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Specialty underwriters at a crossroads

Contents

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EDITORIAL Report editor Helen Yates [email protected]

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Specialty UnderwriterS SUrvey

4 Specialtyunderwritersatacrossroads Reactionsresearchrevealsthestateofunderwritingriskmanagementwithinspecialtylines

cat Modelling

9 Thenewapproachtocatmodelling “Opensource”and“transparent”arethetwobuzzwordsincatastrophemodellingin

2013.HelenYatestakesalookathowtheapproachischangingandwhatitmeansforspecialtyclasses

interview

12 Thecomplexitiesofspecialtylines RussellGroup’smanagingdirectorSukiBasiexplainswhyspecialtyclasseshavehistorically

nothadassophisticatedanapproachtounderwritingriskmanagementascatastropheclasses

interview

14 Managingreal-timeriskexposure HemantShah,chiefexecutiveofRiskManagementSolutions,explainswhathethinksisdriving

achangeinapproachtounderwritingwithinspecialtylines

IntroductionFor the better part of three decades property-catastrophe underwriters have been able to use catastrophe models to help price the business and test their portfolios. Specialty underwriters have lacked such probabilistic tools and as such, each re/insurer has developed its own specialised approach to underwriting risk management.

But several factors are forcing a change. Competition is a big one at a time when capital is flooding into the industry. Those with a more sophisticated and analytical way of approaching specialty underwriting would argue they have the competitive advantage.

Meanwhile, regulators increasingly demand realistic return period figures, such as a one-in-200 year event. And while it is debatable whether a marine, energy or aviation book could generate a loss on the same scale as a property book, recent cat events have surprised insurers with their high level of specialty claims. Ten percent of the insured loss from Hurricane Sandy fell to marine insurers. It may not sound overly significant but it is by far the costliest catastrophe ever for the marine sector in absolute terms.

Deepwater Horizon was another wake-up call for specialty insurers, revealing some carriers had more exposure to the blowout event than they had initially realised. It drove many to reassess how they measured their aggregates, looking for new approaches that would better reveal concentrations of risk across classes of business.

While it is clear from our research that some companies are leading the way by investing in such tools, there is a long way to go. As an industry, these pockets of excellence remain in their silos. While the use of probabilistic models is impossible for most specialty classes, broader application of deterministic scenarios and third-party systems could help level the playing field.

HelenYates,reporteditor

4 Reactions Insurance Market Study: Specialty underwriters 2013 www.reactionsnet.com

Throughout the months of July and August 2013 Reactions, in partnership with Russell Group, conducted a piece of qualitative research on underwriting risk management within specialty classes (including aerospace, energy, marine and non-marine lines of business).

We interviewed specialty underwriters, heads of exposure management, chief risk officers and catastrophe risk specialists in an effort to gauge the varying levels of sophistication of approaches within specialty classes. The companies that took part ranged from major multi-line European and Lloyd’s re/insurance companies to smaller niche players focusing on one or two specialty classes.

Underwriting risk management is the skill with which risks are underwritten by insurers and reinsurers. It includes processes such as aggregate monitoring (ensuring you don’t have too many eggs in one basket), risk pricing (making sure the price adequately

reflects the risk being underwritten) and portfolio modelling (building a balanced portfolio of business that does not leave the carrier overexposed in the event of a loss).

For two decades, underwriters in property-catastrophe classes of business have had catastrophe models at their disposal to help inform their underwriting decisions. While the models are far from perfect, they have nevertheless offered a probabilistic, or stochastic, tool with which aggregates can be monitored and portfolios tested. This has helped dictate how much capital carriers need to hold in order to write a certain level of business.

Specialty classes have lacked such analytics and typically, underwriters have taken a more conservative view in the absence of probabilistic tools. Often specialists in their own field, be it political risk, fine art or aerospace, underwriting within specialty classes has often remained as much of an art as a science.

There are a variety of approaches to underwriting risk

Specialty underwriterS Survey

Specialty underwriters at a crossroadsreactions research reveals the state of underwriting risk management within specialty lines.

Reactions Insurance Market Study: Specialty underwriters 2013 5www.reactionsnet.com


management within specialty classes, varying by line of business as well as re/insurer. Here, deterministic scenarios such as realistic disaster scenarios (RDSs) are typically used to test portfolio resilience. Perhaps unsurprisingly, while some carriers have an increasingly technical approach to processes such as aggregate monitoring, others have further to go.

Some of the companies that took part in the survey were:• Amlin• Cathedral Underwriting• Hannover Re• Lighthill Risk Network• Montpelier Re• Munich Re• Partner Re• RMS• R&V Versicherung • XL

Chapterone:DrivingachangeAmong the underwriters and risk specialists we interviewed it was clear that both internal and external factors are driving a more sophisticated approach to underwriting risk management in many classes of business. Large natural and manmade catastrophe events, including Deepwater Horizon and Superstorm Sandy, were a wake-up call for specialty underwriters who were surprised by both the size of the claims and – for some – their exposure to the loss.

