In Simple Words About Catastrophe Modelling€¦ · Use of the Catastrophe Models Catastrophe Modelling – History and Applications Loss RP (years) 1in250 Cat capacity Probability

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In Simple Words AboutCatastrophe Modelling21 June 2018

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1. Catastrophe Perils

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Natural Catastrophes

“A natural catastrophe is a major adverse event resulting from natural processes of the Earth. It can cause loss oflife or property damage. Severity of the damage depends on the affected population’s and property’s resilience,or ability to recover and also on the infrastructure available.“ (source: Wikipedia)

Catastrophe Perils

WildfiresHydrological§ Floods§ Tsunamis

Meteorogical§ Thunderstorms§ Hailstorms§ Tornadoes§ Cyclonic storms§ Droughts§ Heat waves

Geological§ Earthquakes§ Volcanic

eruptions§ Landslides

Space disasters§ Solar flair§ Asteroids


WindstormCatastrophe Perils

§ Typical features:– Large territories affected– Low damage ratios, serious structural damage is rare– Low number of casualties– Multi-country losses in Europe

§ Main windstorm territories: Western European winterstorms, US hurricanes.

§ US Hurricane season: June – October§ European Windstorm season: October – March


EarthquakeCatastrophe Perils

GSHAP seismic hazard map

Kobe, Japan 1995Izmit, Turkey, 1999

§ Typical features:– Smaller territories affected– Usually only single country losses– Damaging earthquakes are less frequent than floods

and windstorms. Typical – low frequency and highseverity

– Serious structural damage can occur. Usually highnumber of casualties

§ Main earthquake territories (RI point of view): Japan,California


FloodCatastrophe Perils

Source: Aon Benfield Impact Forecasting

§ Typical features:– Flood propagates along river streams and cannot affect

large areas continuously– Serious structural damage is not common– Low number of casualties– Typical – multi-country losses in Europe– Loss prevention can be very effective – flood defences,

early warning§ Main flood territories (RI point of view): Western Europe,

CEE, UK

Modelled flood extent


Global Insured Catastrophe Losses

Global Insured Losses – All natural disasters

Catastrophe Perils

Insured and non-insured losses

Source: Aon Benfield Impact Forecasting Source: Aon Benfield Impact Forecasting

§ 2017 was an exceptional year in terms of catastropheactivity– Overall amount of insured losses: USD 134 bn

§ Average 2000-2017: USD 51 bn§ Available capital of global reinsurers: USD 600 bn§ Annual proportion of non-insured losses: 60-80%


Hazard and Risk

Shenzen, China

Catastrophe Perils

MiamiBeach 1926


2. Catastrophe Modelling –History and Applications


History of the Catastrophe ModellingCatastrophe Modelling – History and Applications

Catastrophe model 200 years ago§ First attempts to control the catastrophe risk areas old as the property fire insurance

§ In early 19th century insurers were using tacks ona map to control the accumulations of insuredrisks, that are critical in case of a fire event

§ The mapping approach was used until 1960’s

§ In the late 1980’s the first commercial modelvendors entered the market in US


§ Perils covered by the catastrophe models: Earthquake, Flood, Windstorm, Hail, Wildfire, Terrorism

Catastrophe Modelling Software TimelineCatastrophe Modelling – History and Applications

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Cartograph

RiskLink

AIR – CATRADER / CLASIC/2

EQECAT – Worldcat Clasic CoreLogic

Oasis

19881986

Touchstone

RMS - IRAS ONE

KC & Co.

Aon Benfield Impact Forecasting

JBA

Worldcat Enterprise RQE

2018

§ Commercially available Cat models appeared in late 1980’s in USA§ Significantly increased demand for Cat modelling after 1992 hurricane Andrew when the US market saw

11 insolvencies§ Katrina 2005 – only 3 insolvencies despite considerably higher financial impact of the event

Regulatory Requirements


Impact Forecasting – Cat Models Development in AonCatastrophe Modelling – History and Applications

§ Impact Forecasting team based in 5 Aon offices: Chicago, London, Prague, Singapore, Bangalore§ Different groups of experts working on the models development:

– Hazard Development – experts with meteorological, hydrological and geophysical background, special team dedicated tothe terrorism modelling

– Vulnerability development – experts with engineering background dealing with the response of insured risks to the naturalperils

– Software development and support – IF modelling software and additional products are currently licensed to ~60 licensees


Use of the Catastrophe ModelsCatastrophe Modelling – History and Applications

Loss

RP (years)

1in250 Cat capacity

Probability vs modelledloss → the most common

output of thecatastrophe modelling

Catastrophe treaty can behardly structured and

placed without themodelling

§ Reinsurance was the first segment of the insurance industry that adoptedthe Catastrophe models.

§ Typical reinsurance related questions:– Is my portfolio exposed to natural hazards?– What is the main peril and what are the losses I can expect?– What protection (limit) do I need?– What price should I expect?


Can we Use the Company Loss Experience instead of the Model?Catastrophe Modelling – History and Applications

1in50 PML = 13 mil

1in50 PML = 100 mil1in50 PML = 35 mil

20 years of loss experience§ Extrapolation of historical lossdata is one of the possibilities ofhow to design the reinsurancestructure without a model

§ The disadvantages of loss dataapproach:– The data is not available for

sufficiently long period– The past losses need to be

properly indexed– Different ways of extrapolation

can lead to substantiallydifferent results

§ All the issues above are bypassedwhen using the Catastrophemodel


Advantages of a Catastrophe Model

§ The catastrophe model takes into account a wide range ofscenarios from the small events occurring on an annual basis tothe extremes without any analogues in the historical observations

§ The modelling is always done for the actual exposure, it thereforereflects the actual position of the insurance company and there’sno need for indexation of the past losses

§ The model can further take into account:– Changes in the regional distribution of the exposure– Changes in the portfolio structure per LOB (householders,

industry, CAR/EAR, BI…)– Model properly takes into account the policy conditions –

deductibles, sublimits…..

