MERCED PROPERTY AND CASUALTY COMPANY: HOW CLIMATE
RISK LED TO ITS FAILURE CASE STUDY SOLUTION
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SYNOPSIS
Facilitated by hot Diablo winds, dry weather, and combustible vegetation, the Camp Fire in November 2018
almost destroyed the town of Paradise in Butte County, California. The fire also led to the demise of Merced
Property and Casualty Company (Merced), a small property and casualty insurer based in Atwater,
n
California. Following the Camp Fire, homeowners’ insurance claims exceeded Merced’s ability to pay out
their insurance claims, and in December 2018, Merced was put into liquidation by the California Insurance
tio
Guarantee Association (CIGA). In September 2021, Jessy Picado, chief executive officer of Insuredhouse,
a small property and casualty insurer in Alberta, Canada, decided to scrutinize the case of Merced in a bid
to restructure Insuredhouse’s climate risk management plan. Picado appointed Dany Voisin, chief risk
lu
officer, to identify the reasons for the downfall of Merced and draw lessons from it. Voisin had to determine
what available information and financial ratios would have been indicators of Merced’s business
So
vulnerability and use them in his analysis before making recommendations to Insuredhouse.
OBJECTIVES
• better understand what climate risk is and identify the risks that could endanger a neighbourhood;
• understand and calculate key financial ratios for property and casualty insurers under statutory
accounting principles (SAP) reporting and identify the differences between SAP and generally accepted
accounting principles (GAAP) reporting; and
• analyze the financial health of a given property and casualty insurer using financial ratios and risk
management strategies.
The Case Solution Starts From page 6
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ASSIGNMENT QUESTIONS
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1. (a) What are the risks that can potentially lead to the failure of a financially viable insurance company?
(b) What are the risk factors that contributed to the failure of Merced?
2. In terms of financial reporting standards, what are the main differences between insurance and non-
insurance companies in terms of GAAP and SAP? What are the main differences between the balance
sheet items of an insurer vs. a non-insurer?
3. What are the key industry-specific financial indicators for an insurance company? How are they
calculated?
4. An insurer can transfer part of its risk to reinsurers; therefore, when an insurer is affected by a
catastrophic event, it can recover some of the losses from its reinsurers. How can you determine whether
an insurer has obtained sufficient protection from reinsurance? Using the ratios you select, analyze
whether the lack of reinsurance contributed to Merced’s failure.
5. (a) How would climate risk affect future pricing strategy?
(b) Given the difficulties CIGA experienced when settling claims during Merced’s liquidation, as a
risk manager what suggestions would you give to the insurer who takes over Merced’s homeowner
insurance in Butte County?
The Case Solution Starts From page 6
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ANALYSIS
1. (a) What are the risks that can potentially lead to the failure of a financially viable insurance
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company?
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1. Internal risk. This includes problems in internal control and corporate governance.
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2. External corporate risks. Examples include financial risks from the parent company, other subsidiaries,
reinsurers, and other related parties (e.g., customers, suppliers, regulators). Such risks can cause a
So
contagion effect and could cripple a well-run insurance company.
3. Systematic risks. These include pandemics, regulatory negligence, global economic downturns, and
natural disasters.
(b) What are the risk factors that contributed to the failure of Merced?
1. Climate risk, where climate change causes more wildfires in the fall and winter seasons in California.
2. External corporate risk from Pacific Gas and Electric Company (PG&E), whose infrastructure is aged.
3. Regulatory negligence, where the local government failed to install a fire alarm system that could reach
residents with clear evacuation orders; also, the insurance regulator did not impose any statutory reinsurance
requirements, which could result in small insurers not having sufficient incentive to divert its risks.
The Case Solution Starts From page 6
, EXHIBIT -1: FINANCIAL RATIO FORMULAS FOR INSURANCE COMPANIES
Ratio type Insurer Formula
specific
Capacity measures
Premium-to-surplus ratio Yes NPW / policyholders’ surplus
GPW / policyholders’ surplus
Reserve-to-surplus ratio Yes (Loss reserves + LAE reserves) / policyholders’
surplus
LAE reserves: reserve set up for unpaid losses and
LAE
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Net premium written growth Yes (NPW – NPW, previous year) / NPW, previous year
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The Case Solution Starts From page 6
, EXHIBIT -2: KEY FINANCIAL RATIOS FOR MERCED (2012–2017) (%)
Key ratios 2017 2016 2015 2014 2013 2012
Expense ratio (SAP) 53.25 58.68 59.19 58.62 58.10 52.09
Loss ratio 61.19 46.46 66.42 55.65 45.60 53.09
Combined ratio 114.44 105.14 125.62 114.27 103.70 105.19
Operating ratio 100.83 87.02 106.16 91.55 86.66 99.18
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The Case Solution Starts From page 6
RISK LED TO ITS FAILURE CASE STUDY SOLUTION
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pl
m
Sa
SYNOPSIS
Facilitated by hot Diablo winds, dry weather, and combustible vegetation, the Camp Fire in November 2018
almost destroyed the town of Paradise in Butte County, California. The fire also led to the demise of Merced
Property and Casualty Company (Merced), a small property and casualty insurer based in Atwater,
n
California. Following the Camp Fire, homeowners’ insurance claims exceeded Merced’s ability to pay out
their insurance claims, and in December 2018, Merced was put into liquidation by the California Insurance
tio
Guarantee Association (CIGA). In September 2021, Jessy Picado, chief executive officer of Insuredhouse,
a small property and casualty insurer in Alberta, Canada, decided to scrutinize the case of Merced in a bid
to restructure Insuredhouse’s climate risk management plan. Picado appointed Dany Voisin, chief risk
lu
officer, to identify the reasons for the downfall of Merced and draw lessons from it. Voisin had to determine
what available information and financial ratios would have been indicators of Merced’s business
So
vulnerability and use them in his analysis before making recommendations to Insuredhouse.
