July 9th, 2009

Get the Most Out of Cat Models, Part IV: The Reinsurance Broker’s Role

Posted at 1:15 AM ET

hurricaneJohn Tedeschi, ACAS, MAAA, Managing Director and Chief of Catastrophe Modeling

The term “reinsurance broker” does not reflect the full role that an intermediary plays in helping clients manage risk. While brokers do facilitate the movement of risk out of cedent portfolios, the process entails much more than placing a program. In fact, a reinsurance broker is as much an advisor as a broker, working with its clients to understand the many choices available — from models to structures to markets — and develop the optimal solutions based on risk appetite, tolerance, and profile.

In the catastrophe modeling space, a savvy reinsurance broker will bring a profound familiarity with the strengths of each of the major modeling firms to a cedent in order to provide an independent assessment of the results and how they inform the risk-transfer process. Guy Carpenter, for example, has run the AIR, RMS, and EQECAT models at least as much as the vendors themselves and is poised to use a position of neutrality to highlight the specific opportunities available based on the differences among them. One model may serve as the anchor for a portfolio, peril, or region, but others may be useful for alternative perspectives. There is no single model that is best all the time. Changing needs and a dynamic marketplace call for a commensurate flexibility.

In evaluating a portfolio of risks — or its entire book of business — a (re)insurer needs to construct a rigorous analytical environment that has as few holes as possible. Of course, the familiarity of a company with its own portfolio is unparalleled. The reinsurance broker, as an independent party, addresses the nuances to which the carrier is too close to recognize. Add to this the perspective of a broker’s insights into model capabilities and broader market trends, and the risk management partnership formed by a cedent and its intermediary is potent. The gaps in risk management plans are closed (or at least narrowed), and the productivity of capital grows.

Yet, to view the broker’s role even in its catastrophe modeling capacity as tactical would be myopic. Every task, however small, should be seen as contributing to a company’s overall financial goals. When a reinsurance broker helps a cedent choose which models to use for a certain peril, the broker is thinking as much about the cedent’s market capitalization as it is about its catastrophe exposure. A decision’s impacts touch every part of the company — and every stakeholder.

As with every other aspect of risk management, catastrophe modeling is a discipline fraught with choice. Limiting one’s options causes a concentration of risk to arise, while diversification provides a level of protection to carriers and their capital. Yet, diversification brings its own challenges, as no (re)insurer has the resources to explore every possible (or, sometimes, plausible) alternative. The reinsurance broker, as a risk-bearer’s trusted advisor, increases the options available through broader perspectives and resources to help its clients understand the many factors that can affect specific courses of action. The wider reach that results not only makes capital more productive, it can drive shareholder returns.

Part I: Manage the Unknown >>
(Monday, July 6, 2009)

Part II: Lessons from Ike >>
(Tuesday, July 7, 2009)

Part III: Model Diversification >>
(Wednesday, July 8, 2009)

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