“Within specialty classes it is typically very high value lines you put down and sometimes it only takes one or two of these losses and all of a sudden you could be in front of your CRO very quickly,” said the group underwriting exposure manager at a global re/insurer. “People should be better aware of the kind of losses that come out from these events for specialty classes. There’s more emphasis on property because of premium numbers – because that’s going to drive the loss if a big event was to happen.”

“I don’t think specialty is less of a priority, but because the driving force is property the inclination is to look at those classes first,” he added. “But you’re still going to get losses from specialty classes which could add up to quite significant amounts.”

2011 and 2012 were two of the costliest years for the marine insurance market as a result of events including the Japanese earthquake and tsunami in March 2011, the Costa Concordia cruise ship disaster and Superstorm Sandy. Claims from Sandy are set to reach $25bn, according to Munich Re, making it the third most costly US hurricane of all time. It overwhelmed marine insurers with claims estimated to fall somewhere between $2.5bn and $3.5bn.

“There’s a big Lloyd’s project looking at warehouse recognition around the world,” revealed one respondent. “Post Hurricane Sandy there’s an increasing realisation that warehouses – typically a marine risk – is something that should be treated like a property cat risk.”

Of all the specialty classes marine remains the “poor relation” in terms of its approach to underwriting risk management, thought some respondents. “I am working on a project looking at ship

“In specialty we have become a bit more precise and granular in how we analyse every class of business. If we take offshore energy business, over the last five years we’ve invested in building our own aggregate tracking tool. Most of the development has been on those specialty classes from an aggregate control point of view, which then leads on to pricing and portfolio modelling.”Head of global specialty at a top five global reinsurer

“Property is being done quite well and therefore the focus tends to shift to specialty classes where it’s not done quite as well. It’s improving but it’s not in the realms of property.” Group underwriting exposure manager of a global re/insurance company

Summary of key findings:

SpecialtyunderwritersaretakinganincreasinglysophisticatedapproachInternal and external factors are driving a more sophisticated approach to underwriting risk management in many classes of business.

ThereisagrowingrolefordeterministicscenariosSome carriers are developing their own realistic disaster scenarios (RDSs) to test portfolios and better monitor aggregates.

Standards,datasharingandtransparencyareessentialCommon standards to help underwriters code each risk will help insurers build a more detailed picture of the underlying risk. However, there is a reluctance to share too much detail.

Theroleofthird-partyprovidersUnderwriters are welcoming more data and better scenarios with which to test their books of business and are looking for solutions from a growing number of third party providers.



and container movements and values around the world and the frequency of collision,” revealed one risk specialist. “Some people think that’s fantastic and some people say: ‘Why bother? We don’t need it.’”

The Deepwater Horizon disaster prompted more scrutiny into how accumulations are assessed for offshore energy and energy liability classes. After the deadly blow-out on the Macondo Well on 20 April 2010 53,000 barrels of oil a day leaked into the Gulf of Mexico over a three-month period. BP set up a $20bn fund to compensate Gulf-area victims and insurance claims rose to over $3bn.

“You could have had the owner and the operator of a rig, and the employees on the rig, you could have had the pipes, the well, the blowout preventer, the cement, the contractor putting in the cement and the 200 other companies who were all pulled into that type of scenario,” said the head of enterprise risk aggregation at a global re/insurer. “The question is: how do you monitor and how do you get underwriters to think about that type of scenario?”

“I worry the brokers are restricting the amount of data that could be made available,” he added. “I did an analysis for our

inwards reinsurance book and I looked at every single bordereaux that had been supplied by our clients to the offshore market. There were companies saying, ‘Our maximum exposure to this rig is x,’ but when I looked at the data – which the broker had provided and cleaned up – the exposure wasn’t ‘x’, it was something like three times ‘x’.”

GrowingrolefordeterministicscenariosRecent losses within specialty classes have driven demand for a better set of deterministic scenarios, with some of the larger carriers developing their own realistic disaster scenarios (RDSs) to test portfolios and better monitor aggregates. “I’m not sure how many people had a Deepwater scenario as a standard RDS,” said the enterprise risk aggregation expert. “Lloyd’s has an oil rig explosion and you could have had a tanker bumping into an oil rig or a cruise ship, but what I’m trying to build evolves out into a casualty clash EP curve type scenario.”

Several interviewees revealed they were building their own internal scenarios to complement existing RDSs, such as those at Lloyd’s, which have been around since the mid-1990s. “Realistic disaster scenarios are a good underpinning to utilise,” added the president of a Bermudian reinsurance company. “We’re trying to judge the future and in order to do that there needs to be several different techniques brought to the table, all of them constantly being amplified and changed based on added knowledge coming through.”

The challenge for specialty insurers, under frameworks such as the UK’s ICA regime and Solvency II, is to come up with realistic return period figures – most commonly for a 1-in-200 year event, according to the chief risk officer of a European reinsurer. The second challenge is to make a judgement on whether the scenario being tested could actually occur in the real world.

