Catastrophe modeling
Encyclopedia
- This article refers to the use of computers to estimate losses caused by disasters. For other meanings of the word catastrophe, including catastrophe theoryCatastrophe theoryIn mathematics, catastrophe theory is a branch of bifurcation theory in the study of dynamical systems; it is also a particular special case of more general singularity theory in geometry....
in mathematics, see catastrophe (disambiguation).
Catastrophe modeling (also known as cat modeling) is the process of using computer
Computer
A computer is a programmable machine designed to sequentially and automatically carry out a sequence of arithmetic or logical operations. The particular sequence of operations can be changed readily, allowing the computer to solve more than one kind of problem...
-assisted calculations to estimate the losses that could be sustained due to a catastrophic event such as a hurricane or earthquake. Cat modeling is especially applicable to analysing risks in the insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
industry and is at the confluence of actuarial science
Actuarial science
Actuarial science is the discipline that applies mathematical and statistical methods to assess risk in the insurance and finance industries. Actuaries are professionals who are qualified in this field through education and experience...
, engineering
Engineering
Engineering is the discipline, art, skill and profession of acquiring and applying scientific, mathematical, economic, social, and practical knowledge, in order to design and build structures, machines, devices, systems, materials and processes that safely realize improvements to the lives of...
, meteorology
Meteorology
Meteorology is the interdisciplinary scientific study of the atmosphere. Studies in the field stretch back millennia, though significant progress in meteorology did not occur until the 18th century. The 19th century saw breakthroughs occur after observing networks developed across several countries...
, and seismology
Seismology
Seismology is the scientific study of earthquakes and the propagation of elastic waves through the Earth or through other planet-like bodies. The field also includes studies of earthquake effects, such as tsunamis as well as diverse seismic sources such as volcanic, tectonic, oceanic,...
.
Perils analysed
Natural catastrophes (sometimes referred to as "nat cat") include:- hurricane (main peril is wind damage; some models can also include storm surge)
- earthquakeEarthquakeAn earthquake is the result of a sudden release of energy in the Earth's crust that creates seismic waves. The seismicity, seismism or seismic activity of an area refers to the frequency, type and size of earthquakes experienced over a period of time...
(main peril is ground shaking; some models can also include fire following earthquakes and sprinkler leakage damage) - tornadoTornadoA tornado is a violent, dangerous, rotating column of air that is in contact with both the surface of the earth and a cumulonimbus cloud or, in rare cases, the base of a cumulus cloud. They are often referred to as a twister or a cyclone, although the word cyclone is used in meteorology in a wider...
- floodFloodA flood is an overflow of an expanse of water that submerges land. The EU Floods directive defines a flood as a temporary covering by water of land not normally covered by water...
- wind storm/hailHailHail is a form of solid precipitation. It consists of balls or irregular lumps of ice, each of which is referred to as a hail stone. Hail stones on Earth consist mostly of water ice and measure between and in diameter, with the larger stones coming from severe thunderstorms...
- wildfireWildfireA wildfire is any uncontrolled fire in combustible vegetation that occurs in the countryside or a wilderness area. Other names such as brush fire, bushfire, forest fire, desert fire, grass fire, hill fire, squirrel fire, vegetation fire, veldfire, and wilkjjofire may be used to describe the same...
Other catastrophes include:
- terrorismTerrorismTerrorism is the systematic use of terror, especially as a means of coercion. In the international community, however, terrorism has no universally agreed, legally binding, criminal law definition...
events - warWarWar is a state of organized, armed, and often prolonged conflict carried on between states, nations, or other parties typified by extreme aggression, social disruption, and usually high mortality. War should be understood as an actual, intentional and widespread armed conflict between political...
fare - Casualty/liability events
- Displacement Crises
Lines of business modeled
- Personal property
- Commercial property
- Forestry
- Workers' compensation
- Automobile physical damage
- Leasehold improvements
- Limited liabilities
- Product liability
Input
The input into a typical cat modelling software package is information on the exposures being analysed that are vulnerable to catastrophe risk. The exposure data can be categorized into three basic groups:- information on the site locations, referred to as geocoding data (street address, postal code, county/CRESTA zone, et cetera)
- information on the physical characteristics of the exposures (construction, occupation/occupancy, year built, number of stories, number of employees, et cetera)
- information on the financial terms of the insurance coverage (coverage value, limit, deductible, et cetera)
Output
The output is estimates of the losses that the model predicts would be associated with a particular event or set of events. When running a probabilistic model, the output is either a probabilistic loss distribution or a set of events that could be used to create a loss distribution; probable maximum losses (PMLs) and average annual losses (AALs) are calculated from the loss distribution. When running a deterministic model, losses caused by a specific event are calculated; for example, Hurricane KatrinaHurricane Katrina
Hurricane Katrina of the 2005 Atlantic hurricane season was a powerful Atlantic hurricane. It is the costliest natural disaster, as well as one of the five deadliest hurricanes, in the history of the United States. Among recorded Atlantic hurricanes, it was the sixth strongest overall...
or "a magnitude 8.0 earthquake in downtown San Francisco" could be analyzed against the portfolio of exposures.
Uses
- Insurers and risk managers use cat modeling to assess the risk in a portfolio of exposures. This might help guide an insurer's underwriting strategy or help them decide how much reinsuranceReinsuranceReinsurance is insurance that is purchased by an insurance company from another insurance company as a means of risk management...
to purchase. - Some state departments of insurance allow insurers to use cat modelling in their rate filings to help determine how much premium their policyholders are charged in catastrophe-prone areas.
- Insurance rating agencies such as A. M. Best and Standard & Poor'sStandard & Poor'sStandard & Poor's is a United States-based financial services company. It is a division of The McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. It is well known for its stock-market indices, the US-based S&P 500, the Australian S&P/ASX 200, the Canadian...
use cat modelling to assess the financial strength of insurers that take on catastrophe risk. - Reinsurers and reinsurance brokers use cat modelling in the pricing and structuring of reinsurance treaties.
- Likewise, cat bond investors, investment banks, and bond rating agencies use cat modeling in the pricing and structuring of catastrophe bondCatastrophe bondCatastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors...
.
Demand surge
Some cat models allow the user the option of including demand surge in the loss estimates, which is post-event inflationInflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...
. After a large disaster, construction material and labor can temporarily be in short supply, so construction costs are inflated. The larger the impact of the event on the local economy, the larger the effect of demand surge. For example, an event that causes a $5 billion insurance industry loss might cause demand surge to increase construction costs by 5%, while an event that causes a $40 billion insurance industry loss might cause demand surge to increase construction costs by 25%.
Open catastrophe modeling
Recently, an effort to create and disseminate open multi-hazard cat risk modelling tools was initiated by the Alliance for Global Open Risk Analysis (AGORA).Additionally, the insurance industry is currently working with the Association for Cooperative Operations Research and Development (ACORD) to develop an industry standard for collecting and sharing exposure data. To date, the industry has been operating on closed, proprietary data formats.
See also
- HAZUSHAZUSHazus is a geographic information system-based natural hazard loss estimation software package developed and by the Federal Emergency Management Agency ....
- International Society of Catastrophe ManagersInternational Society of Catastrophe ManagersThe International Society of Catastrophe Managers is a professional association that promotes catastrophe management professionalism within the insurance industry.-Goal and objectives:...
- Risk Management Solutions