Are insurers increasingly over reliant on models?
On 3rd July FTI’s Insurance Practice co-hosted a Breakfast Briefing with Amlin. The topic was ‘Are insurers increasingly over-reliant on models’? Our guest speakers were Anders Sandberg, Oxford University and JB Crozet, Amlin.
The speakers focused on the ramifications that over-reliance on models can have on systemic risk. Simon Beale of Amlin introduced the speakers and explained why Amlin has become interested in the subject of systemic risk following an encounter with the late Dr. James Martin, founder of the Oxford Martin School at the University of Oxford. Since meeting Dr. Martin, Amlin has been investing in research at the Oxford Martin School to ensure modelling does not cause the collapse of the insurance market, because, in Mr. Beale’s words ‘models are not perfect’.
JB Crozet argues that we are breeding a form of systemic risk with too many models. Whilst he does assert that models are generally an efficient way of gathering and monitoring data and predicting trends, they can create vulnerability. Mr. Crozet’s definition of systemic risk is as a structural link that makes us more vulnerable collectively. He used a unique analogy of frogs crossing the road: for systemic risk, the frogs all line up together to cross the road at the same time, which can make them more susceptible to being decimated by a rogue vehicle. Of course, he points out that on some occasions, the frogs would safely pass without fear of being run over because they’ve carefully analysed the safest time to cross.
On the positive side, Mr. Crozet conceded that models have enabled the industry to get a clearer idea of risk, which has resulted in lowering the cost of capital, therefore making insurance more affordable.
Mr. Crozet believes that systemic risk arises from two occurrences; bad events and structural links. He used the example of the September 11th attacks on the World Trade Centres as a ‘bad event’, which, aside from the tragic loss of lives, resulted in massive losses across property, accident, aviation and casualty lines of business. Whilst we would like to believe in the benefits of the diversification of risk, this may not always be the case.