“The RDS logic is better-grounded than making some wild assumption about the annual frequency correlations – which to some extent you can do with natural hazards – but within specialist classes is hard to do,” says one risk specialist. “The question is how much capital do you hold against that? That requires you to take a view as to how often such a thing could occur. How often is something like Deepwater Horizon going to occur? Can anyone know the answer to that? Personally I don’t think you can.”

One of the difficulties in monitoring aggregations across a business is the silos that exist within insurance groups, particularly within specialty lines. Unwanted accumulations can build up across departments and classes of business if there is no effective way of monitoring these. Aggregate control tools exist to prevent this from happening (both proprietary and third party). However plenty of carriers have yet to get a good handle on it, according to our respondents.

“There is a lot of activity going on with big global clients in the US, in the Bermuda market and London market and the awareness of [underwriting risk management] has increased dramatically. From my observation one of the triggers for this increased activity was Deepwater Horizon. A lot of insurers found themselves with a lot of participation on this platform that they were not even aware of and several of our clients were really surprised. Everybody was thinking it was so diluted in the market that it wouldn’t hurt them. It turned out that although it was diluted, some companies took a real hit because they just didn’t know what was on their books.”Head of casualty facultative at a European reinsurer

Probabilistic – 25%

Lloyd’s RDS – 17%

Internal deterministic scenarios – 33%

Other portfolio stress tests – 25%

How do you incorporate specific scenarios within your aggregate monitoring?

MacondoWellblowout



“If you have several papers writing on the same risk and you don’t do a real consolidation on this you can end up with a claim which is beyond your risk tolerance, and that’s what makes the whole thing a concern for risk managers,” said the head of casualty facultative at a global reinsurer.

“You would assume that for an insurance company it would be best practice to have something like this in place, but risk managers are really concerned,” he continued. “I don’t know any of the big global companies that have a system in place that is working 100%. You always have some disruption somewhere along the communication chain so that you don’t know what you have on your balance sheet in the end.”

Systems,dataandoutsourcingSeveral respondents said that better coordination across the market was needed. Common standards to help underwriters code each risk will help insurers provide more consistent and detailed information on the underlying risk. “What we’re doing is at the source system, when a policy is written, we’re asking the underwriter to put in one industry code at the highest level of granularity to tell us what they’re concerned about when they’re writing the risk,” said the head of enterprise risk aggregation. “What I’d like to see is a more consistent way that the market thinks about these industry classifications.”

Despite these calls for better standards, data sharing and transparency there was an obvious reluctance to divulge too much detail about individual approaches to aggregate monitoring, pricing and portfolio modelling. It appears that those re/insurers taking a proactive and sophisticated approach to underwriting risk management within specialty classes are unwilling to lose their competitive edge.

Embarrassment could be another reason some carriers may be reluctant to discuss their approaches in this area, suggested one respondent. “Over the last 10 years I was involved in creating a standard for offshore risk aggregation,” says the head of global

specialty lines at an international re/insurer. “I’ve talked to some of my competitors in those days and my observation is that there is a state of the market which is suboptimal. While on the face of it we show that we have the ultimate high-tech way of looking at aggregates, a lot of people suffer and they do not necessarily want to show that as a weakness.”

It was corporate policy for a number of respondents (particularly those from large global players) not to outsource their underwriting risk management. Those that would consider

“You get some big losses on the specialty side… Recent events tell you that. You don’t typically need to have a huge frequency of events to have a big loss – you can have one big loss or a big line on it and it eats into your profit. Things like the Costa Concordia and Transocean, and in aviation you only need one or two hull airline losses. Marine cargo took big hit from Superstorm Sandy.”Group underwriting exposure manager of a global re/insurer

“The black swan is hiding better in the specialty lines than in the traditional lines.”Chief risk officer of a global re/insurer

“My largest surprise so far was the offshore marine part of Hurricane Katrina back in 2005 – especially the portion of the offshore marine part which was caused by business interruption. I didn’t have this on my radar and I think the entire industry didn’t have this on their radar. The property damage was not too bad but the BI loss following this hurricane was a real event.”Chief risk officer of a global re/insurer

Exposure rated – 27%

Loss experience – 36%

Stochastic – 18%

Loss simulation – 18%

Which of the follow techniques are used for pricing?

Major losses – 60%

Competition – 10%

External pressure – 30%(eg. regulation/market-wide standards)

What external factors are driving a more sophisticated approach to underwriting risk management within specialty classes? PartialsinkingofCostaConcordia



an online hosted service agreed that this would be most suitable within aggregate control. Risk pricing and portfolio modelling are generally considered too sensitive to consider third party hosting.

“I don’t think the portfolio modelling would be something we would outsource,” said the head of global specialty. “As far as the aggregate control and the primary part of the pricing – we don’t mind. The appreciation of the ultimate price is very personal – it’s very difficult to outsource that.”

