Cat risk modelling “duopoly” limits re/insurance industry view of risk: Simplitium

The insurance, reinsurance and insurance-linked securities (ILS) market faces a catastrophe risk modelling duopoly as 30 years after the commercialisation of cat risk models the industry is still dominated by just two vendors, says Simplitium.

A paper from the firm, a provider of a platform that encourages multiple vendor model views of risk, discusses the domination of AIR Worldwide and RMS and asks whether this is healthy for the industry.

The firm explains that the reliance of the insurance and reinsurance industry on just two catastrophe risk model vendors has effectively limited the sectors view of risk.

The company explains that there are positives to having only a few main vendors of catastrophe risk models being used in the industry, such as standardisation of data, methodologies and terminology used.

But negatives include the increasingly high barriers to changing or adding new risk models, the difficulty that new risk model vendors face in getting traction, a lack of choice and the stifling of innovation.

“This has ultimately resulted in the (re)insurance industry having a limited view of risk,” Simplitium explains.

Adding that, “However, considering the role of insurance within the financial system, and the damage caused by natural catastrophes, improving risk awareness must be a key focus.”

The firm calls for the barriers to entry to be lowered and notes that the recent wave of interest in insurance technology (InsurTech) is beginning to have an effect here.

Of course Simplitium would like everyone to adopt its multi-vendor model platform, which is powered by the open-source Oasis platform, but that ambition aside, the firm does raise important points.

There is currently a divide between insurance and reinsurance firms using a single model and those using multiple, with the latter generally the larger, more global and obviously richer firms.

In the ILS space the same happens, that not everyone can put the resources aside to fund multiple views of risk from the main vendors, resulting in many relying on one model.

A multi-model view of risk can have significant benefits, but in the market currently this is costly and unfeasible for many.

But Simplitium notes that this is changing, with regulatory pressures and also advancing technology helping to open up the range of models available to smaller players.

But the cost barrier to adoption is high and the paper says, “The consequence of this is that firms will have an unnecessarily limited view of their catastrophe risk,” going on to explain that it creates a “competitive advantage” for market participants who can invest money, time and effort into overcoming the barriers to multi-model adoption.

“To improve how we, as an industry, view and manage cat risk, we need to reduce the barriers to changing or adding models, open up the marketplace and make it easier for firms to access multiple views of risk,” Simplitium concludes.

The topic of catastrophe risk models is extremely relevant for the insurance-linked securities (ILS) space, with participants from the fund managers to the end-investors having a vested interest in ensuring the most accurate views of risk are taken into account for allocation decisions.

But everyone has their favourite risk models, while subscribing to all is costly and certainly out of the reach of the majority of end-investors in the space who largely want to keep their costs associated with allocations to ILS down.

Hence, to us, it seems that it will be new technology and start-ups that end up breaking down the barriers to entry, to provide more alternatives to the main catastrophe risk model vendors and democratising access to cat risk insights.

How that impacts the main vendors in years to come remains to be seen, but it’s certain they will face increasing competition as young pretenders try to break open the market and provide greater choice.

This is not the fault of the two main vendors. They have done a fantastic job of propelling the sophistication of the industry to new heights and calling it a duopoly is perhaps a little harsh. We’d also assume they fully expect more democratised access to a range of risk models to be the future of the industry anyway, as both of their latest platforms suggest.

But, it’s true that limiting yourself to one, or even two, risk models will also naturally limit your view of risk (to the outputs of the models you subscribe to).

With a wealth of scientific opinion, methodologies and ways of analysing catastrophe risk available, the question is how many risk models is enough?

And is being limited a problem for most? Possibly not.

But as the capital market becomes increasingly embedded in re/insurance, it’s likely the end-investors will push for the view of catastrophe risk to become less limited, adding pressure on those allocating their funds to offer more insight into how they model and manage risk.