RenaissanceRe CEO warns against relying on single view of risk

by Artemis on August 7, 2014

The proliferation of risk models and technical tools for understanding risks in the reinsurance industry would lead you to believe that the market would become more efficient, but so far this is not the case, according to RenaissanceRe CEO Kevin O’Donnell.

As reinsurers, as well as insurance-linked securities (ILS) investment fund managers, access to risk models and tools to better understand risk have increased in recent years, you would have expected that the reinsurance market would have become more efficient, said O’Donnell.

However, this is not the case in his view. “Instead of greater efficiency the clock seems to have turned back to the 1990s and there has instead been a return to a single view of risk and a resulting decline in risk assessment quality,” O’Donnell said during the Bermuda-based reinsurers recent second quarter earnings call.

It’s an interesting comment as the way risk modelling tools and platforms are developing, as well as the ILS market with its investor driven demand for multiple-views of risk, you would expect the market to move towards a more model-agnostic, holistic view of the risks it underwrites.

Indeed the main risk modelling platforms are now keen to allow different views of risks from competitors models to be viewed within their interface, as they try to accommodate the demand for a multiple model view. At the same time, there is always much discussion of the right way to adopt a multiple model, or customised, approach to analysing risk, with some vociferous opponents to the blended approach stating that you must add your own opinion into the mix, rather than simply taking the average of all outputs.

However, for all the discussion of a multiple model view, O’Donnell believes we are still a way off from this becoming reality in the reinsurance market, suggesting that this is holding back the market’s efficiency.

With capital becoming ever more efficient, as new lower-cost sources of capacity increasingly target the reinsurance market, you would expect market efficiency to accelerate in-line with this. The accusation of a single model approach is often levelled against some ILS investors, however many of these are the end-investors who rely on not just their own model access, but also that of their ILS managers as well.

We’ve seen the multiple model approach break into the catastrophe bond primary issuance market as well in the last year, with AIG’s Tradewynd Re Ltd. (Series 2013-2) seeing the underwriting data being passed to the three main risk modelling firms, RMS, AIR and EQECAT, to enable them to also analyse the risks and provide advice to their ILS investor clients. However this is not the standard, in fact far from it, it is the exception to the rule for the moment.

O’Donnell said that RenaissanceRe believes that; “The right way to price risk is to consider multiple views understanding the full distribution of outcomes.”

But he said that he sees an increasing focus on a single point of view and single expected loss, which does not allow the analyst to find the mean of all possible outcomes, which RenRe relies on. RenRe also likely runs its own risk models, perhaps layered on top of the main vendor models, giving it both third-party and internal views of risk.

“There is over reliance on a single view of risk, which not only encourages poor pricing behavior but can also lead to poor portfolio construction,” O’Donnell stated.

O’Donnell’s comments are a call for underwriting discipline, making sure you fully appreciate the risks you are assuming and for market participants to ensure they access as many viewpoints on the risks they assume as is possible. The risk otherwise is that you deploy capital into risks you don’t fully understand, leaving yourself open to much larger than expected losses.

“We believe that good underwriting will continue to be the key differentiator amongst reinsurers and capital providers and it’s the best pass for long-term success,” O’Donnell explained.

RenaissanceRe’s track record speaks for itself in this regard, their track record is impressive and their understanding of the risks they write second to none. The ILS market clearly appreciates the importance of adopting a holistic view of risk, including its own view, but as with every reinsurance market there will be those who cannot afford to license multiple models, making the multiple view much more difficult to achieve.

As technology advances and platforms embrace the multi-model view we would expect this to become less of an issue. Technological efficiency looks set to drive further capital efficiencies, in that case, as the tools to analyse risk look set to help ensure that the capital with the right risk appetite is the one that actually ends up assuming it.

Read other recent articles covering RenaissanceRe:

RenaissanceRe pulls back on catastrophe risk, DaVinci profits rise.

RenaissanceRe CEO says not actively looking for new third-party capital.

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