CATand Mouse GAME

As insurers keep a cautious eye on Washington, D.C., to see whether the federal government will extend the Terrorism Risk Insurance Act mandate beyond 2005, they also are looking at catastrophe-modeling tools to help them make smart moves in a risky business. Whether assessing natural disaster or terrorism, risk selection often is a bigger challenge than pricing.

By Robert Regis Hyle

Insurance is supposed to deal with catastrophe, but insurers found out all too well in 2001 there are certain events that just arent insurable in the traditional sense. We dont think terrorism is insurable on a traditional basis, says Jim McDonald, chief underwriting officer for ACE INA, the national and international property/casualty carrier. Theres simply too much catastrophic risk.

Even though the U.S. Treasury Department recently extended the Terrorism Risk Insurance Act (TRIA) make available provisions for federal coverage through 2005, there are concerns about what happens after that as well as to the policies written in 2005 that carry into 2006 and beyond. The clock counting down to the previous deadline had been ticking loudly. The act passed by Congress in the wake of 9/11 had a Sept. 1, 2004, deadline for extending through 2005 the requirement that insurers make terrorism insurance available.

Tony Sammur, senior vice president of Gen Re Intermediaries and head of the CAT modeling group, believes the insurance industrys successful lobbying efforts were aided in part by the mortgage lenders on some of Americas biggest buildings in the countrys biggest cities. [The bankers] need terrorism coverage on the properties for which they are providing loans, he says. In order for that part of the economy not to be affected, I think the government [has been] pressured into prolonging [TRIA] as it is.
TRIA has been working and will continue to work as a combined effort between the insurance industry and the government, notes McDonald. [Insurance] has the infrastructure that makes a combined public and private sector solution very effective, he says. The federal role should be to protect the solvency [of carriers] for large losses. Anything short of risking the solvency of an insurer, we should find the way for a private-sector pool in combination with the insurance companies own capital and the skin in the game by insureds.

To try to get a better handle on exposures, technology has been developed to create models to deal with potential terrorism risk just as catastrophe-modeling technology has been used to determine risk from natural disasters. There are three major catastrophe-modeling companiesRisk Management Solutions, AIR Worldwide, and EQECAT. They all have developed terrorism CAT models, but Sammur asserts the models are not mature enough in the eyes of some insurers to trust completely. That may change, he says. Its kind of like the advent of the natural peril models. Nobody really used them at first, but they caught on.

Day of Infamy

In the insurance industry, its easy to look at certain dates and recall how the industry has changed. September 11th is easy to remember because of its impact on the world and the insurance industry, but most insurance carriers dealing with property exposures in Florida will have little trouble remembering August 1992. That time period belonged to Hurricane Andrew, the most costly natural disaster in U.S. history with losses of $20 billion.
Prior to Hurricane Andrew, it was almost as if people were OK with using rules of thumb prevalent in the insurance industry to price risk and to manage it, says Sammur. They were satisfied with tracking their aggregate insured values, but after Andrew and a couple of publications by some folks in the actuarial field addressed the possibility that a single event could be a $50 billion event to the industry, it kind of woke people up. The world of scientific modeling opened to the insurance industry, and carriers were able to examine their exposure risk to certain events. [Insurers] now can estimate scientifically what their loss potential is using catastrophe models instead of just talking about a 100-year storm or a 250-year event, he says.
The modeling vendors are good, according to Todd Eyler, vice president of the research and consulting firm META Group, but most carriers arent ready to invest in such technology. They still are pretty much relying on their [reinsurance] brokers, he says. In many cases, the carrier will use the reinsurers models to analyze risks at the point of underwriting and after the fact to monitor their portfolios on an ongoing basis.

The risk modeling tools are an outgrowth of the relationship between the insurers and the reinsurers, Eyler believes. Reinsurers realize they are using the tools as a way to solidify relationships, he says. Only some large carriers purchase the software on their own, according to Eyler.
Predicting Losses

One such insurer with its own modeling tools is ACE INA, which uses the RMS software, McDonald says. We looked at the three modeling firms, and they all had good things to say, but the output is significantly different, he reports. They have different assumptions, so they predict different results. The key in the search is what is the probable maximum loss (PML). There are two bases of PML, he explains. One is probabilistic, and the other is deterministic. The probabilistic estimates are in line with what you get on natural catastrophes. You would be getting an estimate on your PML for an event that is assumed to occur over a specified number of years. The software basically answers the question, If you were to wait for X number of years, what do you think the expected loss might be on your portfolio?
The question that follows is whether the PML falls within the threshold of what the risk manager has told management and the board of directors and is going to be within their fiduciary responsibilities in terms of capital at risk, according to McDonald.

