Cat losses and Solvency II drive demand for better model evaluation

LONDON - Aon Benfield, the global reinsurance intermediary and capital advisor of Aon Corporation (NYSE:AON), will be highlighting how recent natural hazards – coupled with Solvency II – have fuelled demand for more in-depth evaluation of catastrophe models. At its International Analytics conference next week, the firm is advising how insurers can drill deeper than the loss estimates to understand how models perform and in turn influence decisions on their reinsurance purchases.

The insurance industry has recently witnessed evidence of models both under and over estimating loss estimates. While it is still too early to review the modeling firms’ performance in the recent earthquake in Japan, the models overestimated the actual incurred loss in last year’s Chile earthquake. This is in contrast to the US hurricane events* of the past decade where the catastrophe models have consistently underestimated the actual incurred losses, in some cases by a factor of two or greater. This illustrates the need for insurers to understand as much about uncertainty and the vendors’ assumptions before deciding upon capital reserves and reinsurance levels.

In addition, today’s Solvency II environment means users of model output need to be able to demonstrate a robust understanding of the inner workings of the ‘black box’ models.

Aon Benfield’s dedicated team of model evaluation experts works with insurers to assess the reliability of loss estimations and identify the strongest model for each territory and peril. The team combines natural hazard expertise and previous experience at the vendor firms to deliver the following evaluation process:
1. Initial overview of the new model loss estimates with a high level review of the model changes
2. In-depth analysis of the key components: the hazard, vulnerability and financial loss
3. Benchmarking individual insurers against the industry and advising on reasons behind any deviations
4. Knowledge sharing with clients to assist with their discussions with regulators and rating agencies.

Paul Miller, head of International Catastrophe Management at Aon Benfield Analytics, said: “Model evaluation is a crucial part of ensuring a company is adequately capitalized to meet its catastrophe exposures. Through our understanding of the robustness of each catastrophe model and assessing its uncertainty, insurers are armed with the necessary information to make appropriate adjustments to the models’ output.”

Ben Fox of the Model Evaluation team at Aon Benfield Analytics added: “There has long been appetite for more transparent catastrophe models as components remain hidden from the end users. The proposed Solvency II regulation has further driven the need for more transparency as insurers are required to explain why they have chosen a particular model. Until ‘open’ models – such as those from Impact Forecasting – are widely available, evaluation is the only way to drill down into the inner workings of these products. Without this insight, it is impossible to critically evaluate their relative strengths and weaknesses.”


Ends

Notes to editors
*The most recent Model Miss Study by Aon Benfield on U.S. hurricanes, completed in 2009 using RMS v. 9.0, showed that actual losses were approximately 1.4 times model estimates (40 percent model miss) for personal lines and small commercial lines business. For large commercial lines business, actual losses were over 2.0 times model estimates (100 percent model miss).


About Aon Benfield
As the industry leader in treaty, facultative and capital markets, Aon Benfield is redefining the role of the reinsurance intermediary and capital advisor. Through our unmatched talent and industry-leading proprietary tools and products, we help our clients to redefine success. Aon Benfield offers unbiased capital advice and customized access to more reinsurance and capital markets than anyone else. As a trusted advocate, we provide local reach to the world’s markets, an unparalleled investment in innovative analytics, including catastrophe management, actuarial, and rating agency advisory, and the right professionals to advise clients in making the optimal capital choice for their business. With an international network of more than 80 offices in 50 countries, our worldwide client base is able to access the broadest portfolio of integrated capital solutions and services. Learn more at aonbenfield.com.