A change to a catastrophe model, like the latest revision announced by Risk Management Solutions, can influence the level of reinsurance purchased by companies and impinge on the rating process.
"If a company relies on only one model, it could have a big impact on its balance-sheet strength," said Thomas Mount, assistant vice president at rating agency A.M. Best Co.
Assuming a company buys reinsurance up to the minimum required for a 1-in-100-year wind event, and it used only one model whose results changed greatly after revisions, a company's overall financial strength may suffer, he said.
"The effects of a model change vary on a case-by-case basis," Mr. Mount explained. But it is not A.M. Best's intent to "automatically downgrade a company just because of a model change," he added.
The rating agency works with a company to assess how it will address the adverse effects of a model revision. The company can purchase more reinsurance, or it can outline a plan to cut back on exposure to reduce risk.
A.M. Best does not require the use of one particular modeling company, nor does it require the use of multiple models. Therefore, if significant revisions are announced for one model, the effect on the overall assessment of risk will not necessarily severely impact a company's capital position.
"Where there is the potential for significant increases in model results due to a model update, and the company has not yet run the [new] model, A.M. Best will apply a factor to the probable maximum loss to more accurately capture the current view of risk," the Oldwick, N.J.-based rating agency said.
(A.M. Best does expect that companies incorporate model updates "as soon as practical.")
A.M. Best specifically advises companies not to rely too heavily on catastrophe models. "As was evident in the past, an overreliance on models can be problematic," according to a briefing released by the company. "While catastrophe models provide an estimate, they cannot be expected to provide an exact loss figure."
This is one reason why a change in loss results due to a model revision is "not necessarily a strike against the company," said Mr. Mount. A.M. Best looks at other factors, such as the company's track record with other storms, he said.
Companies can also attempt to convince A.M. Best that their in-house PMLs (probable maximum losses) are better than the standard model assessments—or that one model fits them better than the other—in which case a weighted average can be used. The basic approach is to use a straight average of multiple models, A.M. Best explained.
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