For insurers post-9/11, the issue has not been how to price terrorism coverage but whether the carrier can afford to write off the account. Pricing is something a lot of people always focus on, but for us, as underwriters, the real lesson of 9/11 has more to do with risk selection than pricing. Pricing actually is the last thing we worry about, he says.

One reason for that is pricing brings state regulators into play, and that often means political issues come into play. As an example, McDonald points to the discrepancies insurers deal with when regulators define terms and conditions. Property rates can be sensitive to given locations, ZIP Codes, and counties, whereas with workers comp, you have a statewide rating system, and you dont have the ability to exclude or limit terrorism coverage in any state. Therefore, your only issue in workers comp is whether youre willing to quote at all. There is no underwriting discretion.

Thanks in part to TRIA, pricing for the commercial property line has been going down in the past year. A study by Marsh found more insurers being active in the market and rates going down by up to 35 percent, McDonald reports.

Eyler agrees pricing has become a secondary consideration for insurers in the property line. You need to be comfortable with the riskthat you have the ability to analyze it and the ability to price it, he says. If youre not comfortable about those things, you should say no. Thats why underwriting is the most important thing an insurance company does. It determines how they use their capital.

Turning to Re

More than half of the primary property carriers in the country get their catastrophe modeling done through their reinsurer, according to Sammur. Some of the large national writers have licensed their own CAT models internally, but the vast majority have their brokers run the models for them, he says. Reinsurers are risk management consultants for most carriers. Thats how the business has evolved, says Sammur. The broker is now the primary source of CAT risk management consulting. Were not just providing the modeling service, we also tell them where they need to shed business and where they need to grow.

Hurricanes are the most predictable and annual form of catastrophe American insurers face, which is why so much of the focus is on Florida and Gulf States, but Northeastern writers have to examine their risks, as well. Sammur indicates the most recent models produced by RMS point to increased perceived risk levels (for a natural catastrophe) in the Northeast.

The CAT models look at storm possibilities in the Midwest and earthquake problems in California. With these areas, the models point out where an insurer has too large a concentration of risk. You are going to use the technology to help improve diversification or your spread of risk geographically, even in the Midwest, says Sammur.

Common Sense

All the technology in the world cant take the place of using old-fashioned common sense, according to Sammur. We tell our clients you dont want to be just dependent on models, you want to use common sense, too, he says. Mapping is a big part of that common senseyour proximity of risk.

Insurers have to look at each new risk they are asked to write. You dont want to write a bunch of commercial buildings on the same street where a major fire could take them out, Sammur says. Its really a combination of the science piece with common sense.

The terrorism models are similar in many ways to the natural catastrophe models in that they rely on the input from experts, he explains. Catastrophe models are based on information from meteorologists and geologists, while the terrorism models rely on input from ex-CIA, FBI, and Department of Defense staff who are experts in this field.

They try to attach probabilities of various attack modes and attack sites, and they categorize these into tiers, Sammur adds. [Risk modelers] have developed a top-down model where they are estimating the annual frequency of terrorism events, and from that, theyll do additional probabilities and the likelihood of where [those events] might occur. From these conditional probabilities, they branch out to the various attack modes and sites within those metropolitan areas. Its a pretty comprehensive model. The one truism of all this is, though, You cant assign a probability to a specific terrorist event, he notes. It would be difficult to do.

What Happens Next

McDonald is optimistic about the future, particularly now that TRIA has been extended. The Treasury Depart-ments decision to keep the TRIA make available provisions in place eliminates potential disruptions in the market. The turnaround on this subject has been amazing, according to McDonald. Six months ago, our senior government affairs person, Trish Henry, thought there was zero chance [it would be extended], he says. Theres no question TRIA has been a huge success. It has created supply, and over the last few years demand has increased.

