“Blind reliance” on catastrophe models could lead to inadequate reinsurance for natural catastrophes, Australian Prudential Regulation Authority (APRA) Deputy Chairman Ian Laughlin warns.

The limitations and unknown shortcomings of models mean insurers must undertake “appropriate due diligence” in using them, he told last week’s Insurance Council of Australia regulatory seminar in Sydney.

“We are quite intent on seeing improvements in this area and our supervision will reflect this.”

Mr Laughlin says the new Oasis loss-modelling framework in London, which provides open-source software to improve data access, is encouraging. 

“This looks to be a valuable addition to industry capabilities and we are keen to see how it evolves. It is good to see that Australian floods risks are already within scope.”

He says developments in alternative markets such as catastrophe bonds, sidecars, insurance-linked securities and industry loss warranties are being closely monitored.

“APRA has no philosophically negative view of these developments. Indeed, we welcome them, because they provide more depth to the market.”

However, potential concerns include their effectiveness in providing coverage for regulatory capital purposes and whether pricing properly reflects risks, Mr Laughlin says.

“There are other risks – legal, counterparty and operational risks – which need to be understood by boards and senior management.”

Mr Laughlin says the regulator will watch insurers’ reserve releases, which can be used to bolster financial results.

“We would like insurers to conduct a thorough analysis and explanation of any release of reserves, distinguishing between sources of movement so they can be clearly justified.”