Using catastrophe models - icmif

Underwriting Cat Reinsurance
with Models
MORO - May 2012
23 May 2012
© Copyright Liberty Syndicates

Models: almost a compulsory practice
More and more pressure to use models:
• They provide an objective view
• There is a huge and complex scientific background
• Quick responses
• It provides lot of statistics
But, it’s only a Model.
© Copyright Liberty Syndicates
23 May 2012 2

Weaknesses and Strenghs of models
Strenghs:
• More detailed statistics
• Good at measuring concentration / diversification
• Easy to use (for underwriters…)
• Includes long historical data on cat events
• Allow pricing of complex structures
• An incentive to Data Normalization
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Weaknesses and Strenghs of models
Weaknesses:
• Not enough accurate
• Difficulty of managing changes from new versions
• Don’t include all countries/perils, covers, contract characteristics
• Highly depends on data quality
• Uniformity of treatment
• Model Parameter sensitivity w/o consensus on their application
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Underwriting use of models
• Pricing
• Risk selection / Portfolio optimization
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23 May 2012 5

Pricing: The theory
Premium = Mean loss + ~30% of loss Standard deviation
Plus loadings for expenses, brokerage, etc.
• The price of working layers is mainly made of the mean loss
• The Standard Deviation is the more important component of
higher layers, the more volatil ones.
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Pricing: Practice (1)
Cost of Capital
Depending on their profile, Reinsurers can charge more or less on the Standard Deviation.
Can be 40% in peak zones
Can be 20% in non peak zones
Premium = Mean loss + ~% of loss Standard deviation
Plus loadings for expenses, brokerage, etc…
Also, more sophisticated approaches based on Marginal contribution to capital.
© Copyright Liberty Syndicates
23 May 2012 7

Pricing: Practice (2)
Sometimes, in long loss free history market, cedants/brokers suggest to ignore
volatility...
Premium = Mean loss (1+ 30%)
Plus loadings for expenses, brokerage, etc.
© Copyright Liberty Syndicates
23 May 2012 8

Pricing
Because models have weaknesses and because markets are not
just technical but based on a consensus price,
Reinsurers use models to get:
• a complementary view to burning cost, Pareto, etc.
• a comparison from one year to the other
• a comparison between treaties in the same area
• a benchmark
But, they rarely base price only on models.
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Portfolio optimization / Risk selection
Each reinsurance treaty in a portfolio has a different contribution to the global
PML and thus to the Capital and/or cost of retro-protection.
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Portfolio optimization / Risk selection
• Models allow to select risks and to allocate capacity in order to improve
Premium to PML ratio by identifying individual contribution per each
treaty.
• Basic and robust criteria: PML contribution to allocated Capacity ratio.
• It can represent a 20% of additional premium over a few years while
keeping the same level of PML.
• More and more applied to direct insurance portfolios.
© Copyright Liberty Syndicates
23 May 2012 11

Conclusion
Reality is more complex than models. Reinsurance treaties can’t be
priced only based on them.
Nevertheless, it’s a very useful help in the decision process when
used on a complementary basis (not standalone basis) and/or on a
relative basis (not absolute value).
© Copyright Liberty Syndicates 23 May 2012 12