Cat losses and Solvency II drive demand for better model evaluation

Written by Staff reporter

Recent natural hazards, coupled with the drive for Solvency II compliance have fuelled demand for more in-depth evaluation of catastrophe models, says Aon Benfield.

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.

Paul Miller, head of International Catastrophe Management at Aon Benfield Analytics, said: “Model evaluation is a crucial part of ensuring a company is adequately capitalised to meet its catastrophe exposures.

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 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.”

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