However, Mr Chikumbu warns that the exposure will completely depend on the individual portfolio and some insurers could face a substantially higher worst case scenario. He also said that buying reinsurance always comes at a cost and historically some insurers have chosen not to transfer the risk because of the cost-benefit ratio. He hoped that the new and more accurate modelling would encourage more insurers to buy reinsurance, protecting their book of business. But the better news is that some insurers may well be able to reduce their cover in the light of the new evidence. The new model should also provide good evidence to regulators about the levels of cover insurers require. “We hope that it will give regulators confidence that insurers are basing their cover on tangible evidence and that they are properly prepared. As regulation steps up across the region, it will become increasingly important that insurers can show they have sufficient protection for their business and their customers,” said Mr Chikumbu. He hopes that the east African model will achieve the same levels of acceptance as the South African model, launched some years ago. He said the South African regulators have accepted the model and are comfortable that insurers use the model to calculate their exposures. There is still a learning curve for east Africa, said Mr Chikumbu. “The only difference between the two regions is that the South African market is more sophisticated and so is quicker to grasp the consequences.” But he is confident that times are changing and the insurance market in east Africa is maturing quickly. Having a new model will help speed that process still further, he concluded.

East African earthquake less of a risk then realised

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