The urgency for (re)insurance probabilistic (CAT) models to capture the dynamics of an increasingly interconnected world

Societal resilience is built upon effective risk transfer strategies. For most developed countries in the world, insurance and reinsurance continues to be the most effective method of sharing this burden and reducing the need for state intervention. However, it’s becoming increasingly clear that the probabilistic (CAT) models used to price natural hazard risk are struggling to capture the increasingly dynamic changes of the climate and our level of interconnection.

The Gallagher Research Centre (GRC) was established recently to support reinsurance stakeholders navigate an increasingly complex risk management landscape. Though probabilistic and deterministic natural catastrophe models were first pioneered in the early 1960’s (Friedman, 1984) it wasn’t until the 1990’s, and the combined losses from Hurricane Andrew ($27.3 billion USD) and the Northridge Earthquake ($25 billion USD) that such models began to be fully embraced by the mainstream reinsurance industry (Reinsurance News, 2023).

While significant and continued progress has been made in the precision and scalability of these models in the last 30 years, climate change and an increasingly globalized world mean the relative impacts of natural hazards are becoming far more complex and diverse than most models successfully capture. This leads to an increasing basis risk and potentially less utility of the models. This session will outline the growing research concerns of focus for the GRC, including how can stochastic models built around historical periods truly capture the non-stationarity of risk we see occurring for wind and flood perils? Should models capture the seasonal dependencies between perils to more accurately price aggregate insurance risk? Should future model development focus on the compounded scenarios? 

 

Friedman, D. G. (1984). Natural hazard risk assessment for an insurance program. Geneva Papers on Risk and Insurance, 57-128.

Reinsurance News (2023). Last accessed 10/01/2023. https://www.reinsurancene.ws/insurance-industry-losses-events-data/