Catastrophic events such as epidemic infections, terrorist attacks, warfare, nuclear power plant failures, hurricanes, earthquakes, tornados, floods, hazardous material incidents, and cosmic hazards jeopardize and threaten human being on a global scale. According to a recent study by the world’s largest reinsurer Munich Re, economic losses[/i] from natural catastrophes was $45 billion in the first half of 2013. Floods in Europe, Canada, Asia and Australia dominated the natural catastrophe losses with around 47% of overall losses and 45% of insured losses.[/i]
The preparation for catastrophic events is crucial and a critical component of the insurance industry’s risk management strategies. Catastrophic risk management strategies must be regularly reviewed, tested and updated to ensure complete preparedness for the upcoming risk.
Risk management and preparation for the event beforehand reduces and mitigates the impact of the loss. Insurers use Geographic Information Systems (GIS) and catastrophic models to assess and handle catastrophic risks, and make informed risk management decisions. Geographic Information Systems contains complete geographical information. It is basically a comprehensive database that associates the property’s address with location using advanced geo-coding technology while Catastrophe models evaluate property characteristics, replacement value, and policy terms and conditions for obtaining accurate loss estimates.
Geographic Information Systems (GIS) and Catastrophe Models
Geographic Information systems are effective tools in predicting damage and assessing post-disaster damage using geographic perspective. The insight from GIS technology help companies understand the places of concern and develop strategies to address the risk.
Catastrophe models help insurers’ gain thorough understanding of the risks and evaluate potential losses from catastrophic events. The reliability of these models lie on the high quality exposure data - location, property characteristics such as building construction, occupancy etc. and replacement values. The results of exposure data analysis combined with results of catastrophe models are analyzed using GIS technology to map property characteristics with catastrophic risks. Further exposure data analysis helps in predicting the intensity and frequency of the event.
Models can have deterministic and probabilistic approaches. Deterministic modeling is scenario based approach where simulation of historical and predetermined events is allowed with known characteristics. This approach can help the management in estimating the time of an event. Probabilistic modeling provides much more information as compared to deterministic modeling. Using this approach, the management of the company can estimate the probability of various levels of loss.
Most insurers use a single model to determine the probable maximum loss for a catastrophic event. More recently, insurers have started using multi-model systems to better insulate themselves against potential losses from catastrophes. Multi-model system promotes informed and proactive decision making. However, choosing between models with different methodologies and approaches is difficult.
Best Practices for mitigating catastrophic risks
As companies globalize, they get more vulnerable and hence it is critical to take informed decisions to mitigate catastrophic risk financially. The following best practices help insurers to take cost-effective decisions for the enterprises.
Insurers must not think in terms of return periods. If they do so, they will fall in the trap of under buying or overbuying insurance and ignoring or underestimating the risk. It will also mislead companies with little information about the probability of the risk.
The best practice to manage and mitigate catastrophic risk is to understand the probability and the impact of the problem to insure them from its occurrence. The companies must be educated, especially in disaster prone areas to formulate emergency response and reduce the impact of the disaster. Knowledge of the potential effects of the risk will result in significant cost savings, advantage against competition and will also help improve brand reputation in the market.
Risk mitigation strategies offer a clear picture of the perils, locations and business operations vulnerabilities. The strategies developed beforehand will help companies identify the overexposed areas and optimize the use of resources. Individuals responsible for developing and designing strategies will help in preparing companies for each phase of post disaster response enabling them for immediate recovery from the event.
? Collect high quality exposure data during the underwriting process[/i][/b]
Organizations should implement a plan to improve the quality of exposure data. Exposure data quality is significantly important for property insurers dealing with catastrophe risk. Without reliable and high quality exposure data catastrophic modeling decisions are skewed. Organizations must maintain high quality data to win more business and generate effective management decisions.
? Identify Catastrophe Risk Appetite[/i][/b]
A company’s risk appetite is the reduction in the income from a catastrophe in a year. The company must identify and understand how much loss an insurer can absorb without any impact and the uncertainty around it. The maximum amount of loss that the company can tolerate within a period must be decided beforehand by the management of the company.
? Evaluate beforehand the ability to pay catastrophe loss[/i][/b]
Businesses must establish a contingency plan to deal with the cash demand at the time of a catastrophic risk. The contingency plan must
? determine the size and timing of the cash that may be required
? determine the dependability of the system on the cash available with the business
? determine the gap between the catastrophic cash requirements and actual cash available
? determine the willingness of the system to dispense cash at the time of urgency
? develop a plan to make sure that enough cash is available at time of the catastrophe by reducing other spending
Prepare for the future
Losses from catastrophes have mounted in the past three decades. In such a complex environment, property/casualty insurance companies must aim at mitigating catastrophic losses and provide sophisticated risk assessment techniques. Mitigating, quantifying and understanding catastrophic losses ensures effective decision making. From a workflow perspective, companies must adopt an aggregation engine with an advanced mapping interface that utilizes the latest Geographical Information Systems (GIS) technology and catastrophic modeling techniques to reduce vulnerabilities from extreme events.