June 8th, 2011

A.M. Best Updates Its Comments on Catastrophe Models

Posted at 1:00 AM ET

During a recent webinar, a panel convened by A.M. Best reviewed catastrophe models and addressed questions that arose as a result of the new RMS and AIR model versions that have been released. The discussion was focused on how A.M. Best wants companies to demonstrate a solid understanding of their catastrophe risk exposure and where it fits within their risk tolerances. The panel outlined the need for rated companies to engage in ongoing discussions with their A.M Best analysts regarding the efficacy of model output, specifically, the companies’ confidence in the model output and the reasoning behind this view.

Overview

A major focus of the A.M. Best rating review is the existence and definition of a company’s risk tolerance (however defined by the company), and in particular, how much risk the company is willing to absorb. A.M. Best expects better managed companies to take ownership of model results and describe their own assessment of how they view new model output. Catastrophe models provide an estimate - they cannot be expected to provide an exact loss number.
A.M Best indicated that the catastrophe model output is just the starting point of a discussion with companies on their risk exposure. A.M. Best begins with the larger of a 1/100 year wind event, 1/250 year earthquake or a recent actual large loss for their base BCAR calculation. They will further stress BCAR for a second event in viewing the company as an ongoing entity.

Companies Using RMS v11

If a company is using the new RMS version, management must judge whether or not it feels that the results are credible. They should be able to determine if the new model better estimates actual results of a recent event. For example, if it can be determined that the new model would have more accurately predicted losses from hurricane Ike, there would then be support for its use. There would also be support for not using another model. Companies should be able to discuss whether their book of business changed since the last cat event. The change could help explain differences in model results, in addition to any changes to deductibles or policy limits.

Changing Model Vendors

Companies who switch vendor models as a result of the recent version change will need to have a dialogue with A.M. Best as to their reasoning. A.M. Best would be concerned if companies were to change their reliance on one model over another in reaction to the model update without a logical explanation as to why. A.M. Best would need to understand what precipitated the change and why the new model more correctly reflects the company’s risk.

Multiple Models

A.M. Best meets with all of the modeling companies regularly to discuss their models. They have no preference for any one vendor, nor do they evaluate cat models. If a company uses two models, A.M. Best’s standard approach is to blend the output evenly, with 50 percent representation from each. They seem to be supportive of the use of multiple models if this helps companies better understand their risks. With sufficient dialogue with their ratings analysts, companies may be able to modify weightings between their models to more accurately reflect the company’s perceived risk.

Summary

The discussion with A.M. Best should be an interactive process. A.M. Best expects management to take ownership in managing risk. They want to know how each company approaches its business and how cat risk is assessed and managed.

How Guy Carpenter Can Help

Guy Carpenter’s Rating Agency Advisory Services offer expertise in areas that help clients in their interaction with A.M. Best. The guidance includes support for evaluating current risk tolerances, catastrophe risk appraisal and advice on the interaction between the company and the rating agency. These services are supported by further offerings including capital advisory, strategic advisory, reserve risk modeling, enterprise risk management and reinsurance counterparty risk exposure.

At Guy Carpenter, we advise companies on the appropriate use of catastrophe models in the risk management process in several ways. When model vendors make material updates to their models, Guy Carpenter helps our clients manage the process of dealing with these changes by using the following approach:

  • Understanding the key drivers of such changes in their individual portfolios
  • Engaging modeling firms in the research of model output anomalies.
  • Strategically profiling multiple models, which offers valuable insights
  • Blending of model results.
  • Adjusting model results to account for model misses and inadequacies

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