Computer Modeling for Property Insurance - Musulin

Question 1

Computer modeling of catastrophe perils for ratemaking purposes is becoming more prevalent. State 3 disincentives for insurers to manipulate model results to inflate loss estimates

Answer 1

• may lose market share to competitors charging lower rates
• increasing rates will increase reinsurance rates
• put pressure on the financial ratings of publicly traded companies since both reinsurance and rating agencies use these models, regardless of whether they are used in pricing or not

Question 2

State 3 safeguards suggested to reduce the risk of model manipulation when a catastrophe model is used for ratemaking

Answer 2

• require a legal affidavit attesting that the user has not manipulated the models/assumptions
• require a formal opinion from the modeler on the proper use and execution of the model by the user
• have modelers provide regulations with a range of results by building type, geographic, deductible options

Question 3

State two effects on the public individuals of computer modeling of catastrophe loss potential

Answer 3

• some may receive significant rate increase

- may be restriction on where can locate or tougher building codes

Question 4

Describe 3 challenges that simulation models pose to the regulatory review of the catastrophe load included in rates

Answer 4

• difficulty in verifying the data: models often use exposure data which is not reported elsewhere in the financial statement
• model complexity: models require complex seismic, meteorological, actuarial expertise to understand the calculation
• black box nature: the data is often sent to the modeler’s facility and run through the proprietary models which makes it difficult to understand the process and calculation

Question 5

6 undesirable consequences if state insurance departments did not accept computer catastrophe models in the regulatory process

Answer 5

• rates would likely be inadequate in higher risk leading to availability problems
• higher insolvency risk when a hurricane occurs
• reduced incentives to mitigate risk
• higher prices caused by greater information risk
• price instability
• not charging adequate rates for high risk insureds cause low risk subsidize high risk

Question 6

Describe 4 consumer benefits of insurers using property catastrophe modeling

Answer 6

• comprehensibility of prices - better understand how their exposures relate to loss
• fair pricing - lessen need for low risk to subsidize high risk
• stable pricing - due to long term data and large volume of data used by the model
• reduced information risk - investors demand higher returns for unknown risk
• rational behavior - when cost of a good reflects its economically correct long term price, consumers will take that cost into account and act accordingly