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Reinsurers seek relief in computer predictions.

Companies specializing in computerized risk assessment of hurricanes, tornadoes and earthquakes are helping property reinsurers better manage their catastrophe exposures. The companies provide software that can be licensed by insurers, reinsurers and risk managers to allow them to more accurately predict the odds of a natural disaster striking and its consequent financial toll. Such disasters cost the industry more than $22 billion last year, $15.5 billion of which was generated by just two hurricanes.

The huge insured losses from the recent catastrophes forced the demise of many reinsurance companies, especially in London, which lost at least one-half of its property reinsurance capacity in the last two years. Those reinsurers that are still providing coverage have become more conservative, evidenced by their higher risk attachment levels, stricter underwriting and increased pricing.

Computerized weather prediction is part of this new trend toward more prudent underwriting. The technology not only provides scientific estimates of probable catastrophes before they occur, but also helps a reinsurer calculate its cedents' exposures, examine the geographic spread of its own and its cedents' risks, and estimate its potential property portfolio losses.

Since reinsurers generally pick up the catastrophic share of property policies, the emphasis on risk management makes clear sense. It's driven by the recent losses, and by studies projecting even higher losses from future storms $53 billion for a Class 5 hurricane (155 mph and higher sustained winds with an 18 ft. and higher storm surge) striking Miami, or $51 billion for a Class 4 (131 to 155 mph sustained winds with a 13 to 18 foot storm surge) storm striking New Jersey and Long Island, according to the Natural Disaster Coalition in Washington, D.C.

The three companies making up the market for computerized catastrophe loss management are Risk Management Software Inc. in Mountain View, California; EQE International in San Francisco; and Boston-based Applied Insurance Research Inc. While they essentially provide similar services, each goes about it in a different way.

The companies report that business is brisk, especially since last year's massive hurricanes, Andrew and Iniki. Indeed, the companies' client lists feature the names of many top international reinsurance companies and intermediaries, including General Reinsurance Corp., American Re-Insurance Co., E.W. Blanch Co., Johnson & Higgins and several others. Interviews with executives from these and other insurance concerns indicate the software companies are providing a valuable service: helping to take the guesswork out of property reinsurance underwriting. "Reinsurers simply need to know in greater detail what the potential fallout can be from natural peril losses," says Hugo Johnsen, a director of Carpenter Bowring Ltd., the London-based brokerage. "Traditionally this has been somewhat of a guessing game. But with the huge losses of the past five years, reinsurers are desperately trying to get their hands around exactly what they are reinsuring and what they might have to pay.

Catastrophe Analysis

Carpenter Bowring turned to EQE International, a risk and safety engineering consulting firm that licenses its software to companies and/or conducts computerized analyses in search of catastrophe exposures. For Carpenter Bowring, EQE conducted an allrisk analysis of earthquakes in Iceland. The government of Iceland insures all properties in the country and buys its reinsurance through Carpenter Bowring in the London market. "The government wanted to come to grips with the amount of damage that could happen in an earthquake," Mr. Johnsen says, "since they had undertaken to reimburse everybody in that event." Carpenter Bowring commissioned a study by EQE after its reinsurance company clients also requested it. EQE examined various types of construction in the country, then cross-referenced each with various "earthquakes" of different magnitudes. Its final report estimated insured property loss figures for each particular earthquake magnitude. Surprisingly, the study's findings raised concern over potentially huge property losses from a major earthquake. Carpenter Bowring's clients decided to raise their reinsurance premiums "by a double-digit increase," Mr. Johnsen says. The government was unable to afford the new premium and is now "going bare" without reinsurance, he adds.

Though primarily known for its work as a consulting firm specializing in structural and earthquake engineering, in recent years EQE has expanded its services to encompass risk assessment and management of other natural and even man-made hazards. "No one can predict Mother Nature," says Earl Aurelius, the company's vice president. "What we can do is develop a computer model that allows us to look at a reinsurer's portfolio relative to historic storms and how fierce they were," he says. "We can calculate the expected damage, providing the reinsurer with the ability to estimate potential damage given certain events. So, in essence, while we can't tell you exactly 'when,' we can tell you 'how much."'

EQE's new windstorm hazard analysis software was unveiled in April at a conference sponsored by the London Insurance and Reinsurance Market Association (LIRMA), an association of 130 international reinsurers based in London. EQE developed the software, called UKWIND, at LIRMA's request for use by its member companies. The software can instantly provide all the necessary information on windstorm hazard and related building damage in the United Kingdom on a singlerisk-analysis basis. Users need specify only a postcode for the software to provide the maximum wind speeds for a selection of exposure periods at various probability levels.

