Tag Archives: actuarial analysis

Modeling Flood — the Peril of Inches

“Baseball is a game of inches” – Branch Rickey

Property damage because of flooding is quite different from any other catastrophic peril such as hurricane, tornado or earthquake. Unlike with those perils, estimating losses from flood requires a higher level of geospatial exactness. Not only do we need to know precisely where that property is located and the distance to the nearest potential flooding source, but we also need to know the elevation of the property in comparison to its nearby surroundings and the source of flooding. Underwriting flood insurance is a game of inches, not ZIP codes.

With flood, a couple feet can make the difference between being in a flood zone or not, and a few inches of elevation can increase or decrease loss estimates by orders of magnitude. This realization helps explain the current financial mess of the National Flood Insurance Program (NFIP). In hindsight, even if the NFIP had perfect actuarial knowledge about the risk of flood, its destiny was preordained simply because it lacked other necessary tools.

This might make the reader believe that insuring flood is essentially impossible. Until just a few years ago, you’d be right. But, since then, interesting stuff has happened.

In the past decade, technologies like data storage, processing, modeling and remote sensing (i.e. mapping) have improved incredibly. All of a sudden it is possible to measure and store all topographical features of the U.S. — it has been done. Throw in analytical servers able to process trillions of calculations in seconds, and all of a sudden processing massive amounts of data is relatively easy. Meanwhile, the science around flood modeling, including meteorology, hydrology and topology, has been developed in a way that the new geospatial information and processing power can be used to produce models that have real predictive capabilities. These are not your grandfather’s flood maps. There are now models and analytics that provide estimates for frequency AND severity of flood loss for a specific location, an incredible leap forward from zone or ZIP code averaging. Like baseball, flood insurance is also a game of inches. And now it’s also a game that can be played and profited from by astute insurance professionals.

For the underwriting of insurance, having dependable frequency and severity loss estimates at a location level is gold. There is no single flood model that will provide all the answers, but there is definitely enough data, models and information available to determine frequency and severity metrics for flood to enable underwriters to segment exposure effectively. Low-, moderate- and high-risk exposures can be discerned and segregated, which means risk–based, actuarial pricing can be confidently implemented. The available data and risk models can also drive the design of flood mitigation actions (with accurate credit incentives attached to them) and marketing campaigns.

With the new generation of models, all three types of flooding can be evaluated, either individually or as a composite, and have their risk segmented appropriately. The available geospatial datasets and analytics support estimations of flood levels, flood depths and the likelihood of water entering a property by knowing the elevation of the structure, floors of occupancy and the relationship between the two.

In the old days, if your home was in a FEMA A or V zone but you were possibly safe from their “base flood” (a hypothetical 1% annual probability flood), you’d have to spend hundreds of dollars to get an elevation certificate and then petition the NFIP, at further cost, hoping to get a re-designation of your home. Today, it’s not complicated to place the structure in a geospatial model and estimate flood likelihood and depths in a way that can be integrated with actuarial information to calculate rates – each building getting rated based on where it is, where the water is and the likelihood of the water inundating the building.

In fact, the new models have essentially made the FEMA flood maps irrelevant in flood loss analysis. We don’t need to evaluate what flood zone the property is in. We just need an address. Homeowners don’t need to spend hundreds of dollars for elevation certificates; the models already have that data stored. Indeed, much of the underwriting required to price flood risk can be handled with two to three additional questions on a standard homeowners insurance application, saving the homeowner, agent and carrier time and frustration. The process we envision would create a distinctive competitive advantage for the enterprising carrier and one that would create and capture real value throughout the distribution chain, if done correctly. This is what disruption looks like before it happens.

In summary, the tools are now available to measure and price flood risk. Capital is flooding (sorry, we couldn’t help ourselves) into the insurance sector, seeking opportunities to be put to work. While we understand the skepticism of the industry to handle flood, the risk can be understood well enough to create products that people desperately need. Insuring flood would be a shot in the arm to an industry that has become stale at offering anything new. Billions of dollars of premium are waiting for the industry to capitalize on. One thing the current data and analytics make clear is this: There are high-, medium- and low-risk locations waiting to be insured based on actuarial methods. As long as flood insurance is being rated by zone (whether it is FEMA zone or Zipcode), there is cherry-picking to be done.