OBJECTIVES
• better understand what climate risk is and identify the risks that could endanger a neighbourhood;
• understand and calculate key financial ratios for property and casualty insurers under statutory
accounting principles (SAP) reporting and identify the differences between SAP and generally accepted
accounting principles (GAAP) reporting; and
• analyze the financial health of a given property and casualty insurer using financial ratios and risk
management strategies.
The Case Solution Starts From page 6
, e
pl
m
Sa
n
tio
lu
ASSIGNMENT QUESTIONS
So
1. (a) What are the risks that can potentially lead to the failure of a financially viable insurance company?
(b) What are the risk factors that contributed to the failure of Merced?
2. In terms of financial reporting standards, what are the main differences between insurance and non-
insurance companies in terms of GAAP and SAP? What are the main differences between the balance
sheet items of an insurer vs. a non-insurer?
3. What are the key industry-specific financial indicators for an insurance company? How are they
calculated?
4. An insurer can transfer part of its risk to reinsurers; therefore, when an insurer is affected by a
catastrophic event, it can recover some of the losses from its reinsurers. How can you determine whether
an insurer has obtained sufficient protection from reinsurance? Using the ratios you select, analyze
whether the lack of reinsurance contributed to Merced’s failure.
5. (a) How would climate risk affect future pricing strategy?
(b) Given the difficulties CIGA experienced when settling claims during Merced’s liquidation, as a
risk manager what suggestions would you give to the insurer who takes over Merced’s homeowner
insurance in Butte County?
The Case Solution Starts From page 6
, e
pl
m
Sa
ANALYSIS
1. (a) What are the risks that can potentially lead to the failure of a financially viable insurance
n
company?
tio
1. Internal risk. This includes problems in internal control and corporate governance.
lu
2. External corporate risks. Examples include financial risks from the parent company, other subsidiaries,
reinsurers, and other related parties (e.g., customers, suppliers, regulators). Such risks can cause a
So
contagion effect and could cripple a well-run insurance company.
3. Systematic risks. These include pandemics, regulatory negligence, global economic downturns, and
natural disasters.
(b) What are the risk factors that contributed to the failure of Merced?
1. Climate risk, where climate change causes more wildfires in the fall and winter seasons in California.
2. External corporate risk from Pacific Gas and Electric Company (PG&E), whose infrastructure is aged.
3. Regulatory negligence, where the local government failed to install a fire alarm system that could reach
residents with clear evacuation orders; also, the insurance regulator did not impose any statutory reinsurance
requirements, which could result in small insurers not having sufficient incentive to divert its risks.
The Case Solution Starts From page 6
, EXHIBIT -1: FINANCIAL RATIO FORMULAS FOR INSURANCE COMPANIES
Ratio type Insurer Formula
specific
Capacity measures
Premium-to-surplus ratio Yes NPW / policyholders’ surplus
GPW / policyholders’ surplus
Reserve-to-surplus ratio Yes (Loss reserves + LAE reserves) / policyholders’
surplus
LAE reserves: reserve set up for unpaid losses and
LAE
e
Net premium written growth Yes (NPW – NPW, previous year) / NPW, previous year
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m
Sa
n
tio
lu
So
The Case Solution Starts From page 6
, EXHIBIT -2: KEY FINANCIAL RATIOS FOR MERCED (2012–2017) (%)
Key ratios 2017 2016 2015 2014 2013 2012
Expense ratio (SAP) 53.25 58.68 59.19 58.62 58.10 52.09
Loss ratio 61.19 46.46 66.42 55.65 45.60 53.09
Combined ratio 114.44 105.14 125.62 114.27 103.70 105.19
Operating ratio 100.83 87.02 106.16 91.55 86.66 99.18
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The Case Solution Starts From page 6
