Cat Modeling Issues and Challenges:Cat Modeling Issues and Challenges:Managing UncertaintyManaging Uncertainty

ICA Conference

Cancun, Mexico18 March 2002

Mark Cravens

1 February 2000 2

Issues of InterestIssues of Interest

■■ Cat models: consistent frameworks forCat models: consistent frameworks forevaluating riskevaluating risk–– But the world is not consistentBut the world is not consistent

■■ More information drives innovationMore information drives innovation–– Respecting need for flexibility and the increasingRespecting need for flexibility and the increasing

pace of changepace of change■■ Progress is increasingly complexProgress is increasingly complex

1 February 2000 3

TopicsTopics

■■ Modeling complex risksModeling complex risks–– Complex exposures/financial structuresComplex exposures/financial structures–– Multi-national modelingMulti-national modeling

■■ Pushing data qualityPushing data quality–– Mechanisms for grading input and resultsMechanisms for grading input and results

■■ Expanding the model environmentExpanding the model environment–– Secondary/supplemental loss modelingSecondary/supplemental loss modeling–– Using multiple modelsUsing multiple models

1 February 2000 4

Wellington Modeling EnvironmentWellington Modeling Environment

■■ Widely diverse set of portfoliosWidely diverse set of portfolios–– Insurance, binders, facultative and treatyInsurance, binders, facultative and treaty

reinsurancereinsurance–– Complicated insureds, cedants, and contractsComplicated insureds, cedants, and contracts

■■ Modeling part of the business processModeling part of the business process–– Underwriting feedbackUnderwriting feedback–– Portfolio risk assessment and managementPortfolio risk assessment and management

■■ Market environments – London and the USMarket environments – London and the US–– Fast response for clientsFast response for clients–– Worldwide portfolioWorldwide portfolio

1 February 2000 5

Complex Exposure ModelingComplex Exposure Modeling

How can I model these risks appropriately?How can I model these risks appropriately?

1 February 2000 6

QuestionsQuestions

■■ How can I describe this correctly?How can I describe this correctly?–– Are construction/occupancy classes enough?Are construction/occupancy classes enough?–– Are there special facilities vulnerability curves?Are there special facilities vulnerability curves?

■■ What happens to huge values?What happens to huge values?–– Are building, contents, and business interruptionAre building, contents, and business interruption

treated appropriately (clean room vs. assemblytreated appropriately (clean room vs. assemblyline)?line)?

■■ How do I handle a concentration of risk?How do I handle a concentration of risk?–– Are there critical internal links or dependencies?Are there critical internal links or dependencies?

1 February 2000 7

Things to Think AboutThings to Think About

■■ Understand any special coding options in theUnderstand any special coding options in themodel environmentmodel environment–– Methodology of development and applicationMethodology of development and application

■■ Models can not address everythingModels can not address everything–– Are the most important aspects covered?Are the most important aspects covered?

■■ Does the treatment of uncertainty account forDoes the treatment of uncertainty account forany potential differences?any potential differences?

■■ Are there other analyses available?Are there other analyses available?–– Comparative value of third-party analysesComparative value of third-party analyses

1 February 2000 8

Complex Financial StructuresComplex Financial Structures

1 February 2000 9

Financial Modeling Issues and OptionsFinancial Modeling Issues and Options

■■ Coding idiosyncrasiesCoding idiosyncrasies■■ Can I “fool” the model to do what I want?Can I “fool” the model to do what I want?

–– What are the consequences?What are the consequences?■■ Uncertainty/volatility measuresUncertainty/volatility measures

–– How are they carried through the construct?How are they carried through the construct?■■ Can I get at the answers for analysis outsideCan I get at the answers for analysis outside

of the model?of the model?–– Granularity of outputGranularity of output–– Availability of risk/volatility metricsAvailability of risk/volatility metrics

1 February 2000 10

Use a Model, See the WorldUse a Model, See the World

■■ International data practicesInternational data practices–– CRESTA zonesCRESTA zones–– Data format issuesData format issues

■■ Regional differences in the modelRegional differences in the model–– Geocoding optionsGeocoding options–– Construction practicesConstruction practices

■■ Market practicesMarket practices–– Coverage terms, deductible structuresCoverage terms, deductible structures–– Pools or other societal instrumentsPools or other societal instruments