Who wants to get their ladder up the cherry tree first? And who will be last?

Getting to 2020: the Finance Function

Even as economies recover, the insurance sector continues to face many competitive pressures and regulatory challenges. Yet a new drive for growth is emerging. The 2014 EY Global Insurance CFO Survey captures the priorities and challenges for finance and actuarial teams as they seek to support business growth strategies while addressing regulatory and cost pressures.

Delivering more value to the business through performance measurement and improved decision support is the top priority for the finance function through 2020. Among senior finance professionals participating in the survey, 71% indicated that “being a better business partner” ranked among their top three priorities, with 35% placing this as number one.

As insurance companies around the world continue to invest in data management and analytics capabilities, the role of finance and actuarial functions has become even more critical. The processes and systems supporting these functions are key to developing deep insights into business performance, as well as customer needs, preferences and behavior. In response, finance leaders have been increasing their efforts to improve the capabilities of their organizations to meet the new demands. In the survey, 89% of respondents stated that they have either begun a change program or are in the planning stage.

However, the drive to better insights is not without challenges. Among the issues is the impact of continuing regulatory compliance demands. According to 35% of those surveyed, implementing new regulatory and financial reporting requirements was the highest priority for finance and actuarial organizations; 56% ranked this among their top three. As a result, the ability for these organizations to strike a balance between delivering value to the business and meeting daily operational demands will continue to be a challenge.

Not surprisingly, the current data and technology footprint will require significant change to meet the challenges of the finance function of the future. Across the finance operating model, survey participants scored data as the least developed capability on average, while technology recorded the greatest gap between current and required future state.

Other Key Findings

  • Top three business drivers: #1 growth, #2 managing costs and #3 regulatory changes
  • Two-thirds of respondents rank data and technology issues among the top three challenges facing finance and actuarial functions; participants on average score data as their least developed capability
  • By 2020, the most significant shifts in maturity levels by operating model will be in data management and technology capabilities
  • Respondents expect onshore shared services to support transaction processing functions, with outsourcing selectively used for payroll and internal audits
  • Decision support and controls are expected to account for a larger share of finance and actuarial headcount by 2020

What insurers must do

We see three key areas where insurers can take action:

  • Modify current reporting processes by developing an efficient reporting solution architecture.
  • Deliver timely and relevant management information and link strategic objectives to performance indicators.
  • Improve finance and actuarial operational performance by using the right skills and processes to strike a balance between effectiveness and efficiency.

For the full survey from which this excerpt was taken, click here.

Insurance Product Development (Excerpt, Part 2)

CHAPTER 3: Creating and Working With a Centralized Product Development Department

There is no single corporate structure for developing a successful product development process. However, there are numerous advantages of creating some type of centralized function. The size and scope of the function depends not only on the size and scope of the corporation itself but also its product development goals. In general, the more robust the product development goals, the greater the need for some centralized unit. For companies that are not large enough to support a centralized division of any size, there is wisdom is creating a senior position that could help the CEO direct innovation within the company. This position has been called the chief innovation officer, the chief strategy officer or even the chief scientist.

Mission Statement

The mission of a centralized product development department is to assist in the creation of innovative and profitable products and services, contributing substantially to the bottom line. Usually working in partnership with the company’s profit centers and the brokerage and risk management communities, a centralized team of creative, experienced professionals can provide a full range

of customer and results-driven solutions, including idea generation and validation, product design and implementation, and post-launch evaluation.

