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Model Brains in Bermuda
Over the years, two comments have continued to delight me about the insurance industry. The first is a definition of insurance that uses an automobile as an analogy for insurance and reinsurance companies.
The chief executive officer is steering. The marketing department has its foot on the gas pedal. The auditors are on the brake. And directions are being given to the driver by the actuary, who is looking in the rear-view mirror. The second was related by a senior reinsurance executive. Not so very long ago, he said, reinsurance premiums were calculated on the back of a napkin in a bar, often after a three-martini lunch.
Don't let's get carried away. Models are by no means the be-all and end-all of making money in insurance and reinsurance. Come four storms in a row, or a Hurricane Katrina, and all bets are off. No amount of sophisticated computer equipment can make a meal out of unreliable data. Everyone has the models, so how do you differentiate your company? But computer models have brought a new sophistication to calculating the cost of risk. Those companies that best marry the modeled results to their own wisdom, experience and common sense represent a new business model. Much of the work has been done in Bermuda, under the umbrella of the Risk Prediction Initiative, a loose federation between reinsurers and scientists. A couple of Bermuda companies have more computers than people, machines running 24/7 to hone their analysis. Data sets improve all the time, and the aforementioned extreme weather scenarios reduce the chances of getting it quite so wrong in the future. Bermuda has also been the locus for innovation in the use of corporate vehicles to better partition risk and to spread it beyond the insurance pool to the capital markets. In the comparatively short period of 20 years, or one generation, Bermuda companies have invented and tested a continuing range of corporate models for marketing catastrophe risk: coverage as part of a reinsurance company's portfolio; companies writing mainly CAT risk; sidecars, with many variations in the debt/equity structure; contingent capital; CAT risk transactions of a very specific nature, tied to one storm or to one tight geographic area; industry loss warranties; and now collateralized debt obligation-based structures, the latest of which allow investors to match their risk appetite to the products on offer within a single company. The very development of the Bermuda model, being adopted by other jurisdictions, might also be counted an innovation. So computers have changed the way risk is calculated, and the creative use of corporate architecture has made survival easier to achieve. In a way, big deal. Insurance has not proven particularly innovative in finding other uses for computers, and corporate vehicles could be seen as just a financial technique. The industry does innovate, but slowly. The basic nature of insurance, in some ways, makes innovation an anathema. Insurance and reinsurance are the bedrock of commerce. For all its flaws and throwback mentalities, my sense is, if you mess with insurance too much, who knows what might happen? Let Apple and NASA worry about innovation; let insurance get on with the stodgy old business of assuming other people's risks so their lives might work better. If it ain't broke too badly, don't fix it. ROGER CROMBIE is a regular columnist for Risk & Insurance®. He also covers issues on alternative risk. READ MORE: Features | Special Reports | Industry Risk Reports | Columnists | In-Depth Series September 15, 2007 Copyright 2007© LRP Publications |
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