“We do things very well ourselves and unless there was something out there that would help us enormously we wouldn’t just swap one product for another product,” added the group

underwriting exposure manager. “Portfolio modelling you’d want to keep inhouse. If there was comfort it would be around aggregate control where you might consider outsourcing.”

The majority of respondents said they would welcome more data in the industry – quality data from cedants and insureds, but also useful third-party data to help better understand and analyse the risk. “The largest danger is data quality, to be honest with you,” said the chief risk officer of a global re/insurer. “Gaming the system by cedants is one of the largest dangers. The cedant often knows where in the dataset they’re providing to us average line values – because providing real values would increase the price. Data quality as such is one of my biggest issues.”

“As always, it will take another plane, another market moving event before people say, ‘I need to have this particular piece of data,’” added the head of enterprise risk aggregation at an international re/insurer. “It is mind boggling that insurers can provide reinsurers with these huge data dumps when modelling property catastrophe but then refuse to give them a bordereaux of who their largest risks are.”

Depending on the class of business – be it aviation, energy, marine, political risk or casualty classes – external data providers can make a real difference, thought our respondents. “For property you have the cat models, the brokers help on certain things offering databases specific to aviation and marine, for political risk there are consultancies – it varies and there’s a wealth of information we use,” said the group underwriting exposure manager.

Within specialty lines it is clear that underwriting remains as much an art as a science. Overwhelmingly, specialty underwriters continue to have a vast experience and proven record. Third-party data is only useful if it is understood and analysed by an expert.

However, these underwriters are welcoming more data and better scenarios with which to test their books of business. “There is a changing culture in the insurance market where increasingly we’re looking to a more diverse set of suppliers of models and data,” added a risk specialist. “That means there are more people coming out the woodwork who have a range of solutions in specialty classes, particularly focused on underwriting. Those third-party providers obviously need to know that there is a marketplace for them. It’s about getting the critical mass and parties together to enable this to happen.”

ConclusionAn increasing number of insurers and reinsurers are taking a more analytical approach to how they underwrite specialty lines. While there are numerous drivers for this, recent big losses that have hit specialty lines such as marine and energy are an important one. It is clear from events such as the Thai floods in 2011 that the world is increasingly interconnected and that a natural catastrophe or financial collapse can impact multiple classes of business.

Having developed sophisticated probabilistic models and scenarios to test property lines of business, it is natural for companies to now want to extend some of these best practices to their specialty accounts. However, a probabilistic approach is poorly suited to specialty classes where there is a lack of data and where it is unlikely that past claims can help predict future claims.

Deterministic scenarios such as RDSs are a better means of stress testing and benchmarking portfolios. These are increasingly being developed within organisations, although it is clear there is a need for common standards and solutions from third-party providers. l

“I’m a believer that aggregation tracking doesn’t give you a competitive advantage – it’s the way you assess risk that gives you a competitive advantage. A lot of people don’t make the difference between aggregate tracking and pricing. So that might be another explanation why people don’t necessarily want to share things, because it might give ideas to other people.”Head of global specialty lines at an international re/insurer

“The aggregate control is the least problematic one (to outsource) because the methods you apply there are fairly simple. For the aggregate control you’re not really giving away information to how the methodology is done. However, each of the components is of such criticality that you’d only really consider third party hosting if you’re sure it’s really safe and in good hands.”Aviation treaty underwriting at a global re/insurer


The catastrophe models have shaped the approach to underwriting risk management within property classes of business over the past three decades. During that time just three companies have dominated catastrophe modelling – AIR Worldwide, RMS and Eqecat. But change is afoot. More effort is being made to understand the uncertainty inherent in model results. In addition, new players are entering this space, offering an alternative approach.

Developed in the late 1980s, the use of cat models in the industry gained significant pace in the aftermath of Hurricane Andrew in 1992. Over this time the models have improved considerably, benefiting from improvements in computer science and better data on both the hazard and the underlying risk.

ModelfrustrationsHowever, in spite of this improvement there are limitations. The models are largely opaque and can differ considerably. When RMS 11 came out in 2011 its view of inland storm risk was ramped up considerably from previous model versions with the result that some companies’ exposures increased by 100%.

Another often-voiced complaint about cat models is the over-reliance on their results. Catastrophe events over the last five years have shown that even in the case of modelled perils, reality is often quite different from the model view and hence, that over-reliance on the models is dangerous. Last year’s Superstorm Sandy, the culmination of various weather systems including an extra-tropical cyclone, failed to match 100% with any events contained in US windstorm models.

“There has been a tendency for companies to underwrite using the catastrophe models over the last 20 years and more recently, with the events of 2011 and RMS version 11, there’s been recognition that there has been this overreliance on the models and they’re really not the right tools,” says Karen Clark, founder and chief executive of Karen Clark & Co and founder of cat modelling agency AIR.

“Catastrophe models are great for doing an aggregate portfolio analysis but they’re really not the right tools for a solvency issue, for pricing an individual account and they’re not the right tool for underwriting,” she adds. “They were never designed with that in mind.”

cat Modelling

The new approach to cat modelling“open source” and “transparent” are the two buzzwords in catastrophe modelling in 2013. Helen yates takes a look at how the approach is changing and what it means for specialty classes.

