Are Models No Longer The Cat's Meow?

Have property insurers become too dependent on computerized catastrophe models, and if so, what is the alternative, given the potentially huge exposures they face? Those were some of the provocative questions raised yesterday by one of the pioneers of cat modeling, Karen Clark.

Insurers have stopped thinking about risks independently, according to Ms. Clark, president and chief executive officer of Karen Clark & Company in Boston. You may be more familiar with her as founder of the first cat modeling company, Applied Insurance Research–later known as AIR Worldwide Corp. after its acquisition by the Insurance Services Office in 2002.

Ms. Clark is now a cat guru of sorts. Her consulting firm, according to her Web site, “helps senior executives and boards of directors make sure their companies have in place effective risk management processes that conform to best practices” when it comes to disaster exposures.

It's ironic that now that she's out of the business of cat modeling per se, she feels free to challenge insurer use of such technology to better assess disaster exposures.

Her message seems to be that cat models, while useful, are a blunt instrument, while emphasizing that underwriting should remain as much an art as a science. In other words, don't blindly follow the models, but instead treat each risk individually. Go with your gut, and use common sense.

Speaking yesterday in New York during an Association of Professional Insurance Women luncheon, Ms. Clark emphasized that models are not designed to replace underwriters, but instead are merely best estimates. They certainly shouldn't be the final word on which risks are acceptable and which are not, she added. (For Phil Gusman's complete coverage of the speech, click here.)

Weve become a modeling society, Ms. Clark said, noting that some insurers had confessed to her they followed whatever the models told them, even if the numbers don't look quite right!

That jives with what I heard in London last October at an ACORD forum, when underwriters admitted that many employed two or even three competing models–which rarely agreed on exposure–hoping to get a range and a comfort zone within which to safely operate.

Ms. Clark's candid speech and my own experience in London makes me wonder why insurers should even bother with computer models if they don't really tell them anything definitive about the risks they face.

The answer, I believe, is that the cat models, however flawed, are literally better than nothing, especially with insurers under tremendous pressure from rating agencies, stock analysts and their own senior managements, board members and shareholders to demonstrate they have a firm grip on such exposures.

What else could they do, buy a crystal ball?

I also think that insurers–burned by back-to-back monster storm seasons in 2004 and 2005–are also choosing to err on the side of caution, with the cat models giving them cover to take a more conservative approach.

A big part of the problem is that some major carriers, way before the extensive use of cat modeling, allowed themselves to become overexposed to windstorm losses in vulnerable areas, such as on Long Island and along the Gulf Coast. Again, the cat models merely provided some objective proof that by cutting back in heavily exposed regions, they were merely being prudent.

That said, Ms. Clark's main point is sound–that underwriters should be considering individual applicants and not rejecting all risks in a hot zone out of hand. Following two very quiet hurricane seasons, it might help restore some credibility with regulators and get consumer advocates off their backs if they demonstrate they have not become enslaved by a computer program, but are in fact making sound, case-by-case decisions.

They may not have much choice, as simply citing models to justify rash pullbacks in any specific area is unlikely to carry much weight with the industry's clients and critics, now that a cat modeling icon has let the cat out of the bag.

What do you folks think?