Tech Guide: Risk Management, Modeling, and Actuarial Tools
AIR Worldwide
Boston, Mass.617-267-6645
www.air-worldwide.com

Algorithmics, Inc.
Toronto, Ont.
416-217-1500
www.algorithmics.com

@Global, Inc.
Golden, Colo.
800-419-4449
www.atglobal.com

Brightwork, Inc.
Chicago, Ill.
773-529-0465
www.aboutalyce.com

Camilion Solutions, Inc.
Thornhill, Ont.
416-346-3713
www.camilion.com

Checkfree Financial andCompliance Solutions
Owings Mills, Md.
410-902-2201
www.checkfree.com

CMS BondEdge
Santa Monica, Calif.
310-479-9715
www.cmsbondedge.com

Corporate Systems
Amarillo, Tex.
800-927-3343
www.csedge.com

COSS Development Corp.
Mequon, Wisc.
262-241-8989
www.cossdev.com

CSC
Austin, Tex.
800-345-7672
www.csc-fs.com

Delphi Technology
Cambridge, Mass.
617-494-8361
www.delphi-tech.com

Digital Sandbox, Inc.
Reston, Va.
703-390-9770
www.dsbox.com

Duck Creek Technologies
Bolivar, Mo.
866-382-5832
www.duckcreektech.com

e2Value, Inc.
Stamford, Conn.
203-9975-7990
www.e2value.com

Effisoft
Boston, Mass.
617-437-9600
www.effisoft.com

Entegra Corp.
Oakbrook Terrace, Ill.
630-613-7661
www.entegracorp.com

Envision Technology Solutions
Midvale, Utah
801-568-1818
www.envision-ts.com

EQECATOakland, Calif.
510-817-3100
www.eqecat.com

Explore Information Services
Eagan, Minn.
800-531-9125
www.exploredata.com

Fair Isaac
San Rafael, Calif.
415-472-2211
www.fairisaac.com

FJA-US
New York, N.Y.
212-840-2618
www.fja-us.com

Forensic Analysis &
Engineering Corp.
Raleigh, N.C.
919-872-8788
www.forensic-analysis.com

GenSource Corp.
Valencia, Calif.
661-294-1300
www.gensourcecorp.com

ICICI Infotech Limited
Vcashi Maharashtra, India
91 22 5592 8000
www.icici-infotech.com

Infoglide Software
Austin, Tex.
214-357-4636
www.infoglidesoftware.com

INSTEC
Naperville, Ill.
630-955-9200
www.instec-corp.com

Insurance Information Exchange
College Station, Tex.
800-683-8553
www.iix.com

International Security
Technology, Inc.
New York, N.Y.
212-557-0900
www.ist-usa.com

Ivega Corp.
San Francisco, Calif.
415-274-2699
www.ivega.com

Marsh USA
Los Angeles, Calif.
213-346-5828
www.marsh.com

Motion Computing
Austin, Tex.
888-682-2538
www.motioncomputing.com

MountainView Software
Layton, Utah
801-544-2446
www.claimzone.com

Portellus
Irvine, Calif.
949-250-9600
www.portellus.com

Risk Laboratories
Marietta, Ga.
678-784-4600
www.risklabs.com

Risk Management Solutions
Newark, Calif.
510-505-2500
www.rms.com

Risk Sciences Group, Inc.
Schaumburg, Ill.
800-619-0224
www.risksciencesgroup.com

RISKTRAC
Portsmouth, N.H.
800-294-3316
www.libertymutual.com/risktrac

RMIS/Lab
Hartford, Conn.
860-543-7341
www.rmislab.com

Safe Risk Management Systems
Baltimore, Md.
410-230-0022
www.saferms.com

SAS Institute, Inc.
Cary, N.C.
919-677-8000
www.sas.com

Searchspace
New York, N.Y.
212-422-5100
www.searchspace.com

SilverPlume
Boulder, Colo.
800-677-4442
www.silverplume.com

SOLCORP
Downers Grove, Ill.
630-960-4604
www.solcorp.com

Sungard Treasury Systems
Calabasas, Calif.
818-223-2300
www.treasury.sungard.com

TDM-Ltd.
Aberdeen, Scotland
44 1224 209 234
www.tdm-ltd.com

Thazar
Frisco, Tex.
972-377-1110
www.thazar.com

Valen Technologies
Denver, Colo.
720-570-3333
www.valentech.com

Valley Oak Systems, Inc.
Alamo, Calif.
925-552-1650
www.valleyoak.com

Vanguard Integrity Professionals
Las Vegas, Nev.
702-794-0014
www.go2vanguard.com

Worldinsure Limited
Quincy, Mass.
416-594-2172
www.worldinsure.com

Worldwide Testing andSecurity Services, Inc.
Clifton Park, N.Y.
518-371-8327
www.world-widetest.com