TheaftermathofSuperstormSandyonManhattanBeach,October2012


cat Modelling

Back in 2011 the Thai floods were an unmodelled peril which took many by surprise. In addition to the sheer size of the loss (the event cost re/insurers between $15bn and $20bn, according to Guy Carpenter) it also demonstrated the interconnected nature of today’s world. Industrial parks hit by the floods caused supply chain disruption around the world in a number of sectors – notably computing, automotive and electronics.

This was also a characteristic of the Japanese earthquake and tsunami. And while Japanese earthquake is a well-modelled peril, none of the models contained an event of that magnitude. Also within the Asia-Pacific region there were significant losses associated with liquefaction after the second Christchurch earthquake, a secondary earthquake characteristic that was not captured by the models.

“The impact of business interruption is something that’s come out of Sandy and the Thai floods,” says Dickie Whitaker, director of the Lighthill Risk Network, project leaders of the Oasis Loss Modelling Framework. “Everyone is focused on business interruption. This is driven by an increasing desire to answer questions about complex risks and looking at better ways of doing it. It is part of a trend in the marketplace and it isn’t particularly losses driving it.

“We’re moving from an environment where the global insurance and reinsurance community have trusted these big model providers to do what they do without really having any transparency into how they’re doing it. The trust that was originally conferred on those organisations has diminished significantly.

There are too many unanswered questions when you don’t have transparency.”

UnderstandinguncertaintyGuy Carpenter thinks modelling firms need to lead the discussion about uncertainty despite the apparent competitive disadvantage of transparency. In a paper titled, ManagingCatastropheModelUncertainty, it explains that a band of uncertainty exists around the output of any cat model, which paints a more realistic – albeit less precise – picture of cat risk.

“Despite considerable refinement of the models over the decades, uncertainty remains – and it is a significantly bigger factor than many users may recognise,” states Guy Carpenter. “Advances within the modelling industry since 1999 have indeed reduced the width of the uncertainty band, but the consideration of smaller areas of geography only introduces additional uncertainty,” it adds.

Oasis is positioning itself as a new way of modelling catastrophes, allowing users to fully test uncertainty in model results. It is providing the simulation and financial module but teaming up with a line-up of other third-party data and analytics providers (including the UK Met Office, University College London, Karen Clark & Co, JBA Risk Management and Perils AG) to bring a flexible and transparent approach to modelling.

“Part of the Oasis message is: Don’t blindly use these models,” explains Whitaker. “We’re giving people permission to say I’m not going to build an overly clever stochastic model to solve this problem, I’m going to get some data and do a deterministic scenario and I’m going to make underwriting judgements based on that because given the paucity of information and uncertainty around that issue, it’s the best way of solving that problem.”

It has potential uses within specialty classes, particularly with the use of deterministic scenarios. The challenge, thinks Whitaker, is to stimulate the new marketplace by getting all the different parties together. Many organisations with useful data and analytics have no idea there is growing demand for their expertise within the industry, he explains.

“There’s nothing wrong with using a deterministic approach,” he continues. “Nobody is going to buy a clever solution for a

“Catastrophe models are great for doing an aggregate portfolio analysis but they’re really not the right tools for a solvency issue, for pricing an individual account and they’re not the right tool for underwriting. They were never designed with that in mind.”Karen Clark, founder and chief executive of Karen Clark & Co and founder of cat modelling agency AIR

FloodinginNewOrleansfollowingHurricaneKatrina,August2005


cat Modelling

complex area like political risk or terrorism unless you’ve got full transparency. I do think in many of these cases we need groups of organisations to get together to articulate what their problems really are, so that some of these new providers can provide the solutions.”

He adds: “We are talking to one casualty organisation about putting casualty into Oasis. We’re also trying to develop something called the Amazon for data. This is a data repository for models and data where if you want to find out if you’ve got something on warehouses, marine risks or property cat risks or anything to do with that you can go to one place and look it up by peril or country and get an answer.”

In her product RiskInsight, Clark has taken realistic disaster scenarios to the next level. “Some people have called our characteristic events ‘RDSs on steroids’,” she explains. “It’s basically a more sophisticated way to accomplish what [the industry] is trying to do with the RDS approach. Let’s say I’m interested in a one-in-100 year loss. We look at every place along the coastline from Texas to Maine and say, at every landfall point, ‘What would be the 100 year event?’”

“In Texas and south Florida that would be a category five hurricane, but in the north-east it would be a weaker storm – say a category three storm,” she continues. “So we have landfall points for hurricanes every 10 miles and at every landfall point there’s the 100-year event. And it takes 300 of them to cover the whole US. So it’s a happy medium between RDSs (of which there are five at Lloyd’s) and 20,000 events from a model, which takes an enormous amount of time to run. So this is the balance between the two.”

