Interview: Karen Clark
The mother of cat models
Risk modelling has changed a lot over the years. Karen Clark, founder of AIR Worldwide and Karen Clark & Company, two of the better known cat risk modelling companies, tells Bermuda:Re+ILS about how the field has developed.
“We had to spend months explaining how the models worked and why they could trust them.”
Karen Clark, Karen Clark & Company
In the 1980s, the re/insurance industry was comfortable. Underwriters had been making money and there were few catastrophe losses. In 1992 all that changed with Hurricane Andrew, which upended the industry and forced re/insurers to pay more attention to catastrophe (cat) models.
Before the rise of cat modelling, the market was a very different place—there was no Bermuda market for cat re/insurance, and it was mostly written out of London.
“The US was in a lull of hurricane activity during the 1970s and 1980s. The largest loss the industry had experienced was $1 billion from Hurricane Alicia in 1983 and this was considered a large loss,” explains Karen Clark, co-founder and chief executive officer of Karen Clark & Company, who is widely regarded as one of the pioneers of cat risk models.
“The industry thought the largest possible loss was about $7 billion, but our model for the time says it was $60 billion.”
In 1987, Clark founded the first cat risk modelling company, AIR Worldwide. Five years later, Hurricane Andrew hit. Four hours after the hurricane made landfall, AIR sent a fax to its clients, stating that losses could exceed $13 billion.
“Nobody believed it, not even our own clients. There was disbelief, even from the underwriters using the models,” Clark recalls. Hurricane Andrew was a real turning point in the industry, but it was not an overnight change. “It took nine months for losses to develop and for the industry to realise they were going to pay out $15 billion for storm damage,” Clark recalls.
“Companies soon recognised that they had to understand models, and rating agencies began to ask insurers for model results,” she adds.
In 1996, the first cat bond was launched. Clark recalls that it was a struggle. “We had to spend months explaining how the models worked and why people could trust them.”
Cat bond models also played a key role in allowing the insurance-linked securities (ILS) market to develop.
“The cat bond market required the models as they had to be rated and the only way to rate them was to get loss estimates from the models,” says Clark.
Clark, by her own admission, is seen as the inventor of the cat model industry, but she gives a lot of credit to the “early adopters”—industry legends who signed up and stuck with her company.
“Even after Hurricane Andrew, it took a while to persuade companies to settle in and say this was going to be the standard technique,” she says. But AIR grew quickly, with a push to develop and approve more models.
In 2002 Clark sold AIR but, five years later, she returned to the cat modelling industry. However, this had not been her plan.
“When we started Karen Clark & Company, we had no intention of building cat models. At the time, we were being called in by global companies—at C-suite and board level—as independent expert consultants on those models. We would consult, but we didn’t plan to build,” says Clark.
“We had a vision of how we could implement science in a better way and package it.”
She soon discovered however that the key decision-makers were not completely satisfied with the models, so the company developed a CEO “wish list” of six items, including more efficient and cost-effective modelling processes, and more accurate models.
“We chewed on that and thought we could fill these gaps. We had a vision of how we could implement science in a better way and package it,” says Clark.
Again, there was scepticism, but there were forward-thinking market leaders who believed in the vision. The company now has 20 global models and expects to complete many more by the end of 2020.
All components of the models are fully transparent, so there are no secrets.
“People ask ‘if you don’t keep things secret, how do you protect your IP?’. That is very counterintuitive, as models are more valuable to clients if they have more confidence in them,” Clark notes.
“It’s a whole new paradigm for cat modelling. Our clients are very excited about the additional value they’re getting,” she concludes.