Expertise and Services

Expertise

Product development as a process includes underwriting, actuarial, legal, compliance, marketing and, perhaps most importantly, project management. The larger the centralized department, the more of these services can be housed in the department. However, as mentioned above, there is no single solution. In many cases, some of these services are provided by a department outside of product development such as the office of general counsel. In my 30 year career, I have led large departments which housed centralized all the necessary product development functions as well as smaller departments which housed some of the function and then partnered with other departments for those services not found within the centralized department. At its most robust, the make-up of a centralized product development team is made up of seasoned professional with experience across all general insurance lines, including Specialty Lines, Personal Lines, General Liability, Property, Casualty, Small Business, Accident & Health, and Financial Lines. Together with these insurance SMEs are a team of dedicated “support staff” including legal, actuarial, marketing etc. An example of a robust centralized new product development team is included in the appendix. This team of professionals works closely with the profit centers, brokers, agents, and risk managers to provide total “end-to-end” services for all areas of product development.

Services:

The following is a comprehensive list of potential services that could be offered by a centralized product development department:

  • Innovation Education and Culture Creation
  • Idea Generation
  • Total Project Management
  • Comprehensive Research
  • Product Demand Analysis
  • Underwriting Assessment Analysis
  • Distribution Assessment Analysis
  • Legal Drafting
  • Actuarial and Rating Plan Creation
  • Reinsurance
  • Financial Analysis and Proforma P&L Creation
  • Marketing Strategies and Communications Implementation
  • Claims Analysis
  • Sales and Business Development
  • Technology, Operations, and Systems
  • Liaison with Risk Managers/Brokers

Each corporate profit center should be encouraged to use as many of the services as their new product development requires. This may mean total end-to-end project management or an a la carte selection of services. This team leads the process of new product development as described in the father chapters of this Guide which include:

Innovation: The process of creating a “culture of creativity” (Chapter 4).

Trend Identification (Generating the idea): Early awareness of societal changes, creating new or increased risk that could be the subject of an insurance product (Chapter 5).

Preliminary Analysis (Evaluating the idea): The new product idea is reviewed to determine viability through an analysis of product Demand, Underwriting, and Distribution (Chapter 6).

Scope and Definition (Developing the idea): Partnering with a profit center, the new product idea is sufficiently assessed to determine a final go/no-go decision on the product idea (Chapter 7).

Design: Partnering with a profit center to create all the components of an insurance policy are created – policy form, rater, application, marketing plan, etc .(Chapter 8).

Implementation (Launching the product): Underwriting and broker training sessions are completed and a “launch event’’ for the product is scheduled. (Chapter 10 -13)

Product Performance Review (Monitoring the product): Three-, six-, and twelvemonth reviews of the product’s performance are done with the profit center to determine if the product needs to be adjusted (Chapter 14).

All of the detailed tasks, research, and analysis that are performed at each stage of the product development process are outlined in this Guide.

Tracking and Managing Innovation

It is a good idea to have a database which tracks the submission and progress of innovative ideas that come to the company. This can be done as simply as a spreadsheet with internal protocol that all ideas are eventually submitted to the holder of the spreadsheet, or could be done by way of a more sophiscated web based data base specially designed for this purpose. Regardless of method, it is advantageous to have all new product ideas entered into the database. In addition, at the time of final product resolution either through product launch or termination of development, it is recommended the database be updated as to the new product status. If terminated a reason should be given (e.g., insufficient demand). As discussed in chapter 3.5 below, best practices to have a dedicated new product web page and intranet site which would allow the easy submission (via a simple to use form) to the centralized department for tracking, and assistance if desired. This will also prevent duplication of effort and the sharing of information across the enterprise.

New Product Web site

It is advantageous to have a dedicated intranet new product web site which is linked to the company’s intranet home page. This site can offer a comprehensive overview of the activities of the centralized department, encouraging executives and employees as well as (if there is an internet site version) brokers and risk managers to participate more fully in the product development process, while providing business unit partners with a convenient, centralized means of promoting their new product activities.

The site offers descriptions of recently developed products as well as some of those currently in development; provides news items of relevant interest; offers easy access to idea submission; and familiarizes the reader with the product development process. Anyone seeking information about new product initiatives will find a centralized source of information on the site.

Employees, brokers, and risk managers who are interested in submitting a new product idea may do so easily and quickly through the portal. Business units that are engaged in new product development or have recently launched a new product can reach interested audiences worldwide by posting information, knowing that readers who access this central repository of new product knowledge have already demonstrated interest in product development, creating a robust marketing opportunity.