Catastrophe modeling (also known as cat modeling) is the process of using computer-assisted calculations to estimate the losses that may be sustained due to an occurrence of catastrophic events such as earthquakes, hurricanes, terrorism and pandemics. It is an important risk management strategy that has been in use for hardly 20 years, but has now become an essential part of the Insurance industry.
Catastrophe modeling allows insurers and reinsurers, financial institutions, corporations, and public agencies to evaluate and manage catastrophe risks. It is used to determine the prices to charge, the potential costs involved, risk retention and transfer.
A combination of science, technology, engineering knowledge, and statistical data is used to simulate the impacts of natural and manmade perils in terms of damage and loss over a period. From these results, the users can predict and mitigate damage resulting from the catastrophic event.
The perils analyzed include both Natural Catastrophes and Human Catastrophes.
The Natural catastrophes, also referred to as "Nat cat" include:
- Hurricane: main peril is wind damage; some models can also include storm surge.
- Earthquake: main peril is ground shaking; some models can also include tsunami, fire following earthquakes, and sprinkler leakage damage)
- Severe Thunderstorm: main perils are tornado and hail.
- Extratropical Cyclone,
- Wildfire, and
- Winter storm
The Human catastrophes include, Terrorism, Warfare, Casualty/liability events and Displacement crisis.
The Lines of Business Modeled include:
- Personal property
- Commercial property
- Workers' compensation
- Automobile physical damage
- Limited liabilities
- Product liability
- Business Interruption
Origins of Catastrophe Modelling
Catastrophe modeling has its origins both in the field of property insurance and in the science of natural hazards. The origin can also be outlined in the modern science of understanding the nature and impact of natural hazards.
In the 1800s, insurers covering fire and lightning risk used pins on a wall-hung map to visualise concentrations of exposure. This practice known as mapping ended in the 1960s when it became too cumbersome and time consuming to execute.
The common practice of measuring an earthquake’s magnitude or a hurricane’s intensity is one of the key ingredients in a catastrophe model.
Modeling requires that a standard set of metrics for a given hazard must be established so that risks can be assessed and managed. This measurement began in the 1800s as well, when the first modern seismograph, measuring earthquake ground motion, was invented and modern versions of the anemometer, measuring wind speed, gained widespread usage.
Computer-based models for measuring catastrophe loss potential were developed by linking scientific studies of natural hazard measurements and historical occurrences with advances in information technology and geographic information systems (GIS).
These two separate developments – mapping risk and measuring hazard – came together in a definitive way in the late 1980s through catastrophe modeling.
In as much as the catastrophe risk modeling occurred in the late 1980s, the use of such sophisticated, technical means of monitoring risks was not widely accepted until Hurricane Andrew landed in Southern Florida in 1992. The hurricane left a lot of damage in its wake causing unprecedented losses and many insurance companies struggled to stay in business.
Hurricane Andrew illustrated that the actuarial approach to managing catastrophe risk was insufficient and a more sophisticated modeling approach was needed. It became clear that a probabilistic approach to loss analysis was the most appropriate way to manage catastrophe risk.
Today, catastrophe models are prevalent throughout the insurance industry, assisting insurers, reinsurers and other stakeholders in managing their risk from both natural perils and more recently, manmade catastrophes.
As models improve, it is hoped that our ability to face these catastrophes and the desire to minimize their negative effects will be achieved in an efficient and less costly way.
Currently the three main providers of Catastrophe Models are RMS, AIR, or EQECAT. These are very young companies founded in 1989, 1897, and 1994 respectively.
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