Internal models: a reinsurance perspective

Reinsurers play a crucial role in the real economy.

Between them, the seven members of the Insurance Europe Reinsurance Advisory Board (RAB) have approaching a millennium of experience in managing society’s extreme and complex risks. Risks have changed considerably since the 19th century, when many RAB firms were established, and those risks continue to evolve today: the negative effects of the financial crisis still ripple through Europe; climate change is increasing the frequency of extreme weather events; governments are under pressure to respond to the risks posed by ageing populations; and technological advances have exposed people and businesses to cyber risk.

Adapting to a rapidly changing risk landscape and identifying emerging risks lie at the heart of reinsurers’ business models. Reinsurers play a crucial role in the real economy. They expand insurers’ capacity to assume risks from businesses and individuals, supporting sustainable growth. By pooling a large number of diverse risks (both in terms of type and geography), reinsurers benefit from diversification, since not all risks will materialise at the same time.

The large variety, complex interdependencies and joint impact of risks require correspondingly sophisticated models. For this reason, most RAB firms already use their own internal models. Models for natural catastrophe risk started to be developed in the 1980s. Reinsurers have invested extensively ever since, particularly over the last 20 years, in developing models that are aimed at the holistic measurement of risk and the effects of diversification.

Internal models have proved crucial for sound risk management and business steering. This is because they create the right risk incentives and promote a better internal and external dialogue about risk exposures, thereby improving risk resilience. From the 19th century onwards, the sector has been able to weather a number of catastrophes and financial downturns, from the San Francisco earthquake of 1906 to the attack on the World Trade Center in 2001 and from the Great Depression in the 1920s to recent and current financial crises...


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