Opinion: Updated Doesn't Mean Better Catastrophe Model

Former catastrophe modeling firm founder and now a chief critic of the insurance underwriting tool, Karen Clark sounds off on RMS 11.0 and other new updates that aren't necessarily more accurate.

By KAREN CLARK, president and CEO of consultancy Karen Clark & Co.

Catastrophe modelers continually update their models, and model updates are typically assumed to be better, even if the modeled loss estimates swing widely, both up and down, from one update to the next. Assuming a newer model is always a better model is not a sound assumption, particularly if we define "better" as a model for which the loss estimates are more credible or closer to reality.

If we were getting closer to reality with each model update, then the variability and volatility in loss estimates would be decreasing, not increasing as we've seen with recent model updates.

A lot of scientific research underlies catastrophe models, but very few scientific facts. The science is highly uncertain due to the paucity of data behind most model assumptions. There are many "unknowns" for which no amount of analyzing recent events can shed more light--even after tens of billions of dollars of claims data is incorporated.

For example, all the data from the hurricanes of the last few decades tell us very little about the probabilities of major hurricanes hitting the mid-Atlantic and Northeast regions. Scientists have very little recorded data on hurricanes striking the coast in these regions. In fact, scientists have reliable recorded information on maximum wind speeds over land for only two Northeast hurricanes, Gloria (1985) and Bob (1991), both Category 2 storms.

If scientists don't know how many major storms have historically struck these regions, how can scientists estimate the future probabilities? Even more problematically, how can a model pinpoint a number for each insurance company's one-in-100 probable maximum hurricane loss in these regions? It's easy to see how the model-generated probable maximum losses can swing by 100 percent or more.

When there is so little data, the model assumptions are based on scientific guesstimates that can change significantly from model to model, and update to update. No authoritative source exists to say which set of guesstimates is better than another. If one model says the chance of a major hurricane in the Northeast is one in 90 years, for instance, and another says one in 110 years, which is more accurate? If those same models are updated and now one model says 75 years and the other 125 years, which is better? All four of these estimates are credible and scientifically defensible, but they can lead to large differences in PML estimates.

WHEN UPDATES GO WRONG

While a new model is not necessarily a better model, a model update can go very wrong, particularly at a regional and local level. There are several reasons for this. First, while the models are good for assessing relative risk, they can only go so far in distinguishing high-risk versus low-risk areas.

While Florida is clearly the region most exposed to hurricane losses, is Florida 200 or 300 percent more exposed than Texas? Is the Florida loss potential five, six or seven times that of the Northeast?

While California is clearly the most earthquake-exposed state, is Northern California less or more risky than Southern California, and by how much?

At higher resolution, it's even more difficult to distinguish the risk from one location to another because secondary causes of loss come into play, such as storm surge and liquefaction. These secondary causes of loss can drive the loss estimates in some areas, but their effects are difficult to quantify and model. Specific areas can be significantly under or overly penalized by a model.

The second reason model loss estimates can go awry is because the catastrophe models have become overspecified. We are trying to model things that we can't even measure. For hurricanes, wind speeds are estimated at individual locations using many assumptions on surface roughness and gust factors when, with very few exceptions, there are no recorded hurricane wind speeds for any of those locations. For earthquakes, ground motion is estimated at individual locations using many assumptions on soil conditions and other factors when there is no recorded data for the vast majority of locations.

High degrees of uncertainty surround all of these assumptions. The problem is compounded by the fact that the model loss estimates are highly sensitive to even small changes in the assumptions. For example, changing an assumption about surface roughness by just 10 percent can cause the hurricane loss estimates to change by over 50 percent. This is a fundamental problem with all the models.

Finally, a model can be overcalibrated to one or two events. There is no average hurricane or earthquake. All catastrophes are unique, and the modeling companies have to decide what can be generalized and what is relatively unique about each actual event.

The Northridge earthquake, for example, occurred on an unknown fault and caused unexpected ground motion at many locations in the Los Angeles area. Scientists would caution against calibrating all future earthquake events to Northridge.

Hurricane Ike was a very unusual storm, particularly with respect to inland damage. Much of Ike's high winds and inland damage were caused by meteorological factors not related to the storm. Occasionally, storms do move far inland, and this should be accounted for in the models. However, calibrating every storm to Hurricane Ike could lead to overestimating inland damage for most storms.

