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).

"That is something that the software industry has improved pretty significantly over the past five years," he says.

Technologies such as EMB North America's Igloo, a financial modeling platform, have also seen widespread use. Launched in 2001, Igloo is now used by about 130 insurers and reinsurers, says Tom Hettinger, managing director of San Diego-based EMB. Interest for Igloo has not only come from both the United States and Europe, but also places such as Bermuda.

"They have that regulatory push on them and saw a need to manage their overall aggregate risk, understand the different drivers of it and start quantifying how they could improve their risk position," Hettinger says.

Given the number of risk management technology providers, choosing the right vendor is but one challenge for reinsurers. Some insurers and reinsurers may be wowed by a technology and plow money into it without focusing on the data or its risk management strategy. But, modeling software is only as good as the underlining data that is fed into it.

"Having the right focus and energy on understanding that data, understanding what is being fed into the models, and making sure that that is accurate, that it is controlled and that you really validated it is incredibly important, and is something that gets missed in some of the results I have seen elsewhere," says Robbins.

A reinsurer can play out innumerable scenarios with modeling software, but it needs to know how to effectively use the technology to make important risk-based decisions.

"The capital model is not the answer to everything," affirms Klein. "There still remains a need for human intervention and for human intuition, so we are not just underwriting on a black-box basis."

IT departments also need to be wary of being enamored with sophisticated risk management technology. Too often, IT executives fail to get buy-in from top management for their new risk management approach.

"It is absolutely necessary for actuaries to be using the DFA tools and other tools to run these analyses," explains Light. "But then the information has to go up the chain of command, and CEO/COO/board members have to understand and actually set policies and monitor risk policies (regarding capital levels) that are based on those models."

Risk management tools, such as Dynamic Portfolio Optimization, are becoming increasingly popular in the industry, notes Klein. These tools enable one to look at a portfolio of risks and identify the most capital-intensive (or high-cost) risk.

As natural disasters, financial crises and other market interrupters swirl around them, reinsurers will not balk at exploring the ever-more sophisticated and proliferating array of risk management technology available to them. Indeed, it is one technological expense that pundits believe may not take a hit due to budgetary cutbacks.

"We will continue to invest significant funds in risk management technology," says Robbins. "It is an important part of our business and what we do. We are a reinsurer - we are accepting risk. So understanding it better is something that really benefits us pretty significantly as an organization."

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