The Multiple-Model Approach to Catastrophes

Insurers are finding that multiple views may be best when modeling for natural disasters.

Insurance Networking News, November 1, 2011

Bob Violino

It's a given that catastrophe models play a key role in helping insurers estimate the losses that could result from cat events such as earthquakes and hurricanes. But these models don't work in isolation. To get even more accurate assessments, insurers increasingly are using them in conjunction with other models-commercial or homegrown-and with data from other sources such as satellite and radar systems.

One recent trend that's spurring the use of multiple cat models is the growing pressure from regulators and ratings agencies in the wake of widespread disaster-related losses for insurers and reinsurers.

For example, ratings firm Standard & Poor's in September 2011 reiterated its call for the use of multiple cat models by insurers. To avoid instances of "model shopping," the ratings firm says it prefers that insurers and reinsurers use models from at least two of the big three modeling firms—Risk Management Solutions (RMS), AIR Worldwide and EQECAT—when assessing catastrophe risk for natural peril catastrophe bonds. "Loss estimates from an event, or the likelihood of an event, can differ significantly between modeling agencies, according to how the data is interpreted," the S&P notes. "We therefore consider that a multiple-model approach would give existing and potential investors a better perspective on the range of potential outcomes."

Sibylle Steimen, head of cat Risk Management at Allianz Re, the internal reinsurer of Munich, Germany-based Allianz group, says the firm uses models from multiple sources. Steimen says in addition to a primary model from one of the big three, the company employs "second opinion" models from another vendor as well as models from brokers and those the company has developed on its own.

"We try to have a broad view," she says. Creating internal models to measure risks such as damage from hail storms and floods gives the firm an even broader view of catastrophe loss data, she says. "If you're exclusively relying on brokers' work [and commercial models] you've lost a bit of control over cat modeling and analysis," Steimen says.

Overall, the frequent use of cat modeling gives Allianz a long-term baseline for catastrophic events. "It's one way to measure the situation over time and compare [catastrophic events and how they affect the group] over a longer period of time," Steimen says.

Before cat models are used by the firm they are validated by in-house experts who have the right scientific expertise. If required, models are adjusted to better reflect the company's own catastrophe exposure, Steimen says.

A Broader Process

Likewise, Matthew Jones, head of catastrophe management, global underwriting at the Schaumburg, Ill.-based Zurich North America says its important for insurers to understand both the scope and the limitations of modeling tools. Jones says the company uses modeling products to inform its "Zurich View" of catastrophe risk, which then feeds into many areas within the company-from risk appetite assessment to risk-based capital calculation to primary pricing. "The main benefit of such tools is that they provide an exposure- based view of risk, which is needed given the low frequency of the type of events we are trying to understand," Jones says. "However we never use such tools without adjustment and do not treat them as 'black boxes.'"

Establishing the Zurich View of risk always involves using multi-model output together with information from external experts, as well as the company's own claims experience and expertise. Zurich uses CAT model output from all the big three vendors, as well as other sources, Miller says.

Farmers Insurance Group is also leveraging multiple models to determine the frequency and severity of losses resulting from specific natural perils in specific geographic locations by licensing models from AIR and RMS, says Derek Gullage, VP, reinsurance at Farmers. Gullage says that Farmers has found the models from both vendors to have strengths and weaknesses.

"We are not a company [that] takes a single output and builds a business plan," he says. "Rather, we use these outputs as one point of view, but continue to have a more robust view of natural catastrophe risk that is not based on a single data point from a single model. Using both [enables] us to minimize the effect of any one model change."

Like Steimen and Jones, Gullage is quick to stress that models are only part of a broader process. "We should point out that the models are only a tool, and we use this tool in concert with our own experience, knowledge and history of losses," he says.

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