1 February 2000 11

Pushing Data QualityPushing Data Quality

Good25%

Fair45%

Moderate20%

Poor10%

Good10%

Fair35%

Moderate30%

Poor25%

ExposureExposure Risk (EL)Risk (EL)

1 February 2000 12

Data Quality IndexingData Quality Indexing

DQI Insurance Reinsurance 1 High-res geocoding

Construction information Detailed exposure data Detailed analysis results

2 Moderate resolution Construction information

Aggregate exposure values Homogenous exposure type

3 Moderate resolution No construction information

Aggregate exposure values Variable exposure type

4 Poor resolution Low resolution aggregates

1 February 2000 13

Secondary/Supplemental LossesSecondary/Supplemental Losses

■■ Multiple types and sourcesMultiple types and sources–– Event-driven: Fire-Following EQ, Storm SurgeEvent-driven: Fire-Following EQ, Storm Surge–– Society-driven: Pools, Demand Surge, LAESociety-driven: Pools, Demand Surge, LAE

■■ Difficult to understand/quantifyDifficult to understand/quantify–– Variable incidence within observed cat eventsVariable incidence within observed cat events–– Some effects clearly occurred but difficult toSome effects clearly occurred but difficult to

measuremeasure–– Subjectivity creates widely divergent resultsSubjectivity creates widely divergent results

■■ Impossible to ignoreImpossible to ignore

1 February 2000 14

Addressing Secondary LossesAddressing Secondary Losses

■■ How are models addressing secondary losses?How are models addressing secondary losses?–– Basic methodologiesBasic methodologies–– Sequential impacts (add Demand Surge after FFEQ)Sequential impacts (add Demand Surge after FFEQ)–– Propagating uncertainty through the processPropagating uncertainty through the process

■■ Fitting into the work flowFitting into the work flow–– Underwriting vs. Portfolio analysisUnderwriting vs. Portfolio analysis–– Some aspects may require significant extra work orSome aspects may require significant extra work or

processing outside of the model environmentprocessing outside of the model environment

1 February 2000 15

Multiple Models: PracticalitiesMultiple Models: Practicalities

■■ Models have different…Models have different……coverage areas…coverage areas…data requirements and capabilities…data requirements and capabilities…coding and financial model features…coding and financial model features

■■ More work flow and resource issuesMore work flow and resource issues–– “Day-to-day” model vs. “second opinion”“Day-to-day” model vs. “second opinion”

THE RESULTS THE RESULTS SHOULDSHOULD DIFFER DIFFER

1 February 2000 16

Multiple Models: ResultsMultiple Models: Results

■■ Isolating drivers of differencesIsolating drivers of differences–– Technical capabilities vs. scientific opinionTechnical capabilities vs. scientific opinion–– Does one model just not do the same things asDoes one model just not do the same things as

another?another?■■ Areas of agreement, divergenceAreas of agreement, divergence

–– Can better describe areas of volatility within theCan better describe areas of volatility within theportfolioportfolio

–– Facilitate managing against a range of potentialFacilitate managing against a range of potentialoutcomes instead of to a magic numberoutcomes instead of to a magic number

1 February 2000 17

What Should We Push For?What Should We Push For?

■■ “More user-friendly”?“More user-friendly”?–– Who is the user, the operator or those who applyWho is the user, the operator or those who apply

the results in the business framework?the results in the business framework?–– Beware trade-offs in flexibility/performanceBeware trade-offs in flexibility/performance

■■ Transparency, transparency, transparencyTransparency, transparency, transparency–– Methodologies and reasoningMethodologies and reasoning–– Access to resultsAccess to results

■■ How best to support the businessHow best to support the business–– Be everything for everybody?Be everything for everybody?–– Concentrate on strengthening core practices?Concentrate on strengthening core practices?

1 February 2000 18

Conclusions: Our PerspectiveConclusions: Our Perspective

■■ Modeling Modeling supplementssupplements underwriting underwriting–– Many exceptions require flexible interpretationMany exceptions require flexible interpretation–– Only one aspect of a complex decision structureOnly one aspect of a complex decision structure

■■ Business goals drive model applicationBusiness goals drive model application–– Obvious, but easy to forgetObvious, but easy to forget

■■ Flexible emphasis/reasoningFlexible emphasis/reasoning–– Modeling different cases consistently?Modeling different cases consistently?–– Consistent frame work for treating different casesConsistent frame work for treating different cases

differently?differently?