Answers to the European Commission on the ... - Eiopa - Europa

E.29 Ano<strong>the</strong>r way <strong>to</strong> express this phenomenon may be <strong>to</strong> consider <strong>the</strong> claim
distributions – at least for some LOBs – as consisting of two possibly
distinctive parts 162
• <strong>the</strong> part of <strong>the</strong> distribution dealing with 'normal' claims; and
• <strong>the</strong> part of <strong>the</strong> distribution dealing with extreme claims.
E.30 Some examples of mechanisms that may give rise <strong>to</strong> correlations
between different LOBs may be as follows 163
• events that generate losses for many insurance policies related <strong>to</strong>
several LOBs;
• cycles of market prices (premium rates) of insurance reflecting
e.g. <strong>the</strong> competitive environment in several LOBs; and
• macro economic trends as e.g. changes in inflation that impact on
<strong>the</strong> single claim amounts (in several or all LOBs).
E.31 More specific examples may be “<strong>the</strong> correlation of various types of
claims with economic influence” and “extreme tail correlation of
insurance and credit risk caused by major catastrophes leading <strong>to</strong>
reinsurance failure.”
E.32 The question arises how <strong>to</strong> assess <strong>the</strong> impact of <strong>the</strong> various
reinsurance covers in this context. To what extent will <strong>the</strong> various
reinsurance covers contribute <strong>to</strong> a reduction of <strong>the</strong> tail correlation (or
tail dependence)?
E.33 As a first general comment, it seems likely that non-proportional
reinsurance (e.g. excess-of loss covers) has <strong>the</strong> potential of mitigating
<strong>the</strong> negative impact of tail correlation when <strong>the</strong> conditions of <strong>the</strong>
insurance markets develop in an adverse manner, e.g. due <strong>to</strong> <strong>the</strong>
occurrence of (catastrophic) events generating extreme aggregate
claim payments. However, it should also be noticed that <strong>the</strong>se
aggregate claim payments may contribute <strong>to</strong> exhaust <strong>the</strong> capacity of
<strong>the</strong> reinsurance markets or trigger a sharp increase in <strong>the</strong> premium
rates for <strong>the</strong> relevant reinsurance covers.
E.34 On <strong>the</strong> o<strong>the</strong>r hand, it seems equally likely that proportional reinsurance
(e.g. quota share covers or surplus covers) will have no material
impact on <strong>the</strong> tail correlations of <strong>the</strong> kind sketched above – with a
possible exception for some facultative reinsurance covers.
E.35 It should however be stressed that in order <strong>to</strong> give a qualified
assessment of <strong>the</strong> impact of various reinsurance arrangements on <strong>the</strong>
tail correlations it will be necessary <strong>to</strong> carry out in depth studies of
individual cases – starting with a detailed mapping of <strong>the</strong> mechanisms
that may lead <strong>to</strong> <strong>the</strong>se correlations or dependencies.
162
Cf. D.E.A. Sanders (2005): “The Modelling of Extreme Events”. Paper presented <strong>to</strong> <strong>the</strong> Institute of
Actuaries.
163 Cf. Andrew D. Smith (2002): ”Dependent Tails”. Paper presented <strong>to</strong> <strong>the</strong> GIRO Convention 2002.
277