Because model users do not have the benefit of transparency on all of these model assumptions, the model-generated loss estimates should be fully vetted before being utilized for important underwriting and pricing decisions. The model loss estimates can go awry, and there are ways to detect anomalies and test the numbers to make sure they are within the bands of credibility and reasonability. No one knows the right answer, but we can certainly weed out the very wrong answers.

If a model update is not credible for a particular book of business, the update should not be used. Major shifts in underwriting strategies are disruptive to business goals and objectives. The test of a "better" model is if the loss estimates are more credible for a particular book of business--not whether it's the latest research a modeling firm has to offer.

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Failure to testify doesn't establish undocumented worker status

In Pennsylvania, a party cannot satisfy its burden of proof in a civil proceeding solely through reliance on the adverse party's failure to testify.

Case name: Cruz v. Kennett Square Specialties, 26 PAWCLR 60 (Pa. W.C.A.B. 2011).

Ruling: The Pennsylvania Workers' Compensation Appeals Board reversed the workers' compensation judge's finding that the claimant was an undocumented worker and the employer's suspension of indemnity benefits.

What it means: In Pennsylvania, a party cannot satisfy its burden of proof in a civil proceeding solely through reliance on the adverse party's failure to testify.

Summary: The board ruled that the WCJ's finding that the claimant was an undocumented worker was not supported by substantial competent evidence. The claimant filed a claim petition alleging a work-related injury to his lower back. The WCJ found that the claimant sustained a work-related lumbar strain, midline disk herniation, and right radiculopathy, and that he was not capable of returning to his preinjury job but could return to modified duty. The WCJ also drew an adverse inference from the claimant's refusal, on the advice of counsel, to answer questions regarding his citizenship or immigration status. The WCJ determined that the claimant was not a U.S. citizen and was not authorized to work in the U.S., and therefore, the employer was entitled to a suspension of indemnity benefits as of the date of the injury. The board reversed the WCJ's finding that the claimant was an undocumented worker and the suspension of indemnity benefits. The adverse inference alone was not sufficient evidence upon which to base the finding that the claimant was an undocumented worker.

The employer did not present any other evidence supporting this contention, and therefore, it had to show job availability or earning capacity to obtain a suspension of benefits.

Read more at the WorkersComp Forum homepage.

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Driver's lack of legal representation doesn't void settlement agreement

Tennessee courts rarely set aside workers' compensation settlements for mistake, inadvertence, surprise, or excusable neglect. A mistake of law stemming from an employee's decision not to secure counsel is not a basis for relief.

Case name: Henderson v. SAIA, Inc., et al., No. M2009-01723-SC-R3-WC (Tenn. 08/24/10).

Ruling: The Tennessee Supreme Court held that a settlement agreement was valid and binding.

What it means: Tennessee courts rarely set aside workers' compensation settlements for mistake, inadvertence, surprise, or excusable neglect. A mistake of law stemming from an employee's decision not to secure counsel is not a basis for relief.

Summary: A truck driver was injured when she fell while exiting the cab of her truck. She had hip surgeries. The driver was contacted by her employer's insurer in an attempt to settle her workers' compensation claim. An agreement was reached. The driver signed the documents, and the settlement was approved by a judge. Six months later, the driver sought to set aside the settlement. The Tennessee Supreme Court held that the agreement was valid and binding.

The driver argued that she did not understand the meaning of maximum medical improvement when she signed the affidavit asking the court to approve the agreement. However, the documents she signed made it clear that she understood that if she chose to litigate her case, she might receive a better or different amount. The driver implied that she was not aware of her legal rights because she did not have an attorney. The court stated that the driver at all times had the right to consult an attorney.

The driver asserted that incorrect information her husband allegedly received from the Department of Labor consisted of fraud, misrepresentation or other misconduct. The court would not impute the information to the employer. Additionally, the documents prepared by the employer clearly and accurately explained the settlement process to the employee.

The court noted that it was reasonable to conclude that the employee believed that the settlement's terms were fair at the time she signed it. The settlement the driver received exceeded the statutory cap on benefits.

The court declined to find that the driver's appeal was frivolous or taken solely for the purpose of delay. It did not impose penalties against the driver.

