Reinsurers Put Risk Under the Microscope

Information Management Online, November 6, 2009

Daniel Joelson

Recent natural disasters and the current economic crisis have forced reinsurers to review their risk models and rethink their risk placement choices.

Reinsurers are facing added complexities and challenges never encountered before, such as pleasing stricter rating agencies and keeping track of layered business transactions. However, companies such as Transamerica Reinsurance and Guy Carpenter use a number of sophisticated technologies and processes to better assess and manage the range of risks now facing them. Find out how.

The economic crisis has laid bare that the risk profiling and management capabilities of certain insurers are somewhat lacking. This has led some reinsurers to reassess potential partners, which has in turn caused insurers to scramble for more capital through new avenues, either by searching out private equity or even by reinsuring internally.

"The financial impact of the market meltdown has really made the reinsurance market much more difficult to access," explains Christian DesRochers, a senior managing director of the life insurance actuarial services practice of SMART Business Advisory and Consulting, a Devon, Pa.-based consulting firm that helps both reinsurers and insurers to better structure business deals.

Natural disasters such as Hurricane Katrina and Hurricane Ike have been even more influential than the recent financial crisis in propelling reinsurers to retool their risk models, notes Chris Klein, global head of business intelligence and a managing director of Guy Carpenter, a New York-based reinsurance broker and a part of the Marsh & McLennan Cos. "But the challenge this time around has been the big damage sustained on the asset side," he says. "We will probably see increased development on the asset side of dynamic financial analysis (DFA) models that are being employed in the industry with respect to determining capital requirements and capital allocations," says Klein. In particular, DFA technology, which actuaries use to examine issues such as reserving risk, pricing/underwriting risk and catastrophe modeling, has drawn significant interest from reinsurers.

Technology Drivers

In becoming more finicky about the carriers with which they work, and in attempting to better assess and manage the range of risks they confront, reinsurers are increasingly discarding simple spreadsheets for more sophisticated technology. For instance, in life reinsurance, actuarial modeling software has advanced leaps and bounds in recent years.

Transamerica Reinsurance, which deals with tens of millions of underlining policies, has been using actuarial modeling software for years, and continues benefiting from its evolution. The company, which is a division of Cedar Rapids, Iowa-based Transamerica Life Insurance Co., has a database that contains rich policy information, offering it a clear view of a client's mortality experience, and how that will likely evolve in the future. With this information, Transamerica Reinsurance creates models to understand how a business is expected to perform under a variety of different scenarios - be it increasing mortality, decreasing mortality, changing the pattern of lapses or looking at different economic scenarios concerning interest rates and defaults. This enables the reinsurer to assess the potential upsides and downsides of working with a particular carrier, and how it affects the risk profile of the reinsurer's entire book of business.

"The benefit that we have found over time is just the speed and amount of information that we are able to put through actuarial modeling software," says Brock Robbins, SVP of life solutions for Transamerica Reinsurance. "It certainly has increased significantly as computer processing has improved, and being able to take advantage of distributed processing, grids and all those sorts of things. [The software] just enables us to run many more scenarios than we were able to do even three or four years ago, and that helps us really fill out the shape of the risk."

Reinsurers are focusing on risk management in part to improve the bottom line, reduce loss and forge strong, long-standing relationships with carriers. (See the "Assuming Risk Responsibly," right, for more). However, their efforts are also largely being shaped by increasingly rigid solvency requirements and accounting standards.

"We really need to be cognizant of not only how a particular contract is going to perform from a purely economic perspective, but also how it will look through the lens of the various accounting regimes that each of the contracts touches," explains Robbins. This could include conforming to U.S. statutory accounting principles, U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).

Additionally, rating agencies that are "getting beat up these days" are now asking for reinsurers to have a better tool set and better policies, notes Donald Light, a senior analyst at Celent, a Boston, Mass.-based financial research and consulting firm. Further, reinsurers are adapting to growing solvency requirements and standards by ensuring that they have the requisite capital to support their business deals. Regulatory developments are fundamentally increasing their demand for decision-support tools that provide reinsurers an economic capital model of their enterprise to help them evaluate risk and capital management opportunities.

In Europe, Solvency II and national requirements, such as those of the United Kingdom's Financial Services Authority, are pushing carriers to establish capital models, which are not something they can develop overnight. "It takes three to five years to develop a DFA model from scratch," Klein says. Guy Carpenter's MetaRisk product is just one tool that is based on a DFA model. And while some reinsurers are using proprietary products from technology providers, others are developing their own capital models to conform to regulations.

Underwriters continue to develop catastrophe models and peril models, which assess catastrophic risks on the property side. And insurance companies, in particular, are developing a wide range of pricing models that take into account various underwriting factors to help establish a price or rate for risk so they can boost profits.

Non-Technological Initiatives

While carriers' risk management needs have quickly evolved, so too have the solutions offered by technology companies. Robbins says the work of a variety of (undisclosed) vendors has vastly improved Transamerica Reinsurance's ability to run more scenarios to better understand underlying risks (i.e., what has increased or decreased Transamerica Reinsurance's risk).

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