Low-Cost De-Risking for the P&C Insurance Market

In the current formidable economic and regulatory environment, with global markets on the verge of recession, P&C insurers must find innovative methods to limit risk exposure and improve solvency ratios in order to control costs, stimulate growth and stay afloat. Vesttoo's stochastic modeling methods optimize de-risking solutions, lowering basis and tail risks while maximizing capital relief per dollar spent

June 18, 2020
insurance, risk transfer, general insurance, insurtech, stochastic modeling
stochastic modeling methods limit risk exposure and improve solvency ratios

P&C insurers and the insurance industry as a whole are experiencing unprecedented times. Global economies are on the verge of recession and markets are extremely volatile despite governmental stimuli. Pre-pandemic challenges such as rising governmental scrutiny (Solvency II), intense competition, and historically low interest rates still remain more relevant than ever. Across the industry, profit margins are shrinking, while risk exposure is increasing. In times like these, it pays for insurers to limit their liability exposure and strive towards a lower risk future.

Existing reinsurance solutions are limited

Unfortunately, traditional reinsurance solutions available on the market are costly and between 20-30% of the risk is retained on the cedent’s balance sheet, for which complementary solutions must be found. Furthermore, reinsurers simply don’t have the capacity to cover the entire industry’s de-risking needs, and in the current turbulent economic environment, they are limiting their capacity even further while elevating prices.

One of the reasons for elevated pricing is that risk models used in traditional reinsurance solutions are based on past models which don’t suit the underlying risk behavior. When using advanced stochastic risk models (that measure the probability distributions of potential outcomes), a much wider range of risk scenarios is taken into account, and are therefore much more reliable. Furthermore, traditional reinsurance solutions usually have long deal durations, also contributing to higher pricing.

Stochastic risk algorithms for accurate, cost effective de-risking

Innovative de-risking derivative programs, such as Vesttoo's, which employ accurate stochastic modeling methods offer a cost-effective alternative to de-risking through traditional reinsurance, as well as a complementary solution for existing reinsurance retention. These programs transfer risk to the capital markets through derivative structures, taking advantage of the unlimited capacity the markets have to offer. Institutional investors substitute traditional reinsurers on the other side of the deal, in exchange for taking on remote loss possibilities, providing a bridge to the capital markets and the capital needed for SCR and risk margin relief, at a fraction of the price.

insurance market, capital market, risk transfer, stochastic models
Vesttoo bridges the insurance and capital markets

In Vesttoo's proprietary solution, accurate risk profiles are created using AI-based proprietary stochastic risk algorithms. Working bottom-up on a pool of policies, claim tranches are grouped according to specific policy cohorts, made up of similar policyholder ages and portfolio characteristics, greatly increasing risk model accuracy. Basis risk, which is defined as the difference between the expected payout and the actual payout, is driven by forecasting errors. The more accurate the risk model is, the lower the basis risk as well as the paid premium.

stochastic models, stochastic modeling, accurate risk models, tranches
Claim tranches are grouped according to specific policy cohorts, increasing risk model accuracy

Accurate portfolio-specific liability indices along with attachment and exhaustion points are also built using stochastic risk algorithms, creating robust and reliable forecasts used to predict the portfolio’s future performance, limiting tail risk and allowing for reduced deal maturity and lower pricing. At deal maturity, actual performance is used to adjust and discount future predictions.

stochastic modeling, basis risk, risk transfer
Vesttoo's accurate stochastic risk models greatly lower basis risk

Due to the way Aggregate Stop Loss deals are structured and modeled, they are especially suited to be transferred as a derivative to capital market investors. Vesttoo has developed a low-cost custom-made Aggregate Stop Loss solution that utilizes accurate proprietary stochastic models developed in-house. Vesttoo’s cost-effective solution transfers risk to the capital markets while allowing insurers to hold on to premiums and upside from their portfolio. With the newly found capital and increased profit margins, insurers can stimulate growth, gaining a competitive edge.

Despite the enormous challenges facing P&C insurers worldwide in the current economic environment, innovative insurtech solutions such as Vesttoo’s, taking advantage of the inherently low basis risk of AI-based stochastic modeling methods, provide insurers with efficient, low-cost capital relief.

Read more about Vesttoo's custom-made solution in our Aggregate Stop Loss Case Study.

Vesttoo has developed advanced technologies for data-driven risk management, transferring actuarial risk to financial risk through the capital markets. Vesttoo specializes in risk modeling and alternative risk transfer for the Life and P&C insurance markets, providing insurers with a low-cost strategic risk management solution for immediate capital relief, value enhancement and liability hedging.