Editor's Note: AIR actuarial consultant Dennis Fasking explores how catastrophe modeling can add significant value in the claims areas of insurance companies—and simultaneously give them a competitive advantage.

Introduction

For most insurers, responsibility for catastrophe risk modeling resides with the actuarial or other risk management areas of the company. However, a case can be made that in-house catastrophe modeling brings equal value to the claims area of insurers. After all, it is the claims department that bears the ultimate responsibility of responding to the needs of claimants following a catastrophic event.

Putting ourselves in the shoes of the claims executive for the moment, we hope to demonstrate in this article best practices for claims management and illustrate how claims management activities before, during, and after a catastrophic event can be greatly enhanced by a strategic application of catastrophe risk modeling.

Creating a game plan

Claims managers are superb managers of both people and process, and are the face of an insurance company at the time of their client's greatest need. They must have established processes in place to process thousands of claims quickly and cost-effectively. In addition, claims staff must have empathy and judgment to be effective in working with customers who are often in both financial and emotional distress. Because of the weight of these diverse responsibilities, rigorous analytics have often taken a back seat within many claims organizations. Yet in today's claims environment, claims managers are being asked increasingly tough questions by senior management regarding the plans they have in place for the next "big one":

Is our claims department adequately prepared to respond? Do we know what to expect in time to plan? Can the right mix of claims staff be brought to bear quickly and effectively with the right experience, specialization, and equipment to any location with concentrated insured exposures at risk? Are the right agreements in place with outside vendors (e.g., third party claims adjusting firms and engineering consulting firms) to fill in the gaps where the company's internal resources may fall short? Is the right internal and external communication plan in place? Is the right financial plan in place to quickly deliver needed cash in the event of a large catastrophe?"

Historically, claims departments have used whatever information and data they had available to address the basic challenges. But pre-event planning can be greatly augmented by running deterministic event scenarios in a detailed catastrophe modeling application like CLASIC/2™. Appropriate deterministic events might be easily recognizable "cousins" of historical events—ones easily visualized and understood by most executives and claims staff. For example, the figure below shows a simulated event much like Hurricane Andrew, but one that is just slightly more intense and tracks just slightly north of Andrew, hitting Miami head on—a completely plausible scenario.

Losses (left) and Claims Counts (right) by ZIP Code for a Simulated "Andrew-like" Hurricane for a hypothetical company. (Source: AIR)

The objective here is not to plan around the specific historical events—which will never recur exactly as they did—but rather to think through the ramifications of similar and equally likely events to ensure that all the right questions are being asked and answered—before they occur. Answers to the tough questions posed above create the underpinnings of a solid catastrophe response and recovery plan, including advanced staging, deployment of resources and communication.

Claims managers can alternatively use models probabilistically to further fine tune their catastrophe response plans. The export utilities within AIR's CLASIC/2 allow users to obtain an exceedance probability of claims counts and a distribution of claims severity for their exposures. Such information could be used by claims managers to develop a very specific resource plan that includes both the number and types of claims resources needed on a granular level. 

When the simulated scenario becomes a reality: Pre-landfall

The value of catastrophe risk modeling to claims becomes more apparent in days and hours before an actual landfall. At the first indication that a hurricane is threatening the coast, a claims manager using AIR's ALERT (AIR Loss Estimates in Real Time) service will be able to monitor potential loss scenarios for a range of possible storm tracks, wind speeds, and other intensity variables. As the storm draws near, the storm's likely track and intensity at landfall become less uncertain. ALERT event sets can be run against the company's detailed exposure data using a detail level modeling tool like CLASIC/2 to estimate the number of claims and their size distribution at high geographic resolution.

This information facilitates the strategic mobilization and deployment of resources where and when they are needed without inadvertently placing them in harm's way. Specific decisions claims managers are enabled to make with this information include where to set up their mobile response units (MRUs) and other claims command and communication centers, the optimal number and experience level of adjusters to dispatch, which hotels to book to house a potential army of adjusters and other support personnel for an extended period of time, what equipment to bring, and what specific external resources need to be contracted. Claims triage areas and the special resources needed to address the challenge can be identified.

In the immediate aftermath

In the immediate aftermath of an event, claims executives and managers barely have a moment to catch their collective breath. They are inundated with calls—from investor relations on behalf of investors and ratings agencies, from their media/PR department, from their legal department, from regulators, from their financial and treasury areas, and from other senior executives. All of these disparate constituencies want fast answers to many of the same questions: how many claims will there be, what is the likely geographic distribution and severity of these claims, what will be the ultimate paid losses and loss adjustment costs, and will there be enough cash on hand to pay the claims? AIR catastrophe modeling enables claim managers to provide immediate credible answers to these questions—well before the actual claims can be tallied.

Yet another application of catastrophe risk modeling during a catastrophe involves the area of internal financial management. The finance treasury departments must ensure that sufficient cash will be on hand in order to fund catastrophic claims or to prepare to liquidate some investments. By having a reliable and timely estimate of eventual losses, the company can make these investment portfolio shifts strategically and with minimal impact. 

Conclusion

Claims departments have an opportunity to shine when a catastrophe strikes. Catastrophe risk modeling offers new planning and deployment tools with which they can further strengthen their ability to serve their clients—both internal and external. This represents a still underutilized area for catastrophe models and can therefore create significant competitive advantage for forward thinking insurers.