Insurers should use a wider range of models to reduce CAT losses and halve the amount of uninsured risk for CAT events, according to new research from Oxford University.
The new study published in the Journal of Economic Interaction & Coordination in March 2021, confirms the industry worries that reliance on an increasingly small number of risk models is creating a dangerously fragile situation.
The study said CATs are notoriously difficult to predict, making accurate models of CAT risks almost impossible. If everyone in the industry bets on the same model then everyone runs the risk of being wrong at the same time, creating high levels of systemic fragility.
There are currently only three significant providers of professional risk models (RMS, EQECAT, and AIR) and, in many cases, firms use just one risk model.
Using a more diverse set of four risk models would create a much stronger CAT insurance industry and better protect buyers.
The study estimates that drawing on a greater number of perspectives could halve the amount of non-insured risks in CAT events and allow 20% more insurers to survive the losses and increase the amount of capital available to write business by 50%.
Researchers built an agent-based model of European CAT insurers to test responses to thousands of different scenarios.
Co-author of the research study professor Torsten Heinrich said, “No one knows for sure which catastrophes are around the corner, so of course some losses are unavoidable. But if everyone bets on the same risk model – as they often currently do – it significantly raises the risk of a disastrous bankruptcy cascade.”
He added, “Using a greater variety of approved risk models would be better for individual firms and customers and provide a far more stable foundation for the sector at large.”
Dr Juan Sabuco, who co-authored the research, said the COVID-19 pandemic has highlighted the challenges caused by catastrophic events. Climate change only increases the need to better get on top of modelling.
“Anything that improves the health of the industry and halves the number of uninsured risks is win-win; insurance is a social good as well as an economic product, after all,” said Dr Sabuco. M