Modelling the tail

Advancements in modelling tools for peak perils have created a scenario where new capital is comfortable transacting around the view of risk provided by the big two modelling vendors.

But as losses escalate around those perils typically viewed as secondary, and new sources of catastrophe risk emerge through cyber exposures, there is a clear need for product innovation to provide the level of comfort that will allow new capital to embrace these risks.

While the leading catastrophe modelling vendors have invested heavily in the development of tools to manage risks such as cyber, climate change and non-peak perils, it is widely recognised within the industry that these tools are not as advanced as the hurricane and earthquake models on which the catastrophe modelling sector was built.

At the first of The Insurer’s #ReinsuranceMonth panel discussions, Matt Fitzgerald, managing partner at Gallagher Re, said it was vital the industry as a whole kept investing in tools to better price cyber risk, which he said would ultimately rival property as the other peak volatility peril and will be measured against casualty for reserve development issues.

“The rating environment is skyrocketing and is only going one way on the cyber insurance side, and ultimately there will be no end in sight in demand for cyber risk,” he said.

“But I think modelling companies have a long way to go with their assessment of the cyber peril and other secondary risks.

“It’s quite difficult for us all when you are trying to convince alternative markets to come in and they’re desperate for a third party to give them some validation. We’ve just got to try and help convince everybody of where the direction of travel is.”

“Modelling companies have a long way to go with their assessment of the cyber peril and other secondary risks”

Matt Fitzgerald, managing partner at Gallagher Re

He said it was the role of both vendor modellers and in-house modelling teams to drive the issue forward.

“The capital and the underwriting community is not going to take a broker view on risk. We can contribute and often our job is to take three or four vendor models, add our own opinion and try to provide a vision of where we think this is going.

“But it’s very difficult when the alternative capacity in the property market has been absolutely used to having a very key vendor model or two to give them a definable something that they can essentially invest and trade on.”

“We’re now in this world where we’ve become so dependent on RMS and AIR for peak perils, rightly or wrongly.”

Kathleen Reardon, CEO of Hiscox Re & ILS, said it was vital to have an in-house view on major risks such as climate change.

“By having your own view, whether you are a reinsurer or broker, it will mean everybody within the market can ultimately support a risk but come at it from a different perspective”

Kathleen Reardon, CEO of Hiscox Re & ILS

“The vendor models are just getting to the topic,” she said, adding that the current set of tools available to form both near-term and long-term views was “far from robust”.

“By having your own view, whether you are a reinsurer or broker, it will mean everybody within the market can ultimately support a risk but come at it from a different perspective, providing different insight and value-add,” she said.

Katie Partington Howarth, chief underwriting officer at Axis Re, supported this view but highlighted the huge lift that had been brought to the industry through the creation of catastrophe models.

“But some of the most fundamental things apply, especially in the emerging risk space, which is looking at overall limits management and exposure management.

“Those things are applying in the casualty space right now. We’re seeing underlying limits which are suppressed which is great for the overall health of the underlying casualty market, but we need to be keeping a keen eye on the volatility we could be exposed to when those limits increase.”

And on cyber, she said it was critical the industry began to gain a better understanding of what a tail scenario might look like.

“In the next five to 10 years the industry is going to get more sophisticated in how we look at those things, and I think that will drive overall demand.

The Insurer comment: Developing an in-house view

Since its development in the late 1980s and its increasing prominence in the aftermath of Hurricane Andrew in 1992, catastrophe modelling has played a pivotal role in helping carriers manage volatility.

Major carriers underwriting catastrophe-exposed portfolios are unable to operate without access to these tools, and the huge investment required to develop and maintain models has meant limited scope for competition.

But risks are evolving and as the panel participants noted, cyber is emerging as a peak peril and losses from other secondary perils are increasing.

This makes the need to develop an in-house view critical, and this is reflected by the huge investments several leading brokers are making to develop their own tools and offer an alternative to the big two modelling firms.

Perhaps the greatest need for modelling tools will be in assessing the impacts of climate change, both in the near and longer term.

The need for these tools also brings opportunity for those providing the models, as reflected by the eye-watering near-$2bn valuation of RMS when it was sold to Moody’s in August.