Cat losses Number 1 threat to insurers’ solvency

A.M. Best Co. says it “considers catastrophic loss, both natural and man-made, to be the Number 1 threat to the financial strength and credit quality of property and casualty insurers” in the face of increasing exposures.
In a recent report, A.M. Best says it is concerned about “the rapid escalation in insured exposures over the past decade.”
The report says: “Demographic trends and rising property values are driving the property concentration risk in catastrophe-prone areas upward. At the same time, the evolution of the global economy to a service-based industry has created an unprecedented geographic concentration of workers, thus changing the composition of catastrophe losses to incorporate workers’ compensation in earthquakes and terrorist attacks.”
Accordingly, the ratings agency says, “A.M. Best has been increasing its surveillance of the catastrophe exposures of primary insurers and reinsurers alike and continues to refine the methodology for evaluating insurers’ financial strength to reflect their ability to manage the potential losses.”
Part of this methodology includes the use of catastrophe modeling. A.M. Best notes that while cat modeling is necessary for the purpose of predicting losses, it may not be sufficient.
“Today, most insurers utilize sophisticated catastrophe modeling tools, primarily those provided by specialized firms with extensive meteorological, seismological, statistical and technological resources, to provided loss estimates,” the A.M. Best report says. “The hurricane events of 2004 and 2005 have reminded us that while the models are extraordinarily useful in the analytical and underwriting process, they are only tools and cannot be relied upon solely for the management of maximum exposures.
“The models are dependent upon the veracity of the data input, subject to manipulation through the use of various options that can add to or reduce the net Probable Maximum Loss (PML) and cannot cover every possible situation.”
A.M. Best continues to endorse the use of modeling, but recommends using multiple models rather than relying on a single one. “The output from any credible model is acceptable, as requiring output from one particular model could limit the practice of utilizing multiple models to gain greater information, increase costs for insurers that do not utilize the chosen model, and limit competition among modeling firms, ultimately discouraging continual improvement in the technology.”