Clark believes the characteristic event approach could be applied successfully to specialty classes. “It’s the right way to go, because when you’re talking about political risks or liability risks there is no way you can develop a credible catastrophe model,” she explains. “We just don’t have the data and a lot of the liability risks are not going to be things that have happened in the past, they’re going to be something new. We’re not going to have another asbestosis.”

She adds: “RiskInsight is an open platform so you can create scenarios for anything. You can create a Thai floods scenario, a marine scenario – potentially an aviation scenario – our clients can create virtually any kind of scenario they want and then apply the damageability. Our platform could also take in scenarios that are developed by other entities.”

MappingacasualtycatastropheOne company that is close to developing a model for casualty classes of business is Arium Risk Architecture. Its network-based platform allows underwriters and risk managers to better understand casualty accumulations and hot spots, as Robin Wilkinson, product development director of Arium, explains.

“It starts from a different place than a property model, for the very obvious reason that casualty risk is a very different risk from a property-cat risk. For one thing you don’t really know what the peril is going to be – they’re hard to predict. So instead of starting with a peril we’ve got to start with a portfolio.”

She continues: “We’re using the power of networks, which is very new to this industry and it’s been used in the banking industry, looking at connectivity between the banks. We’ve got some government data about who trades with whom in the entire economy and that’s at quite a granular level on an industry basis. The theory is it’s the connected activities that lead to connected liabilities, and that’s where we’re looking for accumulations.”

She adds: “Then we’re overlaying that with a particular portfolio along with factors that affect the propensity to have a casualty catastrophe. And we can start exploring the potential for accumulations within that portfolio. It will also highlight hotspots – areas where there lots of highly interconnected, clustered highly-rated risks with the potential for a casualty catastrophe.”

She gives an example of meat contamination and how it might cascade through the industry to impact seemingly unrelated risks, for instance meat processing and hospitals. There are other potential applications, including modelling supply chain/contingent business interruption exposures. While it does have a stochastic element she is quick to point out there is a large band of uncertainty and it is primarily intended as an exposure management tool.

Such initiatives should bring more transparency to catastrophe modelling and offer wider scope for scenario testing. They also promise to broaden the toolkit for specialty underwriters, allowing them to better benchmark their portfolios and monitor risk aggregations across all classes of business. While the traditional Lloyd’s RDS may only be a starting point, it remains a good place to begin.

“Models are getting better and in so doing are highlighting uncertainties and the scope for judgement,” says Dr Peter Taylor, technical director of the Oasis Loss Modelling initiative and founder of the Lighthill Risk Network. “The information we’re talking about aids that judgement so even though it may not be fully probabilistic, it still makes a big difference.” l

HelenYatesisafreelancejournalist

“Casualty risk is a very different risk from a property cat risk. For one thing you don’t really know what the peril is going to be – they’re hard to predict. So instead of starting with a peril we’ve got to start with a portfolio.”Robin Wilkinson, product development director of Arium


The specialty classes deal with unusual risks that tend to have high severity exposure, volatile loss experience and are largely customised underwriting solutions placed through brokers into a co-insurance market. Lloyd’s of London leads many of these classes, examples of which include aviation, space, marine, specie, offshore energy, political risks, professional indemnity and casualty. Catastrophe classes on the other hand deal with natural peril risks such as wind, storms, earthquakes, floods and bushfire. Unlike catastrophe classes, specialty classes tend to have long-tail liability exposure as claims are complex and can take time to develop.

Given that these risks are insured and reinsured into subscription markets, a conveyor belt of information is required between clients, brokers and underwriters encompassing exposure, risk and claims data. In the catastrophe classes, the modelling agencies have standardised the capture of exposure data in the form of Exposure Data Models, in a way that the specialty classes have not, which has resulted in bespoke approaches in every specialty class. This is rather unfortunate as

the insurance and reinsurance structures in the various specialty classes are largely similar, the only difference being the way in which the underlying specialty risk within each class is structured and its PML (probable maximum loss) is calculated.

Howdospecialtyunderwritersapproachunderwritingriskmanagementandwhatarethedrawbacks?Underwriters in the specialty classes, helped by in-house actuaries, have developed their own models for capturing the portfolio, calculating aggregates and pricing risk. The outputs of these models feed into enterprise risk management functions where portfolio level exposure analysis is performed for capital management. Where industry data sets exist, actuaries have attempted to incorporate underlying risk exposures into pricing methodologies and across the specialty classes, in-house models have been developed, largely in spreadsheet-based systems.

This does bring the underwriter closer to the portfolio and underlying risk which serves to develop knowledge of the class,

interview

The complexities of specialty linesrussell group is a risk management software and service company that provides an integrated approach to underwriting risk management for the specialty (re)insurance classes. reactions asks russell’s managing director Suki Basi why specialty classes have historically not had as sophisticated an approach to underwriting risk management as catastrophe classes?


interview

arguably in a much deeper way than within the catastrophe classes as in the specialty classes the underwriter has greater transparency of the data, the assumptions being used and the calculations being performed.

