Consumer Groups Allege Insurance Wind Models More Politics Than Science

April 6, 2006

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 that they 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 upgrades in the RMS wind models that the groups maintain 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 also blasted state regulators for failing to closely monitor the activities of RMS and other third-party rating organizations.

The consumer watchdogs referred to a recent announcement buy 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, claiming this would mean overall double-digit rate increases from Maine to Texas, contend that while RMS says that this 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.”

CFA and CEJ claim that the new approach is the complete opposite of that promised by insurers over a decade ago 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.

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

CFA and CJE allege that insurance companies sought this move to justify higher rates and this desire 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 other firms that are reworking their models.

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

They also cite Fair Isaac and Choicepoint as examples of third-party firms whose credit data insurers use in pricing decisions but whose “black boxes” and other formulas are beyond regulatory reach.

The groups blasted the NAIC for allegedly not monitoring these 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,” Hunter and Birnbaum charge.

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

The NAIC offered no response as of press time. Scott Holeman, NAIC spokesperson, said the group had received the letter and was still 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 also said its changes are the result of consulting with a “panel of leading hurricane climatologists” and that it is updating its model to “reflect expectations of sustained higher average levels of hurricane activity over at least the next 5 years.”

It maintained that its decisions are independent of how insurance companies may use their 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.”

Significant changes to its model, in either direction, have ramifications beyond premium levels and can be disruptive to its insurance and reinsurance clients, according to the modeling firm:

“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 the past seven years.

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