I want to start this article with a couple of related questions: How do capital models help insurance businesses, and what can you do in your own business to get more out of them?
My answer is that capital models represent a very powerful, yet often underutilized, platform that can help insurers make better, or at least more informed, decisions. They are, or should be, a central repository of the best assumptions from nearly every part of an insurance company; nowhere else in the company will something like this exist.
Ultimately, their purpose is to attempt to quantify unknowable numbers, exemplified by the old adage from George Box: “All models are wrong; some are useful.” The uncertainty of forecasting the future means that in any capital model the values indicated are ultimately incorrect. But that’s not the point; the goal is that they are indicative and directionally correct.
Nonetheless, it does beg a question that I receive from time to time: If everyone knows the answers are wrong, how can and why would anyone trust the numbers being produced? The answer relies on the socialization of the capital model.
Socializing the capital model involves business units outside of the capital modeling team having buy-in to the assumptions that are feeding the model and providing feedback regarding the output being produced.
Historically, socialization has been difficult to achieve, as capital models have been siloed within modeling teams. They may be expert modelers, but they also must rely on the expertise of the business teams to develop quality assumptions. Any disconnect between the business experts and the capital modelers, due to the capital modeling team acting as an intermediary, is likely to impede the speed of information transfer and result in the model being a black box to the business. This is a problem.
Capital modeling is evolving, however. We increasingly see a future where the business experts have direct access to relevant sections of the capital model, for example, the reinsurance team has access to the reinsurance section or the asset management team interacts in the investment assumptions. So, we are moving toward a common practice of each line of business having access to its reserving and new business assumptions.
From a controls perspective, this broader access may sound overwhelming for the business — and dangerous, right? Yes and no.
The teams outside of the capital modeling team can run the full model using their adjusted what-if inputs, but they won’t be able to commit to the official capital model; they will be operating in a safe zone. Information outside their area of expertise will be restricted to protect sensitive assumptions; therefore, broader access is not terribly dangerous.
Those outside the capital modeling team will also only be able to see their relevant sections. While reinsurance teams may care about the number of reinstatements, and asset teams may care about the fixed-income portfolio, it’s unlikely they will want to see the other sections. This both limits what information is available to the different areas and reduces what the teams need to understand. As such, broader access is not terribly overwhelming.
The result is that the capital modeling team will have far more input from the business, and external teams will have vetted the assumptions feeding the capital model far more than previously. The net results for those within the business:
With such socialization of the capital model, the capital modeling team still has a significant, if changing, role to play. The team will need to work with the business units to ensure risk is being viewed consistently. They will also need to model how different risks are related (including correlation and/or risk factors, as mentioned in a previous blog).
How can you make this kind of model socialization and buy-in happen in your own insurance business? Today, technology, especially the cloud, supports the capabilities needed.
Increasingly, we’re seeing that companies that embrace the technology and its new socialization features benefit from:
That, in my book, all adds up to a more solid foundation for business decision making.
