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By CYRIL TUOHY is managing editor of Risk & Insurance®.

Embrace catastrophe models and welcome them, as you might, say, models sashaying down the catwalk wearing the latest spring and fall fashions.

That's the whole point. Models are a fantasy. Catastrophe models allow underwriters and modelers to simulate reality. That's precisely why models have value. Modelers can tinker with them, add a module here, remove a section there. Software engineers can turn the model around, upside down and inside out. They can superimpose large-scale weather events from another era to add perspective, to get a sense of magnitude.

Modelers can alter the risk formulas, and mess with values-at-risk. In a fit of quiet envy I'm sure they even secretly perform losses on their bosses, on their enemies. Catastrophe models allow us to change the numbers to our heart's content, and watch all the cells in the hundreds of columns and thousands of rows turn like an odometer.

In the end, catastrophe models allow us to come up with an idea of how to price the risk, just as buyers at Saks Fifth Avenue can get an idea of what next spring's apparel line will look like.

Admit it, catastrophe modeling is to underwriters and scientists with Ph.D.s what video games are to the rest of us: Models allow us to indulge in a bit of mental and visual fantasy. When new hurricanes, tornadoes and floods come barreling through the neighborhood, the modelers simply update the models, relying on the latest meteorological, geographical, atmospheric and loss pattern data.

That's what RMS did with its recent 11.0 iteration, which ended up causing consternation among modeling skeptics within insurance circles.

RMS, AIR Worldwide and Eqecat, the three major catastrophe modeling firms on which the industry relies, never said the models were a substitute for truth. Models are never foolproof anymore than investments "may lose value," as institutions are quick to remind us.

Catastrophe models represent a particular version of potential losses. If underwriters and ratings agencies take the models too seriously, or rely too heavily on them to price the risk, then the fault lies with the underwriter or the ratings agency, not the modeler.

Risk managers should cast a cold eye on modeling patterns, and feel free--in fact should be encouraged--to question their brokers and cast doubt on the models.

(Read Senior Editor Matthew Brodsky's Counterpoint, "An Urge to Eat a Modeler," here.)

August 1, 2011

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