Modeling Fundamentals: Loss Modification in Touchstone
Mar 26, 2020
Many companies have their own unique view of risk, which distinguishes it from other companies’ views, potentially leading to different risk appetites and capital requirements. In addition to AIR models, these views of risk can be informed by various sources, ranging from engineering studies and claims analyses conducted on books of business to updated hazard maps and regulatory changes. Ultimately, companies seek to use their unique insight and experience for their own risk management to make decisions that make sense for their business so that they can truly own their risk. To ensure these views of risk are accounted for in risk analyses and management strategies, these days model users are taking a more active role in the modeling process and need tools that provide the necessary flexibility.
Touchstone®, AIR’s enterprise risk management platform, provides you with an option to modify ground-up losses based on a set of filter criteria, such as event, geography, exposure characteristics, and more (Table 1). These criteria enable users to modify model output to account for various aspects of loss, including extra expenses and non-modeled perils. To stress test policies, they also provide additional flexibility in defining the loss modification factors for specific types of locations or for specific kinds of events.
|Geography||Number of Stories|
|Line of Business||Contract and Location ID|
|Event Parameter||Individual Event|
|Occupancy||Location User-Defined Field|
Touchstone applies user-specified loss modification factors to losses from events or locations that satisfy the rules you set. A loss modification factor is applied to the entire ground-up loss distribution for any analysis—whether for single or multiple locations or single or multiple events—and the changes made to the ground-up losses are propagated to downstream perspectives.
Why Modify Losses in Touchstone?
Align with Claims Analysis Results
A claims analysis study may indicate that certain classes of business perform differently than suggested by the model. In this case, you can apply loss modification factors by location characteristics, such as construction, occupancy, line of business, or building age or height, which allows for the scaling of losses for entire sets of damage functions. Factors can also be applied based on location via User Defined Fields (UDFs) that would allow losses to be scaled based on specific location characteristics encapsulated in the UDF, such as distance to coast or soil type.
Comply with Regulatory Requirements
There is continued regulatory demand on insurers to truly own their view of risk. Scaling event losses for a specific region and model can help you seamlessly integrate a custom view of risk into your operation. It is also a good way to meet regulatory requirements regarding scenario simulations and stress testing around climate change.
In 2019, for example, AIR provided event-based loss modification factors to respond to a request from the Prudential Regulatory Authority (PRA) to provide estimates of the impact to annual aggregate loss and 100-year return period losses for several climate change scenarios, including some for U.S. hurricane (and storm surge) and for UK inland flood.
Account for Changing Views of Risk
When there are changes in the scientific literature and/or data available for a given model, which can impact the underlying assumptions and ultimately losses, loss modification provides an avenue for model users to account for these changes prior to a model update. For example, the recently updated National Seismic Hazard Map from Geosciences Australia challenges established conceptions of Australia’s seismic hazard and generally decreases seismic hazard factors significantly. You can account for these recent changes within the existing modeling workflow by using loss modification factors before the release of the updated AIR Earthquake Model for Australia, anticipated for release this year.
In addition, you can modify modeled losses to reflect non-modeled sub-perils or loss adjustment expenses via loss modification in Touchstone. You can account for losses from non-modeled sub-perils, such as European tsunami, related to a modeled primary peril, such as European earthquake shake, by applying a modification factor to coastal exposure for earthquakes with specified event parameters. To account for loss adjustment expenses, you can apply a simple uplift factor, which is also useful for creating individual company views of risk, such as adjusting losses for particular occupancy or construction codes.
Loss modification in Touchstone also allows model users to account for unsupported constructions or occupancies. For example, you could develop your own loss modification factors to model wind turbines based off of generic AIR occupancy codes for locations or models where they are not yet supported (e.g., the AIR Hurricane Model for Mexico).
Run Sensitivity Tests
Model users can apply a varying set of loss modification factors to run a set of what-if scenarios, enabling you to check how layer, sublimit, or reinsurance terms react under different conditions and could ultimately impact your portfolio. Some regulators may ask to see the impact of increasing losses for particular region/peril models to understand the impact of “model miss” on capital requirements. To gauge the impact of contract terms, you may want to vary a loss amount either up or down to see the impact on layers at different points in the exceedance probability (EP) curve—something that can also be helpful in meeting regulatory demands and assessing capital adequacy regarding reinsurance requirements.
With Flexibility Comes Responsibility
Loss modification in Touchstone offers you a greater level of flexibility and transparency so that you can develop a custom view of risk. When using Touchstone's loss modification functionality, users should keep in mind the importance of maintaining a scientifically credible, internally consistent view of risk. AIR spends significant resources on validation and our model components and configurations have been carefully calibrated to align with observed loss outputs. When modifying views of risk, users should clearly document, justify, and validate loss modifications in anticipation of questions from both internal and external stakeholders. To facilitate those processes, the AIR view of risk will be preserved and can be obtained to use as a benchmark alongside the modified view.
Further Enhancing Flexibility: Custom Vulnerability
AIR is committed to providing increased transparency and flexibility options with the ability to adjust model components and modify the model output. Last year, we introduced Model BuilderTM to allow custom models to be built and deployed in Touchstone along with AIR models. Beginning later this year, Touchstone users will be able to implement custom damage functions built from scratch into a select set of models to make modifications to the vulnerability modules of these models.
This new functionality will provide flexibility when user views of damage levels or type may differ from those inherent in the AIR model, or when a certain exposure does not exhibit the expected damage given known event parameters. While the current Loss Modification Functionality enables you to modify losses for individual events or event categories, vulnerability is directly related to the intensity at the modeled location.
AIR has developed a set of tools to give you the flexibility you need to implement your own view of risk, and is committed to continuing to deliver flexible tools to help each company use their unique insight and experience in making decisions that make sense for their business.