Conning
“The model needs to demonstrate how the interplay of all of these external events is affecting your company, given the strategy that you have in place, which is also dynamic.”
“The only way you can do this is with systems,” he says. “The problem is
too complicated to write down a functional relationship between decisions and outcomes. To deal with this kind of complexity you need to drive a model of your company and a model of the external events simultaneously through time using ‘Monte Carlo’ simulation. This method of probability distribution analysis can then give you a good idea of the distribution of possible repercussions of your business strategy.
“The simulations enable you to understand what it is about the mix of
your strategy and external events that can get you into trouble. By knowing this, you can design your business strategy to mitigate the downside under those circumstances.
“A well designed system, like this, can show you the events, and the
likelihood of those events. Then you can either choose to do something about it, or choose not to. For an event such as 2008, you could have taken out certain kinds of hedges or insurance against that event if you did not want to take on that risk. If you had had a system like this, you could have done something about it.
“Some insurance companies are suffering badly in the current low
interest rate environment. They have guarantees out there, but they can’t get enough income from high grade low risk investments to cover these liabilities. It means that they have to take on some additional risk; otherwise they cannot cover the liabilities. But that additional risk needs to be managed, lest it exacerbates the problem.”
In order to use simulation technology to help manage that sort of risk,
a number of system components must be present, says Urbach. One necessary component is a model of the external economy, including the financial markets and macro economy. Then there is a model of the liability side of your company, and how the risks are developing on the insurance side. And of course there must be a module that enables you to express the business strategy.
“There are companies who provide software to generate scenarios for
your liabilities, based on segmentations of your business lines that involve certain groupings of risk,” says Urbach. “Other companies can supply an engine to simulate the financial markets and the macro economy, and still others offer a complete system with components that model the economy and other external events affecting the company, the liabilities and assets, and your business strategy.
40 | INTELLIGENT INSURER | Spring 2012 “When you have it all in one system the economy and the company are
interacting dynamically over time,” he says. “This allows you to have a clear picture of what is happening within your company.”
Conning offers an award-winning economic scenario generator, called GEMS, as well as ADVISE, a system that can model the total company, including assets, liabilities and business decisions, right through to tax and accounting.
“These are offered separately—a company that wants only the economic
scenario generator can buy just that. If it wants an asset/liability generator, or the whole enterprise risk management (ERM) package, it can have that also. We can tailor packages to a company’s exact requirements,” says Urbach.
Another important issue around building models is the granularity of
the data produced. The greater the granularity of the data, the more precise the scenarios will be. According to Urbach, this is also an area where Conning performs strongly.
“We have the ability to model at a very granular level. We can model individual risks and individual securities. This is the kind of modelling that allows you to see the concentration and diversification risks and benefits properly.
“If a model cannot work at that level of granularity, then you can’t really
see all of the risks that you bear, because you have to treat as one entity things that have different sensitivities to the risk drivers. This is what we do very well—in the financial markets, we model right down to the securities, the bonds and the derivatives.”
Insurers in different geographic locations will come up against different
issues, so it is important that the modelling software they use is designed to take into account the nuances of the location, argues Urbach.
“Each area has its own specific problems,” he says, “and these tools allow
you to explore your own particular situation. For example, Europe has its own challenges and it is affecting insurers in a certain way, so by using the right software, companies can explore how to design their business strategies to cope with this kind of situation. Equally, many companies do business across multiple economic zones so you need to model the effects of global external events on an international enterprise. Our tools are applicable to any free market.”
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