December 3rd, 2014

Casualty Catastrophe Risk Modeling: Part I

Posted at 1:00 AM ET

Casualty (or liability based) catastrophes have become increasingly frequent and severe over the past decade, exposing (re)insurers to much more risk than they may have realized and reserved for. One root cause can trigger a chain reaction that can bleed balance sheets and even imperil solvency. Until recently, casualty carriers had little choice but to accept this risk as losses emerged.

The maturation of enterprise risk management (ERM) practice and the development of new niche, open-platform and casualty-specific catastrophe models, though, signal a change. The more complex the casualty risks and regulations carriers face, the more they are recognizing that improving their underwriting and ERM practices could in some cases even yield competitive advantage.

It is becoming possible to model the accumulation of an increasing number of casualty risks, whether technological, crystalizing or aggravating, both knowable and manageable. As casualty catastrophes become more common and more models become accepted, insurers should be able to take informed action to protect and allocate their capital as they have on the property side.

On a relative scale, property catastrophes are utterly familiar and have had the ability to be modeled for over 25 years. The same exposures generally can be found in the same regions with little change from one year to the next. As a result, property (re)insurers have access to a considerable amount of historical exposure and event data, which is evident in the sophistication and utility of the models at their disposal. In fact modeling firms have responded to an increasing demand on property by broadening the scopes of property risks, regions and perils. They are also increasingly opening their models and shifting to open-source platforms as a means of expanding their demand and offering. Part of this increased demand has resulted from the need to accommodate an increasing number of complex and changing risks, perils and countries emanating from the aggregating emerging risk category. Examples of these risks include climate change, the growing complexity of supply chains and megacities. Unfortunately, casualty (re)insurers have not had similar access to models and the data required to run them near this depth. The historical record on casualty and liability risks has been relatively thin and constantly changing. And in some cases the variables almost seem infinite, making it very challenging to identify, model, prioritize, evaluate and integrate a large set and broadening array of scenarios.

The “casualty catastrophe” is perhaps the most daunting threat that casualty (re)insurers face today. One root cause has the potential to trigger a chain reaction of liability through a web of tightly intertwined business relationships that in many cases can involve multiple lines of business.

The proliferation of liability is replicated in casualty (re)insurance portfolios, leading to the possibility of unexpectedly high claims, a drain on capital, and, in the extreme, risk to a firm’s solvency. Multiple lines of business insureds and even multiple accident years can be swept up in a casualty catastrophe, and the carriers involved may have to pay claims that may at first seem unrelated to the event’s initial trigger. 

Link to Part II>>

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