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6/14 M97/February 2018 Reinsurance

Today, the models are prevalent and assist (re)insurers with valuable insights into the potential
frequency and severity of catastrophic losses and, by quantifying those losses, enable them to make
decisions around pricing but also portfolio management, individual risk assessment and extent of
reinsurance cover. They are also used by regulators and rating agencies to assess the financial strength
of (re)insurers.
Useful website
www.air-worldwide.com/models/about-catastrophe-modeling/

B2A Components
Catastrophe models identify and quantify the likelihood of the occurrence of specific natural disasters in
Four basic
components to the a region and estimate the extent of incurred losses. We will now consider the four basic components to
catastrophe model the catastrophe model.
Hazard
This component defines the hazards, that is, a set of stochastic (simulated hypothetical) events. Each
event is defined by a specific strength or size, location or path, and probability of occurrence. In the case
of hurricanes, the model looks at storm tracks and wind speeds for a given landfall and route. In the
case of earthquakes, the model estimates the level of ground motion across the region.
Inventory
This component defines the inventory or portfolio of properties at risk as accurately as possible. Key
information includes the precise location of structures and their construction type, use or occupancy,
height/number of stories and age. The quality of this data is paramount.
Vulnerability
The next step is the quantification of the expected damage to the inventory caused by the hazard
phenomena, in other words, the vulnerability of those risks.
Together, these first three components or modules are traditionally known as a probabilistic risk
6 analysis.
Chapter Loss (or financial) Reference copy for CII Face to Face Training
This component translates the physical damage into total monetary loss. Loss is characterised as either
Translates the
physical damage into direct – for example, the costs of repair or reinstatement – or indirect – for example, business
total monetary loss interruption or relocation costs. Once total losses have been calculated, estimates of insured losses are
computed by applying policy conditions, for example, deductibles and limits.

B2B Output
The main output of a catastrophe model is an exceedance probability (EP) curve, which gives the annual
probability that a certain level of loss will be exceeded.
In figure 6.8, there is a 1% probability of a loss exceeding US$4m in the year. Alternatively, a US$4m loss
(or more) is expected to occur once in a 100-year period. The event is said to have a return period of
100 years.