For example, if one enters the postcode B1 2XF, for Birmingham, England, the computer will show that a maximum gust speed of 42.7 meters per second in a period of 50 years has a .50 level of probability in a given year. The software then inputs that information into a data base displaying selected types of building construction and evaluates the potential damage range. Using the same postcode, the computer indicates that a building made of light steel and weak cladding would suffer damage costing 5.1 percent of its replacement cost. In other words, if the building cost $1 million, the storm would result in a $51,000 loss.

The key to determining potential insured property damage losses is the underwriter's understanding of the structural integrity of a building, Mr. Aurelius says. EQE's engineers work with insurers to identify the critical factors in structural performance, i.e., to know what to look for in a particular building. The engineers even visit buildings after an earthquake or hurricane to see what happened and why to buildings of given heights and compositions.

EQE's work for LIRMA indicated that U.K. housing actually is less likely to be damaged from windstorm than housing in the United States. "The conclusion is reasonable, since housing in the U.K. tends to be masonry with relatively small openings and good wind-resistive roofing," Mr. Aurelius says. "Housing in the United States tends to be less wind-resistive wood frame, with more vulnerable larger openings and/or roof openings."

EQE's software licensing fee runs about $25,000 annually. Other insurers and reinsurers that have bought its software include Swiss Re, Eagle Star and Toa-Re, as well as a number of London insurance entities "who are unfortunately going out of business very rapidly," says Mr. Aurelius.

CATMAP and Catastrophes

The oldest catastrophe risk assessment package designed specifically for reinsurers was developed by Applied Insurance Research (AIR), and is called CATMAP. The package includes the software, which can be used on any personal computer, as well as a variety of support functions, including a disaster information hot line, user groups and newsletters. The program was designed in 1987 with the help of three reinsurance underwriters, says Karen M. Clark, AIR president.

Like EQE's UKWIND, CATMAP uses a property risk's five digit zip code in the United States (or British postcode) to evaluate the probable maximum losses from a windstorm, earthquake or other natural disaster. Once that data is entered, the computer generates the characteristics - location, size, intensity, direction, etc. - of a storm. Based on these characteristics, wind speeds are estimated for each zip code or postcode in the affected area, and insured damages are estimated and tabulated. "For example, we can tell a company that there is a possibility of a $250,000 loss one year in 20, or one year in 50, and so on," Ms. Clark says.

A reinsurer using CATMAP can calculate the cost of a variety of property-related risks, claims Ms. Clark. For example, the software estimates the expected losses for any layer of catastrophe cover for any ceding company; potential catastrophic losses on pro-rata treaties; potential losses on a total

portfolio of property treaties; exposures and potential losses by geographic zone; and even the expected and potential losses on retrocessional covers.

CATMAP uses a system built on so-called Monte Carlo computer simulation models of natural catastrophes. Its crystal ball-gazing in Florida prior to Hurricane Andrew was "pretty accurate," notes Ms. Clark. "We did very well with

Andrew," she adds. "One factor that will add 30 percent to the losses that we didn't allow for in the computer models is increased construction and labor costs in the aftermath of the hurricane." She explains that the higher costs were a function of the number of claims caused by the disaster: "You have 700,000 claims being settled," she says. "Obviously that has put a supply crunch on lumber, labor and whatever else, resulting in an increase in the cost for these goods and services."

Some clients that bought CATMAP before Andrew struck were very satisfied with the product, Ms. Clark claims. "One of our clients is attributing CATMAP for saving them $70 million," she says. "They decided to cut their exposure on one pro-rata treaty in half after CATMAP information. We can't eliminate losses, but because of our data in this instance, instead of a $140 million loss, the client had a $70 million loss."

"CATMAP has been saying for years that Florida is the most likely exposure for big losses," Ms. Clark continues. "Florida has been amazingly free of hurricanes in the past 20 years, but before 1970, a hurricane hit every other year. Many underwriters forgot that. What CATMAP does is prevent random annual variations from making the underwriter complacent."

Birmingham, Alabama-based Liberty National Fire Insurance Co., which sells both property insurance and reinsurance, bought the CATMAP system three years ago and continues to pay annual licensing fees. "We wanted to get a better idea of our exposures to windstorm perils," says Russell Fletcher, the company's senior vice president. "We had previously used models based on historic windstorms, but they were fairly simplistic and not necessarily actuarially based."

"We were looking for a probabilistic model that was based on essentially modern day methods of random sampling," Mr. Fletcher notes. "And that is exactly what CATMAP does. It gives you a series of probabilities, running random numbers through different variables to get all answer."

The software helps the company determine its exposures in a particular geographic area, Mr. Fletcher says, and the probabilities of loss if it exceeds a certain threshold. "It allows us to determine how much reinsurance we can accept in a given region or state," he says. "Before CATMAP, we may have had too much exposure in one zone or too little in another. Now we are able to spread these exposures more evenly. For example, if I have a cedent with a lot of experience in Florida, I may not want to write another company in that area."

