As the number of natural catastrophes appears to be on the rise and interest in the impact of climate change grows, James Lay, Commercial Director- Insurance, at Simplitium highlights the important role the cat risk modelling industry has to play.
A recent Aon report revealed 394 natural catastrophe events occurred in 2018 responsible for economic losses totalling US$225 billion. Of that total, private sector and government-sponsored insurance programmes covered only US$90 billion of the total.
Catastrophe modelling has evolved from simple spreadsheets to a multi-tiered, multi-event modelled approach to risk management. Greater access to scientific data, building footprints and assessments on structural damage, in addition to improved computing resources via Cloud technology, have encouraged this evolution of catastrophe models, ultimately providing insurers with a more comprehensive view of potential losses. Catastrophe models also evolve as more is learnt from specific events. For example, the 2011 Japanese earthquake confirmed that magnitude 9 quakes can occur in that region, when prior to this, models had not accounted for that possibility.
Being able to estimate the potential impact of catastrophes is critical for insurers to ensure sufficient solvency should a disaster occur. This is what makes cat models an invaluable tool for risk managers. However, it is important to realise that catastrophe models are not forecasts. They do not aim to predict what events will occur in any given year. Instead, they seek to present the range of possible events and the likely costs insurers may incur should they transpire.
The biggest natural catastrophes in 2018 were a result of tropical cyclones. This included Hurricane Florence and Hurricane Michael (United States), Typhoon Trami and Typhoon Jebi (Japan), Typhoon Mangkhut (Philippines, Hong Kong, China), and Typhoon Rumbia (China). Consequently, 2017 and 2018 resulted in the costliest back-to-back years on record for both economic losses (USD653 billion) solely due to weather-related events, and for insured losses across all perils (USD237 billion).
Given these considerable sums, corporate risk managers increasingly require better information that helps them to understand the risks associated with potentially v catastrophic events, ensuring cat risk specialists have a key role to play in improving understanding and coverage. In many cases, this information has not been easy to access in a form that is readily useable and, historically, access to models has been resource-intensive and very expensive. The marketplace for catastrophe risk models has remained generally static for the past 20-30 years – with insurers facing significant barriers to change or add models. Consequently, the industry has learnt to settle for a limited view of risk, since resource constraints have prevented (re)insurers from adopting multiple models.
Clearly, the need for comprehensive, detailed and up-to-date models is escalating. In response to the growing need for better information, a collaborative effort between 21 insurers, reinsurers and brokers, including Lloyd’s of London, has led to the development of the Oasis Loss Modelling Framework (OLMF). The OLMF initiative delivers a standardised framework for the development of catastrophe models with Simplitium’s ModEx platform providing access to a broad range of independent models. Risk managers can now take advantage of catastrophe modelling in a way that has not been practical previously.
A particular challenge has been model coverage for emerging markets, resulting in a so called natural catastrophe “protection gap”. To counter the lack of models, the Insurance Development Forum (IDF) has been making significant progress in this area with their Risk Modelling and Mapping Working Group. The working group are stimulating collaboration between industry, government and academia to improve cat risk coverage in these regions.
The future of catastrophe modelling may well be linked closely to developing economies. As they expand around the world and populations become wealthier, there should be a corresponding increase in demand for insurance. These regions will become more significant and so demand for more granular modelling in those regions is likely to follow.
Technology will play a key enabling role in improving access to new models and new platforms are emerging, such as Simplitium’s ModEx, that are aggregating multiple vendors and delivering cost reductions and efficiency gains that were previously hard to achieve. This is allowing (re)insurance firms to access a wider range of models, increasing demand and thus encouraging model vendors to develop models for both existing and emerging markets. With better risk assessment tools in emerging markets, risk awareness will improve, which should lead to increased insurance provision in these regions.
The recognition that catastrophe risk modelling has a vital role to play in providing adequate insurance protection against disasters continues to grow. With climate change seemingly contributing to extreme weather conditions, and populations continuing to grow in vulnerable locations, the need effective solutions is urgent. Natural disasters are, unfortunately, inevitable. The need to be well-prepared is essential in effectively managing future event losses.