Monthly Archives: February 2013

How RMS came up with its estimate for Sandy

Hemant Shah of RMS discusses how his company came up with its estimate ($20B to $25B) for superstorm Sandy, which has held up well as industry losses have taken shape. Takeaways:

  • Sandy was “not a textbook hurricane: [It had] an unusual track; a large, diffuse and transitioning windfield; and a catastrophic storm surge. . .”
  • The storm had less than hurricane winds at landfall, but the storm surge was equivalent to a Category 2 storm. Shah credits an overhaul of RMS’s storm-surge model in v11.
  • Lots of on-site research to get an idea of how well reality synced with the model.
  • Increased precision: “. . .we dynamically modeled the surge street-by-street, distinguishing the flood risk by property based on the elevation and proximity of each building to the water’s edge. Complex interrelationships between extensive power outages, disruption from flooding, widespread coastal property damage and the closure of transportation systems provided additional insights, as did other factors driving potential post-event loss amplification.”

Paying the chargemaster

Blogosphere is all over Steven Brill’s long, long (>20K words) article about medical bills. In reality, the story is pretty short, but it says something profound about the role of a health insurer.

If you have health insurance you are familiar at least with the outlines of a claim:

  1. Your medical provider bills you for a ridiculously large amount, like $240 for a single session of physical therapy.
  2. Because you have insurance, the provider agrees to settle for less, say $88.
  3. The insurance company pays part of the amount in Step 2 above, say $26.40.
  4. You are responsible for the remainder. Here that would be $61.60.

Brill focuses on price No. 1, which he calls the chargemaster. If you have insurance, the chargemaster is meaningless. Recognizing how absurdly high it is, I call it the Fairy Unicorn Price – FU Price for short.

But if you don’t have insurance, that’s the price you pay.

Much of Brill’s article is example after example of the absurdity of the chargemaster. One woman thought she had a heart attack, but it was a false alarm. She was billed $21,000. Another woman fell down in her backyard and was billed $9,400. And he’s unhappy, of course, that the uninsured – presumably the least able to pay – get billed the most.

I have to agree. We had a close brush with the chargemaster.

My wife broke her elbow last Aug. 4. A couple days earlier (Aug. 1) our insurer changed Liz’s policy number. Unfortunately, the insurer waited till Aug. 8 to tell us what they had done.

That meant Liz’s ER bills were all rejected – a pretty big deal because she ended up spending a night in the hospital after surgery. We were able to clear up the billing SNAFU, after a couple months. But it looked, however briefly, like we would have to pay the chargemaster.

And it meant I kept very, very close tabs on medical expenses. Last week, we paid the final bill. (I think.) All up, the chargemaster hit us for $72,346.66. We paid $4,529.14. Insurance paid $3,239.88. The rest was the insurer-negotiated discount. The chart tells the story.


This chart implies that the main value of a health insurer is as a price negotiator. In our case, the insurer’s indemnification was worth $3,200. Its negotiating power was worth almost 20 times as much, winning us a discount of almost $65,000.

Brill, I think, would disagree. And he argues that insurance companies like the chargemaster “because they can then make their customers feel good when they get an Explanation of Benefits that shows the terrific discounts their insurance company won for them.”

He makes the entirely valid point that the chargemaster price is absurdly high. Hospital reps he talked to agree.¹

Heck, I agree.  Who could argue? That’s why I call it the FU Price. No way a broken elbow should cost $70,000.  But had we lacked insurance, that’s the bill we’d be negotiating.

And its hard to negotiate down from the chargemaster. Brill talks to medical-billing advocates – people who bargain against the chargemaster for a living. Rarely do they get a price as low as an insurer’s.  That $9,418 slip-and-fall chargemaster, for example, only got reduced to about $8,900.

So these days, a health insurer’s ability to negotiate is more important than its willingness to pay claims.


¹ The hospital reps said the chargemaster was just an opening bid toward negotiating a final payment. Of course, it’s an odd negotiation wherein the patient is at a disadvantage. He is forced to make a counteroffer after he has signed a contract to pay what he has been billed.


The spreadsheet did it.

This goes back to the London Whale’s multibillion-dollar botch at JPMorgan last year. Recall that Morgan had just implemented a new Value at Risk model. Using it, the bank underestimated VaR, which helped trigger the debacle.

So what happened? Excel happened:

The new model “operated through a series of Excel spreadsheets, which had to be completed manually, by a process of copying and pasting data from one spreadsheet to another.” The internal Model Review Group identified this problem as well as a few others, but approved the model, while saying that it should be automated and another significant flaw should be fixed. After the London Whale trade blew up, the Model Review Group discovered that the model had not been automated and found several other errors. Most spectacularly,

“After subtracting the old rate from the new rate, the spreadsheet divided by their sum instead of their average, as the modeler had intended. This error likely had the effect of muting volatility by a factor of two and of lowering the VaR . . .”

The Baseline Scenario blames Excel’s shortcomings, rightly noting . . .

. . . while Excel the program is reasonably robust, the spreadsheets that people create with Excel are incredibly fragile. There is no way to trace where your data come from, there’s no audit trail (so you can overtype numbers and not know it), and there’s no easy way to test spreadsheets, for starters. The biggest problem is that anyone can create Excel spreadsheets—badly. Because it’s so easy to use, the creation of even important spreadsheets is not restricted to people who understand programming and do it in a methodical, well-documented way.

True as far as it goes. But it also shows an epic ERM failure. If you are going to pin a company’s future on a model, said model should be thoroughly tested. A model that doubles or halves the old model’s calculations should be presumed to be incorrect, then checked, double-checked and triple-checked to make sure that it’s calculating correctly. There should also be some theoretical and heuristic support for why the old model’s calculation was inferior and why the new model is superior.

Further, a model that critical to a company that large just has to be more robust. It should use code to extract and transfer data from sheet to sheet. It should be engineered to minimize manual inputs. All of those inputs should take place on one screen. These things should be in place before you change models. You shouldn’t be able to catch up on the upgrade.

And responsibility for all that should go to the highest level at the company, here CEO Jamie Dimon.

I’ve seen companies one-sminteenth the size of JPMorgan do all of these things with Excel. Hard to think the big bank was so rigorous when a formula uses =sum() instead of =average() halves a result and nobody notices.

All of which helps one better understand what’s behind the Agnes Rule: If banks sold anything but money, they’d go broke.

Medicare actuary retires

Richard Foster, perhaps the nation’s most famous actuary, is retiring. American Academy of Actuaries pays tribute.