December 24th, 2009

2009 Top Stories: Modeling

Posted at 12:30 AM ET

With 2009 coming to a close, this week we’re taking a look at the most popular stories of the year.

CRESTA Zone Updates: Swiss Re and Munich Re, which are responsible for Catastrophe Risk Evaluating and Standardising Target Accumulations (CRESTA) boundaries, have recently made some major updates to the zones in a number of countries. In the Asia-Pacific region, the CRESTA boundaries for Australia, China, Japan, and New Zealand have undergone significant changes.

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Get the Most Out of Cat Models, Part I: Manage the Unknown: Insurer and reinsurer reliance on catastrophe models has become part of the fabric of risk management. Though they provide guidance rather than clear courses of action, these tools help quantify risk and deploy their capital as effectively as possible. But, they aren’t perfect. Every catastrophe model has specific strengths and weaknesses, which is why risk-bearers tend to use several models to evaluate exposures, with the final decisions on whether to cover a particular risk shaped by loss history, company objectives and risk manager judgment. As a result, models are crucial to (re)insurer success … as long as they are used properly.

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Known Unknowns: The “black swan” is trumpeting! Last year, we saw the first-hand effects of random, unforeseen, and massive events. Catastrophe models — the tools we use to forecast disaster and protect capital — were shown to be quite fallible, leaving balance sheets exposed to more risk than carriers realized. Yet, maybe we’ve been a bit hasty in meting out blame. Catastrophe models have made great strides since they were first introduced, and our industry must continue to use them for a reason. What has emerged is an essential tension between the unknown and efforts to counteract it.

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Risk Modeling Part I: Overview: The global financial crisis has increased the world’s focus on risk modeling, and for some it has called the very validity of the practice into question. Common themes resonating throughout the popular press include the difficulty of modeling human behavior and the complexity of the intricate webs of financial hedging that imploded to create the current crisis. In-depth investigations into the mechanics of subprime have revealed the existence of known blind spots in the models. Management considered these blind spots either unimportant or unlikely to have an impact on results, but they point to the real culprits in most modeling mishaps — a lack of holistic risk awareness, or what the 9/11 Commission’s report called “a failure of the imagination.”

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Casualty Cat Part I: Casualty Catastrophe Risk Modeling: Casualty catastrophes have become increasingly frequent and severe over the past decade, exposing (re)insurers to much more risk than they may realize. One root cause can trigger a chain reaction that can bleed balance sheets and even imperil solvency. Until recently, casualty carriers had little choice but to accept this risk. The maturation of Enterprise Risk Management (ERM) practice and the development of new casualty-specific catastrophe models, though, signal a change. The more complex the casualty risks and regulations carriers face, the more they are recognizing that improving their ERM practices could yield competitive advantage. Now, it is possible to make the accumulation of casualty risks both knowable and manageable. As casualty catastrophes become more common, carriers will be able to take informed action to protect their capital.

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