New York-based Phoenix Reinsurance Co. also uses CATMAP. "We bought it in 1987 because we are a property specialist and, at the time, it was the only one out there," according to Mark Christie, Phoenix Re vice president. "It's proved itself to be a good way to get an idea of our company's exposures to possible loss scenarios, and helps us select the insurance companies whose books of business prove to be better."

Phoenix Re also uses CATMAP to manage its portfolio, running simulated storms against its overall book of business to see how it would fare as a company. "Right after Andrew hit, AIR sent down a diskette that simulated the storm," Mr. Christie says. "We ran it against our book of business and got a loss estimate. The information that popped out was dead on, within a few points."

Much of the current interest in CATMAP is coming from newer reinsurance players, according to Ms. Clark. "They very obviously want to use the most sophisticated risk management tools they can in their underwriting decisions," she says. "This is not the same kind of naive capacity that entered the market a decade ago."

Policy Analysis and Exposures Risk Management Software Inc. (RMS) is the newest of the computerized catastrophe management companies, formed in late 1988. As yet, the company offers only computerized modeling of hurricanes and earthquakes, though it anticipates expanding into other disaster-analysis areas like tornadoes and hailstorms. G. Thompson Hutton, RMS president, says his company is able to quantify hurricane risks on an individual insurance policy basis.

While other software products use historical data to simulate a likely disaster, the RMS program analyzes an insurer's policies to locate the "vulnerable" pockets of concentration, Mr. Hutton explains. "The software provides information on probable maximum loss, how much of the loss will be net of reinsurance and which reinsurance treaties likely will respond," Mr. Hutton says. "What we bring to the table that is different is our site-specific analyses. For example, we will look at a specific hurricane of particular parameters that is expected to hit Savannah, Georgia, at a particular angle. This is different from a Monte Carlo analysis, where one would run a few thousand simulations and the number of times a disaster occurs is the probability."

RMS' software, called IRAS (Insurance and Investment Risk Assessment), can also be used to map the concentration of risks that an insurer has in a given geographic area. "Basically, computer modeling provides answers to typical questions like: Where are our risks? How much are they worth? What do they look

like? What is our insurance structure? This is data that every insurance company has, but doesn't track on a day-to-day basis," Mr. Hutton says. "Our software helps underwriters stay informed by quantifying these risks at the portfolio level and by helping with individual underwriting decisions."

American Re-Insurance Co., the Princeton, Newjersey-based reinsurer, has been licensing IRAS since 1989, according to Carl Hedde, the company's vice president. "We licensed it to measure both our facultative and treaty exposures," Mr. Hedde says. "On the facultative side, the individual risks coming to us as a reinsurer, we input the location of the insured, the type and class of construction involved, the policy limits, information on the certificate of insurance and other data concerning the exposures involved. We then come up with the expected loss on that certificate and the accumulated loss for our portfolio."

The software provides underwriters with information they otherwise may not get, Mr. Hedde claims. "It'll tell us things like how far the building is from an earthquake fault, the landslide potential and so on," he says. "Our underwriters are getting a much better sense of what they are binding as a result of having this information available, and we are in a better position to evaluate our entire portfolio. It's saving us money and making us smarter."

E.W. Blanch Co., the Minneapolis-based reinsurance brokerage, has been using RMS' products since 1990, according to Jean Taylor, the firm's senior vice president. She uses IRAS to better service her insurer clients that need reinsurance, she says. "The issues a company has with a traditional catastrophe reinsurance program are what sort of retention it should take, what limits and what the cost of that is in the reinsurance market of today," Ms. Taylor says. "The information in the RMS model allows us to look at different retentions and limits and pricing offered by the reinsurers so we can make a judgment as to what they want to do. It gives us different structuring alternatives on behalf of the primary company." For her reinsurance clients, Ms. Taylor says IRAS provides them a "comfort level" regarding how their ceding companies are managing their portfolios. "It says 'I'm dealing with a professional cedent,"' she notes.

The services offered by the computerized catastrophe risk assessment companies appear headed for further growth, according to several industry executives. "There's been tremendous interest in this type of service," Mr. Hutton says. "The 1992 catastrophe results drained so much capital out of the industry that almost every insurance company today has a catastrophe committee formed in the last six months at the directive of senior management. One of the first things these committees do is ask what tools are available on the outside to help them better manage their catastrophe business." These insurance companies' catastrophe committees are making Mr. Hutton's job much easier, he maintains. "Frankly, I don't have to call them for business," he says. "They're calling me."
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Author:Banham, Russ
Publication:Risk Management
Date:Aug 1, 1993
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