Within the catastrophe classes the modelling agencies provide an integrated view point on exposure, which serves as an industry benchmark for underwriters. A similar situation does not exist within any of the specialty classes. Furthermore, in-house models are often not integrated either, in that pricing, aggregate control and portfolio budgeting are done separately. This results in the situation that the effect of pricing a risk on aggregate exposure and on portfolio profitability is not known at the time of risk pricing and the bases used for pricing and capital reserving may not be consistent with each other.

Whichbigeventshavetestedspecialtyclassesandwhatarethelessonslearned?Events such as 9/11, Madoff, Deep Water Horizon, the Elgin offshore gas leak, the Libor scandal, the Japanese earthquake and tsunami, the Thai floods, the Costa Concordia disaster and more recently Superstorm Sandy have all tested the market in many ways. 9/11, Libor and Madoff demonstrated how underwriters need to understand exposures for a number of multi-assured events on a single day. Costa Concordia has shown that losses above the billion dollar mark do occur in the marine shipping market. Deep Water Horizon introduced a casualty exposure from an offshore multi-insured event, which was a total loss, whilst Elgin was a partial loss with the potential for substantial loss development. Nat cat events such as Sandy, and the Japanese tsunami and Thai floods before it, demonstrate how such events can trigger a substantial loss development for the specialty classes.

The lessons from these events have been that specialty underwriters need a more integrated risk-management approach that allows them to model exposure from scenarios they can be realistically exposed to directly or indirectly, and to ensure such exposures are priced into their pricing methodologies. Such an approach requires the ability to perform realistic, probabilistic and unexpected event analysis, based on catastrophe modelling techniques and principles and built-on database-enabled models, which cannot be done on spreadsheets.

Whatisprompting(re)insurerstoreassesshowtheyapproachunderwritingriskmanagementwithintheirspecialtyclasses?A combination of Solvency II, the aforementioned big events and competition have combined to cause (re)insurers to reassess how they approach underwriting risk management. Solvency II requires better control over capital deployment and risk management and through pillar one especially, requires quantitative analysis of the amount of and charge for the capital required for underwriting each class of business.

The catastrophe modelling approach of determining exceedance probability curves, percentiles and tail value at risk are the essential inputs to capital modelling and determining risk concentration and diversification, and therefore the capital charge to a class of business. This bottom-up approach of risk quantification is essential to determining the true capital charge.

Recent events have shown that underwriting risk management needs better scenario modelling in which realistic, probabilistic and unexpected events need to have been modelled during the pricing process so that all events can be factored in. One way of assessing the efficiency of this process is to see whether recent events have in fact figured in the catalogue of events being used

for pricing. If not the model needs to be revisited and refined.The competitive nature within the marketplace has focused

management on profitability and therefore underwriting returns are being increasingly scrutinised. This becomes quite difficult for underwriters when they don’t have integrated tools to assess aggregate development, pricing and portfolio profitability.

Whatareyourthoughtsontheoutcomeofthispieceofresearch?Wereyousurprisedbywhatpeoplesaid?The main findings of the research are of no surprise as we have been increasingly aware of the requirements for more sophisticated analysis, better data quality and the use of deterministic scenarios for modelled and un-modelled risks.

One of the interesting points raised in the report is when we asked, “Do you want to outsource?” respondents seemed to be happy to outsource aggregates but not pricing and portfolio modelling, citing that the assumptions which lead to the latter are proprietary. This is fine but does imply that the industry is not aware of third-party tools out there that perform aggregate, pricing and portfolio modelling in an integrated architecture that also facilitates the generation and/or processing of user-driven events. Such tools would enable the industry to separate a model into the following three component forms: • Detailed underlying industry and portfolio data capture;• Proprietary assumptions to generate events; and• Processing engine to drive events.In my view these are essential to the needs of the industry. l

“Recent events have shown that underwriting risk management needs better scenario modelling in which realistic, probabilistic and unexpected events need to have been modelled during the pricing process so that all events can be factored in.”Suki Basi, managing director, Russell Group


Those writing these specialty classes are often also the same balance sheets writing the property-catastrophe. There has been a growing awareness of the need for an integrated way to assess exposure, accumulate risk and measure capital and risk-adjusted profitability. One thing we have been seeing over the past two years – and it’s a trend that is accelerating – is these platforms are looking to have an integrated view of exposure and risk. This is not only because different classes are correlated in certain scenarios and catastrophes. People are now looking to apply the kind of analytic best practices that have been developed on the property catastrophe front to other lines of business in order to get superior risk adjusted returns.

Isthelosspotentialasgreatwithinspecialtyclassesasitiswithpropertycatastrophe?In aggregate the answer is certainly no. The accumulations of exposure and risk on property catastrophe are significantly greater than the aggregate accumulations. However, what can be material are the accumulations across these lines of business. While the standalone exposures to, say, marine or energy or aviation may

not be on the same scale as property-catastrophe, when you start to think through the way in which these exposures stack on underlying events, they can be material and can result in surprises if not managed on an integrated basis.