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Illinois: Comp reform doesn't go far enough, business advocates say

Illinois' workers' comp premiums are among the highest in the nation. In fact, the most recent Oregon Workers' Compensation Premium Rate Ranking puts the state third highest behind Montana and Alaska.
The high workers' comp rates coupled with a recently imposed tax hike make the state a tough sell for businesses to locate -- or stay in, say business proponents. They're looking to state lawmakers to strengthen and adopt reforms proposed by the governor despite protests by medical providers.
Gov. Pat Quinn recently unveiled his proposed workers' comp reforms. Included is a 30 percent reduction in Illinois' medical fee schedule, an idea that is not sitting well with medical providers.
"Any proposal for a 30 percent payment reduction for injured workers' medical care is unacceptable," said Dr. Steven M. Malkin, president of the Illinois State Medical Society. "Illinois physicians strongly oppose such arbitrary slashing of the workers' compensation fee schedule under the guise of reform. The proposed cut is excessive and unwarranted."
But business proponents say the idea is more than fair to medical providers. "Illinois' fee schedule is incredibly rewarding to providers," said attorney Richard Lenkov, a partner in Bryce Downey & Lenkov in Chicago. "It's one of the most generous in the country."
Gov. Quinn said even with the cut the state would still have the second-highest medical reimbursement rates in the nation, "Our employers could save up to $500 million -- as much as 14.9 percent in premiums," he said.
Other elements in the governor's plan would:
Require that arbitrators be licensed attorneys.Mandate that personal claims made by arbitrators and commission employees be heard by the Illinois Court of Claims rather than arbitrators with the Illinois Workers' Compensation Commission.Put greater scrutiny on claims made by intoxicated employees and deny claims when the intoxication caused an employee's own injury.
The release of the proposal coincided roughly with Caterpillar Inc., one of the state's largest employers, sending a letter expressing dissatisfaction with the business climate, including the workers' comp system. There have been suggestions the company may consider leaving the state if things don't change.
Business advocates say the governor's plan is a good start but doesn't go far enough. They say what is needed is a provision that strengthens causation.
"What needs to happen is that the reforms are amended so the claimant has to prove work was a substantial factor in causing the disability," Lenkov said. "Right now, the standard is very, very low."
Changing the statute to require that the workplace accident or condition resulting from employment was a "significant" or "primary" factor that caused the disability rather than a "possible" factor would bring Illinois in line with many other states, Lenkov said. "Illinois is one of the most liberal states anywhere."
But getting the causation issue into the reform plan may be difficult, given that the Quinn administration is not backing it at this point, nor is the Democratically controlled Legislature.
In unveiling his proposals, the governor called on the Legislature to pass his plan by mid-April.
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Conflicting medical testimony doesn't block temporary benefits for nurse

In Kentucky when there is conflicting medical evidence, an administrative law judge's decision will not be reversed if there is substantial evidence supporting his decision.
Case name: Bluegrass Regional Mental Health v. Bellamy, No. 2010-CA-000522-WC (Ky. Ct. App. 03/11/11, unpublished).
Ruling: In an unpublished decision, the Kentucky Court of Appeals held that a nurse was entitled to temporary total disability benefits and future medical and income benefits.
What it means: When there is conflicting medical evidence, an administrative law judge's decision will not be reversed if there is substantial evidence supporting his decision.
Summary: A nurse slipped and fell on ice in the parking lot of her employer, injuring her low back and left leg. The parties agreed that she suffered a work-related injury. The nurse had a history of low back problems. She said that her pain increased after the work-related slip and fall from radiating halfway down her left leg to radiating across both legs with numbness in both her legs and arms. The nurse sought benefits. The Kentucky Court of Appeals held that she was entitled to temporary total disability benefits and future medical and income benefits.
The employer argued that the nurse did not suffer a compensable injury. The court disagreed. One doctor testified that the work-related slip and fall produced permanent impairment while two other doctors said the injuries were temporary. Although there was conflicting medical testimony, the court said substantial evidence supported a conclusion of compensability.
The court also found that the doctor's opinion was objective medical evidence. He physically examined her and considered her history of complaints, treatment, and various injuries dating back 10 years. He also conducted motion studies, pinprick studies, strength measurements, and motor, reflex, and pulse testing. Further, he reviewed her medical records.
The court found that an award of TTD benefits was proper because the nurse was unable to return to the type of work she was customarily performing at the time of her injury. The nurse was placed on work restrictions, and the employer would not allow her to return to work with any restrictions.
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Testifying at wife's hearing doesn't yield protections under ADA

