9 June 2017 Insurance

Open-loss modelling “significant as first cat models” says pioneer

A new generation of catastrophe models could be completely transparent to their users – heralding a seismic change in the way risk models are built and used, which could be as significant a change for the industry as when the very first cat models were built in the early 1980s.

This is according to Karen Clark, co-founder and CEO of Karen Clark & Company and one of the pioneers of the catastrophe modelling industry, who spoke to Intelligent Insurer ahead of the Airmic Conference 2017 in Birmingham, UK.

"Insurers and reinsurers can't see inside the models; they're essentially black boxes,” said Clark. “An insurer will put in their exposure data and then they get loss estimates. They don't really see how the model is working to estimate the losses.”

She proposes that the future of cat models lies within open-loss modelling platforms, which follow the same fundamental structure as the traditional models, but instead have all the components visible and accessible to the model user.

Clark continued: “We are confident that this is the future of the cat models because making them open is really the only way to improve them significantly. This is as significant as the first cat models were back in the late 1980s. The difference between having no cat model and having a cat model, that's pretty much where we are today with having a closed cat model and an open cat model.”

Although the solution is relatively new, she said that adoption is happening among property/casualty re/insurers, which are becoming more informed about the risk, and are learning to modify assumptions to better reflect their loss experience.

And these open models have been tried and tested, Clark claimed, with Hurricane Matthew last year as an example.

“Before Matthew even made landfall, our clients were able to track the event in real time,” Clark said. "They could get estimates on their number of claims, the location of their claims and even what the dollar loss would be.

“As the storm got closer, they could keep updating that information. For individual companies, our estimates of their claims and losses were dead on.”

The four main components which can be visible within the open model are: event generation (a catalogue of potential events); intensity calculation (if you have an event such as a hurricane or earthquake, what would wind speeds or ground motion be at every location); vulnerability functions (giving damage estimations based on property characteristics); and the financial module (where the damage is turned into an insured loss).

There are thousands of damage functions, Clark explained, which take into consideration the experiences of a high-rise office building versus a single-family home versus a gas station, for example.

The biggest benefit of the open models is that they are more accurate than a traditional model, Clark suggested.

She gave two reasons to explain this, the first being that they are more transparent, and can be verified.

“There is a lot of talk in the industry about 'validating' a model. You can verify the model is working as it is supposed to, making all the components more credible and reliable.”

The second reason is that the model has greater accuracy is due to the idea they can be customised to reflect actual claims and loss experience.

She gave an example: “If you are an insurance company, you pay a lot of claims when there is a catastrophe. Those claims are your big data, and they can be used to improve the damage functions in the cat model.

“If you have claims information that tells you for example when wind speeds are 100mph, we didn't get 1 percent damage like the model said, we got a half a percent damage. So then you can modify the damage function to better reflect your actual experience.”

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