NU Online News Service, Oct. 28, 9:44 a.m.EST

The extraordinary path of Hurricane Irene through various inlandregions of the Northeastern United States partly validates aspectsof the guidance provided by the new Atlantic Hurricane Model fromRisk Management Solutions.

RMS' Version 11 upgrade to its catastrophe model posited agreater likelihood of hurricane exposures beyond U.S. coastlines.The company recalibrated its model to account for the higherrisk-potential of a hurricane affecting a greater swath ofgeography—not just coastal properties, but inland regions.

AIR's upgrade to version 12 made similar strides in advancingour understanding of hurricane risks. For instance, AIR updatedwind damage functions based on the latest findings from theiranalysis of detailed claims data from recent hurricaneseasons. This resulted in increased inland loss estimates andthe addition of new states.

While the industry should applaud the increasing sophisticationof the information provided by catastrophe modelers, the models arenot a replacement for human ingenuity in the underwritingprocess.

Cat models only provide estimates of hurricane (or othercatastrophe) losses. The process is conceptually simple: generate asample event, follow it across the country, and simulate the lossesbased on both storm characteristics and policy conditions. Then, aggregate the results over thousands of years. However,there will always be a need for flexibility in assessing individualproperty risks and accumulated exposures in a particularregion.

Although some climatologists cite a “new normal” in hurricaneactivity—a greater propensity for windstorms to cause damage ingeographic areas formerly deemed “non-critical”—placing too muchemphasis on the catastrophe models fails to account for theplethora of other risk factors at play.

Yet, many insurance carriers seem to be doing just that—lettingtechnology via the models make the underwriting decisions for them.Why?

Part of this is due to the pressure from the rating agencies andreinsurers, not to mention elected officials and regulators. Standard insurance carriers, to a good extent, have their handstied. Their cost of goods sold has gone up, insofar as the capitalthey must have to address the higher apparent risk of theirproperty catastrophe exposures.

Why higher apparent risk? The risk of loss hasn't changed. Theassessment of that risk has. This is not a problem for the excessand surplus lines marketplace, which enjoys the benefit ofremarkable flexibility in its underwriting process andapproach.

Given the current upheaval in the property catastrophe market,with prices firming, underwriting terms and conditions tightening,and retail brokers shopping accounts left in the lurch, the E&Smarket has the rare opportunity to take the lead in developing aflexible underwriting solution to these challenges.

The market's greater freedoms are needed in this time ofvolatility, and there are significant business opportunities forwholesale brokers and E&S carriers that step up and assume thisvital role.

A Different Storm

RMS Version 11 was the consequence of information gleanedprimarily but not exclusively from Hurricane Ike—the thirdcostliest hurricane to make landfall in the United States.

RMS took the hurricane's atypical activity into account in itsunderlying calibration data and modeling methodologies, releasingVersion 11 this past February. Compared to Version 10, thedifferences are significant.

Whether new data increases or decreases risk estimates is beyondthe modeler's control—that's the job of insuranceunderwriters. As the organization attests, “We believecompanies should have access to all new and relevant informationknown to and reviewed by us so they can adjust underwritingdecisions and capital requirements appropriately. Thealternative would lead to compromised decisions and surprises whencatastrophes strike, and has associated liabilityimplications.”

Certainly, the insurance industry looks to AIR, RMS, and othermodelers to provide greater details assisting the underwritingprocess. But, in this case the new models have brought aboutsignificant changes in underwriting that pose serious challengesfor buyers of property catastrophe insurance, many of them inregions of the country heretofore considered to pose non-criticalrisk.

The new models have also made an impact on regulators, ratingagencies and reinsurers, compelling the standard insurance marketto review its risk aggregations and pricing. The recent changeshave resulted in extraordinary volatility in the homeowners andbusiness premises insurance markets, spurred on by both capital andregulatory concerns. We are at the beginning of a sea changein the underwriting treatment of these risks, one with enormoussocial and economic implications.

This puts the spotlight on the underwriter, and the level ofskill and experience that he or she brings to bear on the risk.Insurers that employ experienced property underwriters with theskill and expertise to evaluate the plethora of weather-relatedrisks and non-disaster exposures confronting building structures ofdifferent type, age and condition will likely see the models as asingle part of the underwriting process.

What does this mean for brokers and theirclients?

This difference in property underwriting has implications forthe broker-client experience. A wholesale broker or managinggeneral agency that partner with a carrier who has expert propertyunderwriters will find that customers are more satisfied with theexperience. This assists greater customer retention rates.Similarly, the ability of a carrier to tailor the policy to theclients' needs will result in a more satisfied customer.

Some underwriters place too much emphasis on a singleunderwriting criterion, such as a sophisticated (and perhapswell-intentioned) catastrophe model. Rather than assess thewealth of historical data drawn from each carrier's respectivebooks of business, a single piece of advice has prevailed.

Instead of evaluating a particular property catastrophe riskinsofar as the many primary and secondary modifiers that moreexplicitly tell its story, a single catastrophe model is beingrelied on for the tale. The human approach to underwritingseems to be disappearing.

Financial Flexibility

Quality data to drive underwriting decisions can be accumulatedand assessed.

This does not mean that RMS Version 11 and other stringentmodels from AIR Worldwide and Eqecat should be discounted. The moreinformation the better the underwriting process, which leads toimproved decision-making. And that's the point—people makedecisions, not machines.

People drive ingenuity, not institutions. People are theentrepreneurial engine of an insurance company's growth, notmachines, not technology.

RMS and other modelers take into account such risk modifiers asa premises' construction quality, the type of roof framing, the ageand anchoring of roofs, and the wind resistance of windows, amongmany other considerations. This is valuable insight, but untilhuman eyes discern and digest these risk factors they remain piecesof information.

Underwriters must evaluate property catastrophe risk on alocation-by-location basis, digging into the detailed constructiondata. Catastrophe models tell the general story, but thereare deviations to the standard. The models are telling, but theyare just one tool, not the entire toolbox.

Certainly, disciplined underwriting is required, given the “newnormal” of climatic events. Regions formerly considered“non-critical” no longer escape the brunt of today's hurricanes.It's a new world.

At the same time, these geographic areas are simply not at therisk level of truly critical regions like the Gulf Coast and theFlorida shoreline. Intellectually, these exposures do appear to begreater, and the path of storms obviously is atypical—a tornadohitting Massachusetts is an eye-opener for sure.

The market must price for these enhanced exposures, and whenregulators do not permit such clear-thinking actions, the E&Sindustry must step forward.

In the volatile market environment, the flexibility toappropriately price the perceived risk exposure is vital. Theindustry can take the lead in forging a “new normal” withunderwriting expertise, refinement and diligence.

Michael J. Carr, is senior vice president, excess andsurplus lines/property, at Liberty InternationalUnderwriters