Need to shift focus from cat model to cat risk

A new approach to catastrophe modelling is required to ensure companies and organizations using the tools gain a better understanding of risks, Karen Clark, president and CEO of Karen Clark & Company, told Canadian Underwriter in advance of speaking at this week’s 2013 RIMS Annual Conference & Exhibition in Los Angeles.

“The catastrophe modelling process is broken. What I mean by that is you have new models coming out that sometimes give results that we call anomalous,” Clark said in an interview. “They don’t look intuitive and they look like something’s wrong, but companies feel like they have to use them.”

Clark emphasizes that models have served the industry well, but argues a change in approach is needed. “You can never really see or touch the model assumptions. It’s all a black box,” she said.

The current process “doesn’t give the user of the model any visibility into the underlying assumptions. So whenever there is a model update, it takes a long time for companies to understand what’s really driving the changes in the loss estimates,” Clark argued. “Changes in those assumptions, even small changes to the underlying model assumptions, make large changes to the output.”

Clark advocates a new generation of tool – a more open platform that is transparent, consistent “and helps companies to really understand the risk. If I’m a CEO or board of directors of a company that has a lot of catastrophe exposure, I should understand the fundamentals of the risk,” she argued.

This includes having some basic facts, such as the expected frequency of events per year and the likely maximum intensity by region, she added.

“What companies need to effectively manage risk is they need a more stable set of transparent risk metrics that they can understand and they can use to guide their very important pricing, underwriting, risk management decisions,” she said.

“A model is a one-size-fits-all approach, but companies should be able to fill their own proprietary subjects,” Clark said. As such, company information can be used to help with determining hazard and damage functions in a way “to better match the claims-handling practices, the policy nuances and all of the different things that make each company unique.”

“It really is a paradigm shift where you investing not just in models, but you’re investing in your own external expertise so that you can take more responsibility for the underlying assumptions that are driving your key risk management decisions,” Clark said.