C1. Catastrophe Modeling

Question 1

Occurrence Exceedance Probability (OEP)

Exceedance Probability Curve

What is it + common uses

Answer 1

EPC shows the probability that at least one event exceeds the specific loss amount in a given period

Common uses:
* Calculate if the portfolio meets solvency goals
* Determine what proprotion of risks should be ceded to reinsurers
* Calculate the average annual loss
* Calculate the probable maximum loss (PML) for a given period

Question 2

Catastrophe Modeling Open Issues (Problems)

Total 4

Answer 2

• Low public acceptance - cat models have usually resulted in rate increases
• Differing model variance - often significant differences between outputs of different models due to different scientific, enginnering, assumption data used
• Regulatory acceptance - regulators don’t have the technical expertise to access reasonability of the model assumptions, inputs, and outputs.
• Actuarial acceptance - since cat models lie outside of usual actuarial expertise, it is important for actuaries to become familiar with the model components

Question 3

Types of Uncertainty in Cat Models

Answer 3

Aleatory - inheret randomness associated with natural hazard events (process risk)
Epistemic - uncertainty due to our lack of knowledge of the hazard (parameter risk)

Question 4

Why are cat models better than using historical averages?

Answer 4

1. Catastrophes are infrequent and claims data may be insufficient
2. There could be varying definitions of what is a catastrophe
3. Historical catastrophe data may no longer be appropriate due to changing factors (repair costs, climate changes, property values)

Question 5

Cat models are used by:

And what do they use them for

Answer 5

• Insurers and Reinsurers: to access their exposure to risk
• Reinsurance brokers: to access risk for their clients to send to reinsurers
• Capital markets: to price catastrophe bonds
• Regulators: to access insurer work
• Emergency Management Agencies: to determine impact of an actual event (post occurrence) and coordinate an emergency response if needed

Question 6

How does cat models help a company risk management strategy?

2 of them

Answer 6

• Risk reduction: non-renewing policies, limiting coverage, increasing deductible and increasing rates
• Risk transfer: purchasing reinsurance or issuing cat bonds

Question 7

Cat Model Components/Modules

Answer 7

Hazard module - simulates natural disasters
Inventory model - contains property at risk and their characteristics
Vulnerability module - estimates how vulnerable each property is to damange given a specific catastrophe and property characteristic
Loss module - quantifies the direct and indirect losses of the event

Question 8

Conditions for an insurer to be willing to provide coverage

Answer 8

1. Able to identify and quantify probability of an event and the severity
2. Able to set premiums for each customer

Question 9

Why are regulators not supportive of cat models

Answer 9

1. Often regulators are not subject matter experts for cat modeling
2. Modeling firms are not willing to share proprietary/confidential information, especially in states that require it to be publicly available