More and more we see insurers and reinsurers looking to put in place an integrated way of measuring and accumulating across all these lines of business. There are two dimensions of accumulation. One is the scenario, ie. the event or catastrophe that would expose multiple specialty lines and correlate to property catastrophe. The other axis of accumulation is the account itself. Multiple accounts that are written are exposed to multiple classes of exposure and being able to accumulate both by account – ie. by the insured – and by the scenario – by the event – is what we see insurers looking to get at.

Lookingbackatrecentevents,haveweseenanysurprisesforspecialtyclasses?Discrete events have highlighted the need for this – certain oil and gas events in the Gulf of Mexico, for instance. But for me most noticeably was the tsunami in Japan in 2011 where there were

interview

Managing real-time risk exposureas one of the three main vendor cat modelling agencies risk Management Solutions has worked closely with property catastrophe underwriters for over two decades. this year it debuted rMS(one), a real-time exposure and risk management platform that goes beyond the “modelled” classes of business. we ask Hemant Shah, chief executive of rMS, what he thinks is driving a more sophisticated approach to underwriting risk management within specialty lines.

AbigshipbeachedinlandbytheJapanesetsunami,March2011


interview

material losses across multiple lines of business. Then prior to that was the World Trade Center which had its own similar kind of dynamic across multiple classes of business. In Hurricane Sandy there were also losses across multiple classes – particularly some of the marine and inland marine exposures due to the catastrophic storm surge in the port and shipping areas around New York City.

TellmeabitaboutRMS(one)andhowitcanbeputtousewithinspecialtyclasses…We very explicitly designed it to not just be the next generation cat modelling product from RMS but to be an exposure and risk management environment for this industry. Fundamentally what we are offering is a single environment to track all of your exposures and all of your risk accumulations all in one place. With respect to specialty lines the offering will enable insurers and reinsurers to have a coherent place to track all of their accumulations across multiple lines.

We’ve taken the view that we need to go upstream from the models – it’s not just about capturing data for classes of exposure that we know how to model. It’s about creating an environment where an insurer and reinsurer can represent all of their exposures, irrespective of if there are models or not and if those models come from us or competitors or from their own internal teams. Because what’s truly needed is not the model, it’s the representation of the exposure, the contract language that defines how you’re financially exposed to those underlying exposures and then an ability to track your risks, inclusive of model them.

Doestheindustryneedtogothroughanychangeinordertodothis?If you think about how specialty classes are developed, it’s very specialised and very wrapped around the really unique expertise of underwriters. That differentiated expertise is all good – it’s bespoke, it’s targeted – but the consequence of that is often a fragmented approach to how the business is written and integrated with other parts of the enterprise. So in many respects companies in those lines have not had the kind of integrated systems to perform these kinds of real-time accumulation and risk management insights, but now they are beginning to make these investments.

This is not a new concept but increasingly these kind of best practices are extending beyond the property catastrophe business into all of the specialty lines, and frankly across all lines of business written by global insurers and reinsurers.

Whatexternalfactorsaredrivingthis?I think it is competition. The market is becoming more competitive and there is pressure to be able to respond more quickly to opportunities and to demonstrate that you have a differentiated ability to manage exposure and capital on a dynamic basis. This is driving innovation and improvement in how companies do business.

There are also regulatory and rating agency imperatives. There’s a lot of additional scrutiny about one’s capabilities to represent what you’ve got, not only the ability to measure things but to implement the insights at the heart of the business process, and that these various processes are well controlled and auditable and there’s only one version of the truth in the enterprise. So there are increasing expectations from external constituencies. But my sense that the key driver of change has been competition on the basis of who can be the most nimble in the marketplace, who can manage capacity most efficiently and who can adapt most quickly to changing market conditions.

WillcompaniesneedtoinvestintheirITinfrastructure?Absolutely, because that is a key enabler in all this. To have the ability to compete and run as a real-time enterprise with a real-time view of risk exposure and capital requires a pretty sophisticated technology infrastructure.

Howusefularerealisticdisasterscenarios?At some level a catastrophe model is just a library of disaster scenarios – when you open up the hood it’s a library of scenarios, event by event and footprint by footprint. Realistic disaster scenarios are a very healthy complement to probabilistic modelling, because it provides intuition and context on actually the drivers of exposure accumulation and loss. So you really need both, because the probabilistic models give you a rigorous definition of the probability of loss, which is what one needs to allocate capital or to price business. But having scenarios, whether they are extracted from the models themselves or provided by Lloyd’s or developed by your own team is an important way to augment those models with intuition. And the scenarios are a healthy way to balance one’s approach to risk management. l

“Fundamentally what we are offering is a single environment to track all of your exposures and all of your risk accumulations all in one place. With respect to specialty lines the offering will enable insurers and reinsurers to have a coherent place to track all of their accumulations across multiple lines.”Heman Shah, chief executive of Risk Management Solutions

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