July 10th, 2009

Get the Most Out of Cat Models, Part V: Creating New Ideas

Posted at 1:15 AM ET

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

Catastrophe models may be invaluable, but they are not all-encompassing. The vendors tend to focus on what can be known — and quantified — which leaves some parts of (re)insurer portfolios unaddressed. Depending on the nature of these gaps, carrier exposures can remain quite high, diluting substantially the effects of any risk management planning and execution. To alleviate this concern, reinsurance brokers have extended catastrophe model capabilities with a variety of tools to help clients limit their exposures further. Guy Carpenter has developed several model enhancements — such as GC LiveCatTM and GC ForeCatTM, available through the i-aXs platform — to facilitate risk identification and capital management beyond the capabilities of the major catastrophe modeling firms.

A portion of most (re)insurers’ portfolios goes unmodeled, of necessity. Some exposures are not addressed by catastrophe models, including automobiles, marine risks, and fine art. The data and tools simply do not exist for these risks, limiting carriers’ abilities to plan and take informed action. Further, some models do not include all the risks associated with a particular event. If regulators change policy terms and conditions after an event, for example, insured losses may be higher than expected.

Other expenses that (re)insurers could incur may also be overlooked by the major catastrophe models. Loss-adjustment expenses (e.g., the cost to settle claims) and assessments from organizations that carriers are obligated to support (such as fair plans and wind pools) can erode margins beyond expectations, ultimately impairing capital positions. This is also the case for differences in claims practices.

Of course, reinsurance broker relationships in general are designed either to minimize the effects of these costs or account for them in risk management efforts. But, additional modeling tools have been developed to integrate these issues into the entire process of evaluating alternatives from the earliest stages of exploration to the execution of specific structures. Guy Carpenter’s GC LiveCat and GC ForeCat tools (developed in conjunction with WSI Corporation), for example, open a range of choices to carriers that would not exist using the vendors’ models alone.

GC ForeCat offers a detailed monthly preseason windstorm forecast from December through April, in order to help property-catastrophe insurers gauge the threats to their portfolios in advance of the Gulf of Mexico hurricane season. Once the season begins, GC LiveCat tracks live hurricanes (with uncertainty estimates), enabling real-time risk management from the time a storm forms through its dissipation. Using technology from WSI, GC LiveCat extends the track and intensity forecast time horizon to 10 days - double the five days offered by the National Hurricane Center (NHC). As a result, insurers can take immediate action on their portfolios to minimize losses and protect their capital.

In addition to the output generated by these proprietary models in relation to catastrophe risks and the deployment of capital, they provide insights into broader implications that can have a significant impact on future risk management decisions and dynamics. How a carrier handles the activity occurring during and after a catastrophe event can have an effect on the language used for “hours clauses” — not to mention how existing contract language is interpreted.

Further, refined analytics around catastrophe events can hone a (re)insurer’s risk management practices, ultimately leading to more cost-effective cover and improved financial performance. Being able to mitigate losses by laying off some catastrophe risk via livecat cover, for example, has an affect on margins, earnings, and market capitalizations (where the effects of earnings and margins are magnified). These benefits do not come from the use of third-party catastrophe models alone. Rather, they are secured by extending existing features with tools developed by reinsurance brokers who are closely engaged with the overall market for risk-transfer.

Catastrophe models provide a starting point for generating the full set of analytics necessary to optimize the deployment of capital, attain clearly stated financial targets, and realize company growth. (Re)insurers thus need to look beyond the core catastrophe models to understand the full natures of the risks they cover, as well as the possible effects to their balance sheets. “Extended” catastrophe models, frankly, extend the financial upside.

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)

Part IV: The Reinsurance Broker’s Role >>
(Thursday, July 9, 2009)

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