In Maine, testifying in a workers' compensation hearing in opposition to an employer does not qualify as protected activity under the Americans with Disabilities Act.
Case name: Leavitt v. SW&B Construction Co., LLC, No. 1:10-cv-00030-JAW (D. Me. 02/25/11).
Ruling: The U.S. District Court, District of Maine granted summary judgment to a construction company on a safety coordinator's discrimination and retaliation claims under the Americans with Disabilities Act of 1990.
What it means: According to this court, testifying in a workers' compensation hearing in opposition to an employer does not qualify as protected activity under the ADA.
Summary: A safety coordinator for a construction company was married to an expediter for the company. The expediter suffered a work-related injury and filed a claim for workers' compensation benefits. The coordinator testified in her case and then later testified in a hearing on her petition to increase benefits. Following this, safety issues arose within the company that led the company to terminate the coordinator as part of a layoff. He sued under the ADA of 1990, alleging association discrimination and retaliation. The U.S. District Court, District of Maine granted summary judgment to the company.
The coordinator failed to establish that his testimony at his wife's workers' compensation hearing raised an inference that her disability was a determining factor in his termination. The court explained that the coordinator's claim was precluded because advocacy on behalf of individuals with disabilities implicates the ADA's retaliation, not association, provisions.
The coordinator also argued that the company's concern about workers' compensation costs and its mistreatment of injured workers showed animus toward individuals with disabilities and that his termination reflected that animus. This argument also failed because the court concluded it was about expense, not disability. Because there would be no expense to the company after settling his wife's claim, he could not establish discrimination.
The court rejected the coordinator's retaliation claim, finding that he did not engage in protected activity. He asserted that testifying in his wife's workers' compensation claim was protected, but the court disagreed. The company's participation in the claims was not an "act or practice made unlawful by the ADA." Although a complaint he made alleging the company failed to accommodate his wife was protected activity, he did not establish a causal link to his termination.
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Worker's sleeping on job doesn't block vocational rehabilitation benefits

In Wisconsin, an injured worker cannot be denied vocational rehabilitation benefits when he is offered suitable employment after his injury and is subsequently terminated for just cause.
Case name: Oshkosh Corp. v. Labor & Industry Review Commission, No. 2010AP1219 (Wis. Ct. App. 02/23/11).
Ruling: The Wisconsin Court of Appeals awarded vocational rehabilitation benefits to a worker.
What it means: In Wisconsin, an injured worker cannot be denied vocational rehabilitation benefits when he is offered suitable employment after his injury and is subsequently terminated for just cause.
Summary: An assembler for a corporation injured both of his knees while working. After two surgeries, he continued working but with permanent restrictions imposed by his treating physicians. Eventually, the assembler's employment was terminated for allegedly sleeping on the job. After, he applied for retraining assistance, which was granted by his vocational rehabilitation counselor. Then, he applied for vocational rehabilitation benefits. The Wisconsin Court of Appeals held that the assembler was entitled to vocational rehabilitation benefits.
The corporation argued that the medical evidence did not show the assembler had permanent work restrictions. The court disagreed, stating that of the four physicians who examined the assembler, only one concluded that he did not require permanent restrictions.
The corporation next asserted that it offered the assembler suitable employment after his injury and later terminated him for just cause, so it should not be liable for vocational rehabilitation benefits. The parties agreed that the assembler was offered suitable employment. The court stated that an injured worker who is terminated is entitled to benefits because he continues to suffer his work-related injury. The injury, not the termination, caused the worker's economic loss. The court explained that the purpose of workers' compensation is to compensate workers who lost the ability to work due to a work-related injury, regardless of whether they are good or bad workers. Therefore, the assembler could not be denied benefits for allegedly sleeping on the job.
The court also found that the vocational rehabilitation counselor did not abuse her discretion when she allowed the assembler to take classes at a technical college before conducting a job search. An injured worker is not required to conduct a job search before he can apply for retraining benefits, and the assembler conducted his own job search.
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