§ Models can often reflect multiple lines of business: property, BI,workers compensations, marine cargo, life, cyber

§ With the growing computational power, the modern catastrophemodels can be used in many other areas beyond the traditionalneeds of the reinsurance

Catastrophe Modelling – History and Applications


Examples of Reinsurance Related ApplicationsCatastrophe Modelling – History and Applications

§ The total sum insured of my portfoliowent up by 15%, however, it remainsstable in the Absheron region, whereI already have 50% of the exposure.Do I need 15% higher Cat limit?

§ Expected model result: The 1in250PML which drives the capacity willremain stable, however, we’ll observegrowth of losses at low return periods(e.g. <1in50 years) due to thegrowing diversification

Example 1

§ My portfolio remains stable since lastyear, however, I lost somehouseholders business, which wascompensated by the new successfulproduct covering BI. Do I need tochange the Cat limit?

§ Expected model result: very likelythere will be need for the higher Catlimit, as the BI exposure cangenerate substantially higher lossescompared to property damage

Example 2

§ The total sum insured of my portfoliowent up by 20%, however, we newlyintroduced the deductible whichcorresponds to 1% of sum insured.What will be the implication forthe reinsurance treaty?

§ Expected model result: the requiredgrowth of the Cat limit will beconsiderably lower than 20% due tothe deductibles

Example 3


Catastrophe Model as an Underwriting ToolCatastrophe Modelling – History and Applications

§ Probabilistic models based on high resolutionhazard maps can be used for location-wiseNat Cat loss assessment

§ The model can indicate how much premiumshould the insurer charge in a given locationfor a given risk type

§ Differentiated by property parameters such as:– Occupancies– Constructions– Number of stories classes– Presence of basement


Catastrophe Model and Insurance Product DesignCatastrophe Modelling – History and Applications

Effect of limits for a given postal code or Lat&Lon square

Effect of deductibles for a given postal code or Lat&Lon square§ Models can be used to determineeffect of insurance conditions– Deductibles– Limits

§ Key for attractive & profitableproduct design– Full limit possible in low risk areas– Effective limits enable insurance

within high risk zones


3. How the Cat ModelWorks


Damage

Calculation

VULNERABILITY

HAZARDEvent set

Physically modelled extents

LOSS

Insured loss calculation

Policy Conditions

EXPOSURE

Risk Characterisation

Risk Location

Catastrophe Model Anatomy

Hazard Component

How the Cat Model Works

Historical information about the past events, theirfrequency and severity, is a basis of the modelhazard component

Vulnerability Component

Damage functions – convert hazard severity(earthquake intensity, wind speed, etc.) into thedamage

Exposure Component

Information about the position of an insured risk

Loss Component

Derives loss exceedance probability curves andapplies the policy conditions


5. Repeat (for every location andevery simulated event), sum upby event to get total loss

Catastrophe Model – How it Works?How the Cat Model Works

Event ID Total loss

1 2,200,000

2 3,400,000

3 5,000,000

… …

120,000 1,200,300

4. Loss Calculation

Ground Up Loss1,000,000 * 0.5 = 500,000 AZN

Gross Loss500,000 – 20,000 = 480,000 AZN

3. Link with damage(vulnerability) function

Intensity

Dam

age

Rat

io

MSK 9

50%

6. Calculate ExceedanceProbability curve

Years

Loss

200

10bn

1. Insured location #1

Location: 40.0°N 49.0°ETIV = 1,000,000 AZNDeductible = 20,000 AZN

2. Link with EQ intensityfootprint

MSK Intensity = 9


Historical Hazard Information

Historical earthquakes in Azerbaijan – country withhigh seismic activity


Historical earthquakes in Hungary (country with lowseismic activity)

§ Historical information is always a basis of a stochastic event set§ Uncertainty is increasing with decreasing hazard activity. In other words it is much easier to built an

earthquake model in high activity country.


§ Earthquake intensity is converted into thedamage based on the damage functions

§ Different risk types behaves differently in thecatastrophe models

Damage CalculationsHow the Cat Model Works

Intensity

Dam

age

ratio

Industrial Agricultural

ResidentialResidential


Working with Catastrophe Exposure Data

Economic region (population density map)


District (Rayon)

§ Catastrophe models very often work withsimplified exposure data

§ The model must be ready for different level ofdetails to be able to produce plausible results evenfor simplified data


4. Conclusion


Modelling of Catastrophe Losses

§ Goal of Cat Modelling is to estimate possiblelosses while minimising uncertainties

§ Similarity to crossing the street– When you want to cross street (Reality) you

don’t have to check for traffic = you can justtake the risk

– Using traffic light (Model) help you to minimiserisk

– But you still think and use all available info/tools before you cross the street, i.e. you don’ttake the traffic light as the only true source ofinformation

Conclusion


Disclaimer

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In Simple Words About Catastrophe Modelling€¦ · Use of the Catastrophe Models Catastrophe Modelling – History and Applications Loss RP (years) 1in250 Cat capacity Probability