While catastrophe modeling firms and insurers continue to work diligently to perfect their models, the recent spate of natural disasters underscores how much work is still to be done,
With models crucial in influence everything from the setting of reserves to decisions regarding reinsurance purchases, the need to get modeling right is critical. Nonetheless, the London-based the global reinsurance intermediary notes the insurance industry has recently witnessed evidence of models both under and over estimating loss estimates. For example, models overestimated the actual incurred loss in last year’s Chile earthquake. In contrast, other models underestimated losses due to hurricanes during the past decade by a factor of two or greater.
Accordingly, Aon says insurers must strive to understand how models perform and benchmark their performance against the industry as a whole. “Model evaluation is a crucial part of ensuring a company is adequately capitalized to meet its catastrophe exposures," says Paul Miller, head of International Catastrophe Management at Aon Benfield Analytics.
What is more, insurers now need to critically evaluate separate internal models for their relative strengths and weaknesses to appease regulators and rating agencies. As a result of the European Union's pending Solvency II regulations, insurers need to be able to demonstrate a robust understanding of the inner workings of the catastrophe models being employed. Ben Fox of the Model Evaluation team at Aon Benfield Analytics says the ‘black box’ approach to modeling is becoming less defensible.
“There has long been appetite for more transparent catastrophe models as components remain hidden from the end users." Fox says. "The proposed Solvency II regulation has further driven the need for more transparency as insurers are required to explain why they have chosen a particular model."
