Critics allege wind modelers influenced by insurers

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Risk Management Solutions has defended its hurricane risk models in the face of consumer groups’ criticisms that the models are more political than they are scientific and are designed to justify insurance premium increases.

RMS declined to address the specific allegations made by the Consumer Federation of America and the Center for Economic Justice but issued a statement claiming that the groups’ viewpoint “is a misrepresentation” of its role in the insurance industry.

On March 27, CFA and CEJ wrote to the National Association of Insurance Commissioners, raising questions about recent up-grades in RMS wind models that they said would lead to “unjustified increases in homeowners and other property casualty insurance rates.” The letter, signed by CFA’s J. Robert Hunter and CEJ’s Bernie Birnbaum, called for state regulators to increase regulation of RMS and other third-party organizations, including credit-scoring firms, whose work impacts insurance rates and availability.

The groups blasted state regulators for failing to closely monitor the activities of RMS and other third-party rating organizations.

Latest upgrades

The consumer watchdogs referred to a recent announcement by RMS that it is changing its hurricane models. RMS said that “increases to hurricane landfall frequencies in the company’s U.S. hurricane model will increase modeled annualized insurance losses by 40 percent on average across the Gulf Coast, Florida and the Southeast, and by 25-30 percent in the Mid-Atlantic and Northeast coastal regions relative to those derived using long-term 1900-2005 historical average hurricane frequencies.”

The groups maintained that this RMS shift would mean overall double-digit rate increases from Maine to Texas and that while RMS claims the increase is necessary for scientific reasons, “the evidence indicates that the primary reason for the change appears to be not science at all, but politics.”

RMS has “dramatically altered the methodology that is being used to predict wind events and set consumer rates, breaking promises that were made to consumers over a decade ago when more sophisticated weather modeling was introduced,” the letter stated.

The groups noted that in its March 23 press release RMS justified the major change as follows:

“To address this period of elevated frequency and intensity of storms, RMS consulted with representatives from all segments of the insurance industry and updated its U.S. and Caribbean hurricane models to provide a ‘medium-term’ (five-year) forward-looking view of risk for estimating po-tential catastrophe losses. To date, catastrophe model results have been based on a long-term historical average baseline.”

But CFA and CEJ claim this ap-proach is the complete opposite of that promised by insurers when these models were first introduced. Consumers were promised that premiums would be based on long-term data not short-term weather history, according to these critics.

“Consumers were assured that, although hurricane activity was cyclical, they would not see significant price decreases during periods of little or no hurricane activity, nor price increases during periods of frequent activity. That promise has now been broken,” the groups continued.

“RMS has become the vehicle for collusive pricing,” the letter charges, because it relied on insurers’ opinions to switch to the medium term five-year view of risk.

Competitive bind

CFA and CJE allege that insurance companies sought this move to justify higher rates, which put RMS in a competitive bind.

“If it did not raise rates, the market would likely go to modelers who did. So RMS acted and the other modelers are following suit,” the consumer leaders charge, citing AIR Worldwide and Eqecat as two that are reworking their models.

They argue that these third-party firms are operating beyond public scrutiny, unlike ratemaking advisory organizations such as Insurance Services Office, which are licensed by states and prohibited from collusive pricing activity.

They cited Fair Isaac and Choice-point as examples of third-party firms whose credit data are used by insurers in pricing decisions but whose “black boxes” and other formulas are beyond regulatory reach.

AIR Worldwide, in a statement by President and CEO Karen Clark, said her company “does not believe there has been a dramatic change in overall hurricane risk. Since 1995, we have been in a period of increased hurricane activity in the Atlantic related to increased sea-surface temperatures. Over the past 100 years, sea-surface temperatures have fluctuated periodically and, as a result, hurricane activity has also fluctuated,” Clark said.

She also noted that, “the recent increases in sea-surface temperatures due to both periodic fluctuations and global warming have had a far smaller impact on the growth of insured losses than the increase in the number and value of insured properties in hurricane prone states.”

NAIC also faulted

The groups blasted the NAIC for not monitoring the third-party rating organizations more closely:

“It is long past time for state insurance regulators to recognize that risk classification methods-the factors insurers use for underwriting, tier placement and rating-have a profound impact on insurance availability and affordability and are not subject to competitive market forces that protect consumers. State insurance regulators generally, and the NAIC in particular, have taken no steps to increase oversight of risk classification methods, despite numerous opportunities. The NAIC has done nothing to prevent the adverse effects of insurers’ increased use of credit information or improper use of loss history databases. State regulators have also generally done nothing about risk classification factors that obviously discriminate against low-income consumers, including use of information about prior liability limits, education and occupation.”

They urged state regulators to reject the new model and examine how it was developed; and called for regulators to assert more authority over other such organizations.

The NAIC offered no response as of press time. Scott Holeman, NAIC spokesperson, said the group has the letter and is reviewing it.

RMS defends itself

RMS, however, defended itself and its approach in general terms:

“At RMS, our mission is to build models that provide the best possible quantification of risk. We are independent, and our approach to risk quantification is completely objective and unbiased. Our models are updated periodically to reflect new scientific research on the characteristics of specific types of catastrophes, the associated risk, and new computing and data capabilities. These updates can cause our risk estimates to increase or decrease in a given region or locale.”

RMS said the upcoming changes to its wind model are designed to “reflect expectations of sustained higher average levels of hurricane activity over at least the next five years” and quantify the implications of increased hurricane activity, which is “currently significantly higher than the long-term average.”

RMS maintained that its changes are the result of consulting with a “panel of leading hurricane climatologists.”

It said its decisions are independent of how insurers may use the models. “We do not provide recommendations on insurance premiums. Our focus is on quantifying the underlying risk, which is an important input to a complex set of decisions involved in how insurers and regulators establish insurance premiums.”

Disruptive to insurers

Significant changes to its model, in either direction, have ramifications beyond premium levels and can be disruptive to its insurance and reinsurance clients, RMS said. “Although higher modeled risk may imply that premiums are inadequate in some areas and should potentially increase, they also imply that insurers may need more capital to underwrite the same volume of business and to maintain their financial strength rating. Due to the pending changes in our hurricane model, rating agencies are actively engaging with insurers and reinsurers regarding the implications of increased risk on capital adequacy and financial strength ratings.”

RMS further noted that its models are not totally beyond regulatory scrutiny in that its residential model has been subject to a certification process in Florida for seven years. The Florida Commission on Hurricane Loss Projection Methodology has certified the RMS model for use in establishing residential insurance rates in that state. To be certified by the commission, a company must provide extensive documentation supporting the hurricane model’s accuracy and be audited by an independent panel of experts, according to RMS.

“We plan to update our model annually to incorporate new data, science, and expert opinion in order to continue representing the best possible quantification of medium term risk. Over time, this may result in either increases or decreases in modeled hurricane risk,” RMS added.