Modeling Disaster

Catastrophe modeling is growing, propelled by IT and a really disastrous Q1.

“Based on satellite data and GPS systems, we know the building stock at each locale,” says RMS
co-founder and chief risk officer Robert Muir-Wood. Using data collected from on-the-ground motion sensors and transmitted through a wireless network, models estimate damage based on the intensity and character of ground movement and translate that into cost.

But even with the increasing comprehensiveness of catastrophe models, the ability to quantify loss and risk is still constrained by lack of data and the fundamental unpredictability of nature.

The most difficult losses to model, AIR’s Guin says, are from what the insurance industry calls contingent business interruption: the impact of a catastrophe on a company’s downstream suppliers and partners. “That can be modeled,” he says, “but it requires input data that doesn’t exist. The physical losses due to ground shaking and the tsunami are easy to estimate, but those $20 billion to $30 billion [insured] loss estimates [of the Tohoku disaster] do not include business interruption.”

The reason the data needed to model business-interruption losses doesn’t exist is simple, says Guin: “More data means more costs.” It’s expensive for companies to collect data about all their suppliers and partners — the location of their factories, the nature of their building stock, and so on — and about those suppliers’ and partners’ factories and supply chains, especially in less-developed corners of the world. Many companies are just not willing to make that investment.

But RMS’s Muir-Wood believes it’s critical for companies to map their suppliers’ risks as well as their own. “Then,” he says, “I’d like to understand if I’m too dependent upon a supplier with exposure to catastrophe. Then I’d diversify. If I couldn’t, I’d specify insurance to cover damage at the supplier.” Does a company in Michigan really need earthquake insurance? If it depends on a supplier in an earthquake zone, it might. Especially as the uncertainty of where a catastrophe might occur is magnified by the uncertainty of when.

“Catastrophes,” says Eqecat president Keogh, “don’t happen in an orderly fashion. It would be nice if we could say that every six months we’ll have this or that catastrophe, but it doesn’t work that way.

“What is happening is that the world economy has grown, and some regions have grown a lot,” says Keogh. “The hazards aren’t changing, but there’s more stuff in harm’s way, particularly in Asia. Therefore, there’s increased risk and loss to the insurance industry.”

According to a recent study conducted by global reinsurer SwissRe, earthquakes, storms, floods, and explosions (remember Deepwater Horizon?) resulted in economic losses of about $218 billion in 2010 and cost insurers $43 billion, an increase in insured loss of more than 60% over 2009. Some of that rise can be attributed to economic development in affected areas.

And if you think 2010 was bad, get ready for 2011.

Already in the first quarter there have been severe winter storms in the United States; a magnitude 6.3 earthquake in New Zealand; cyclone Yasi in Australia (with an estimated insured loss of $5 billion); and, of course, the earthquake and tsunami in Japan, where the insured loss has been variously estimated so far to be between $12 billion and $34 billion. And, as Guin points out, “The U.S. hurricane season is still ahead of us.”

Meanwhile, off the northwest coast of the United States stretching from Vancouver Island to Northern California, the Cascadian subduction zone (where one tectonic plate is plunging beneath another, deforming the earth’s crust and storing scary amounts of potential energy) looks a lot like Tohoku. Scientists, says Harvard’s Ishii, believe the inevitable release of energy — that is, the earthquake — could well be as large as 9.0 in magnitude.

That quake could happen tonight; it might not happen for hundreds of years. But it will happen. In the meantime, Keogh suggests that his insurance clients “stress-test their portfolios to account for things not in their models. For example, one of the unanticipated consequences of the Tohoku event was a nuclear plant with its electrical backup at a relatively low elevation knocked out by a larger-than-anticipated tsunami. That’s not something you’re going to pick up in a catastrophe risk model.

“Chief risk officers, to paraphrase Donald Rumsfeld, need to think about the known knowns (what happened before), the known unknowns (possible events that could occur), and unknown unknowns (everything else),” says Keogh.

And that’s why global CROs, CFOs, and insurance company executives are not getting much sleep these days.

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