Model results can empower buyers negotiating with underwriters on renewals
In the wake of recent allegations against insurance brokers, all parties–carriers, insurance buyers and brokers–need to more clearly define the costs and the extent of coverage proposed for a corporation.
Fortunately, sophisticated modeling techniques are available to risk managers and their brokers to provide an objective view of a company's catastrophe risk.
Thankfully, natural and manmade events capable of derailing a company's operations are rare occurrences. But the fact that these events can and do occur makes it necessary for risk managers to understand the events' likelihood in order to answer questions such as how much coverage to buy, what deductible level to choose and at what cost.
How an organization's loss potential compares with its tolerance for risk will also be a key consideration in providing answers to these questions.
A company with an extremely low tolerance for risk might buy enough insurance to cover even unlikely losses, such as the loss amount from an event with a 250-year return period. On the other hand, companies with a greater tolerance for risk might choose to buy coverage equal to the 100-year return period loss.
The latest generation computer models simulate thousands of years of earthquakes, hurricanes, severe thunderstorms, wildfires, winter storms, terrorist acts and other natural and manmade events. These are then superimposed over property exposures to determine the likelihood of one or more of these perils causing a loss.
The primary benefit of catastrophe modeling is that it provides a statistical measure of potential losses, so risk managers can more closely align their insurance buying with their organization's risk tolerance level.
Models also enable side-by-side comparisons of various scenarios–such as the probable cost of various risk transfer/retention strategies–that can help risk managers and their brokers decide the amount of the deductible as well as the optimal way to apply it.
For example, risk managers can more confidently determine whether a deductible should be a percentage of site replacement cost, a percentage of the aggregate loss, or a fixed sum–and whether it should be applied on an occurrence basis or capped annually.
The acceptance and use of catastrophe modeling among insurance and reinsurance companies is widespread, and nearly universal for the larger organizations. Thus, underwriters' recognition of the technology works in favor of insurance buyers who include model results with a submission.
Sharing model results with underwriters, particularly if analyses include a level of detail to which the underwriter doesn't normally have access, can be a powerful negotiating tool at renewal time.
Besides serving as a differentiator from other submissions, client-provided model results help reduce the uncertainty an underwriter may have about a portfolio's loss potential. For a given level of risk, the more uncertain an underwriter is about a portfolio's loss potential, the greater the premium. Including model results with a renewal submission can reduce the uncertainty, which will allow the underwriter to price a risk more favorably.
Beyond improving insurance renewal pricing, catastrophe models can improve information on which numerous business decisions are based. For example, they can:
o Reveal the impact of a sale of acquisition on an organization's risk profile when a risk manager is dealing with a large portfolio of properties
o Help to identify the contribution of each location to an enterprise's overall catastrophe risk.
The location, value and construction type of properties in question, and their relation to the existing portfolio, can significantly alter an organization's overall exposure.
o Help in determining if coverage renegotiation is warranted, and to quantify the appropriate rebate or additional coverage desired.
o Provide insight into more effective ways of managing exposure to catastrophe risk.
Model output presents a clear picture of a company's geographical distribution of exposures and key drivers of its catastrophe risk, including which perils, regions and lines of business have the greatest marginal impact on probable maximum losses. Such information can help corporations fine-tune growth strategies to manage future catastrophe loss potential.
o Be used to allocate the cost of insurance back to individual locations or business units. This type of analysis allows organizations to fully assess the net benefit of geographically diverse operations or assets.
While catastrophe risk has been a part of insurance purchasing decisions for years, catastrophe models enable risk managers to more precisely quantify and optimize their risk management strategy and work with their brokers to design insurance coverage to accurately match the corporate requirements.
Thomas O'Brien is a risk modeling consultant at AIR Worldwide Corporation, a catastrophe modeling company based in Boston, Mass.
"Underwriters' recognition of the technology works in favor of insurance buyers who include model results with a submission."
Thomas O'Brien
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