A blog post by Tarik Yildirim.
Risk selection is not about blind diversification, it is about right kind of diversification.
At UrbanStat, once we geocode our clients’ policies, the resulting geographical visualization dazzles the risk managers who have been thinking in the tabular format for years. Rightly so, they feel as if they have been blind for years.
Their first reaction often has to do with how the company can finally handle their diversification goals more accurately. Now that they can see everything on a map, they can modify their sales goals to create the perfectly-uniform geographic distribution they have been after.
Of course, this uniformity business is exactly the opposite of UrbanStat‘s thesis. The whole point of our geographical approach is to bring out the unseen non-uniformities and help insurers adjust their portfolio allocations accordingly.
Blind diversification works well only after all the known unknowns are factored out. Left with the remaining unknown unknowns, there is, in fact, nothing to do but to distribute all the bets evenly.
Everything else being equal, the density of bets in a certain region should be lesser than the one in a less risky region. After all, why assume greater risk for the same price unless all the sale opportunities in the less risky region are exhausted?