Catastrophe Modeling

by Crossi, Patricia; Grossi, Patricia

• ISBN13: 9780387241050
• ISBN10: 0387241051
• Format: Paperback
• Copyright: 2005-02-28
• Publisher: Springer Verlag

Summary

Catastrophe Modeling: A New Approach to Managing Risk is the first book that systematically analyzes how catastrophe models can be used for assessing and managing risks of extreme events. It focuses on natural disaster risk, but also discusses the management of terrorism risk. A unique feature of this book is the involvement of three leading catastrophe modeling firms, AIR Worldwide, EQECAT, and Risk Management Solutions, who examine the role of catastrophe modeling in rate setting, portfolio management and risk financing.Using data from three model cities (Oakland, CA, Long Beach, CA and Miami/Dade County, FLA), experts from the Wharton School of the University of Pennsylvania examine the role of catastrophe modeling to develop risk management strategies for reducing and spreading the losses from future disasters. Given the uncertainties associated with terrorism the book points out the opportunities for utilizing catastrophe models to set insurance rates and to examine public-private partnerships for providing financial assistance in the event of a terrorist attack.

Table of Contents

Preface and Acknowledgements	xiii
Prelude	xvii
PART I - Framework for Risk Management Using Catastrophe Models	1	(42)
Introduction: Needs, Stakeholders, and Government Initiatives	3	(20)
Patricia Grossi
Howard Kunreuther
Need to Manage Risk	3	(4)
Private Sector Stateholders in the Management of Risk	7	(6)
Property Owners	8	(1)
Insurers	9	(1)
Reinsurers	10	(1)
Capital Markets	10	(1)
Rating Agencies	11	(1)
State Insurance Commissioners	11	(1)
Other Stakeholders	12	(1)
Government's Role in Management of Risk	13	(6)
Types of Programs	13	(2)
Federal Disaster Insurance	15	(4)
Summary of Chapter	19	(1)
References	20	(3)
An Introduction to Catastrophe Models and Insurance	23	(20)
Patricia Grossi
Howard Kunreuther
Don Windeler
History of Catastrophe Models	23	(3)
Structure of Catastrophe Models	26	(1)
Uses of a Catastrophe Model for Risk Management	27	(2)
Derivation and Use of an Exceedance Probability Curve	29	(5)
Generating an Exceedance Probability Curve	29	(3)
Stakeholders and the Exceedance Probability Curve	32	(2)
Insurability of Catastrophe Risks	34	(5)
Conditions for Insurability of a Risk	35	(1)
Uncertainty of Losses	36	(1)
Highly Correlated Losses	37	(1)
Determining Whether to Provide Coverage	38	(1)
Framework to Integrate Risk Assessment with Risk Management	39	(1)
Summary and Relationship to Parts II-IV	40	(1)
References	41	(2)
PART II -- Natural Hazard Risk Assessment	43	(50)
The Risk Assessment Process: The Role of Catastrophe Modeling in Dealing with Natural Hazards	45	(24)
Mehrdad Mahdyiar
Beverly Porter
Introduction	45	(2)
Hazard Module	47	(11)
Locations of Potential Future Events	47	(4)
Frequency of Occurrence	51	(3)
Parameterizing Severity at the Hazard's Source	54	(1)
Parameters for Local Intensity and Site Effects	55	(3)
Inventory Module	58	(1)
Vulnerability Module	59	(5)
Identification of Typical Buildings	60	(1)
Evaluation of Building Performance	60	(4)
Loss Module	64	(1)
Summary	65	(2)
References	67	(2)
Sources, Nature, and Impact of Uncertainties on Catastrophe Modeling	69	(24)
Patricia Grossi
Don Windeler
Introduction	69	(1)
Classifications of Uncertainty	70	(1)
Sources of Uncertainty	70	(4)
Representing and Quantifying Uncertainty	74	(5)
Logic Trees	74	(2)
Simulation Techniques	76	(2)
Uncertainty and the Exceedance Probability Curve	78	(1)
Case Studies in Uncertainty	79	(10)
Hurricane Hazard: Florida	79	(3)
Earthquake Hazard: Charleston, South Carolina	82	(7)
Summary and Conclusions	89	(1)
References	90	(3)
PART III -- Linking Risk Assessment With Insurance	93	(72)
Use of Catastrophe Models in Insurance Rate Making	97	(22)
Dennis Kuzak
Tom Larsen
Introduction	97	(1)
Actuarial Principles	98	(2)
Use of Catastrophe Models in Rate Making	100	(6)
A Simple Rate Making Model	100	(2)
Differentiating Risk	102	(4)
Regulation and Catastrophe Modeling	106	(2)
Case Study of Rate-Setting: California Earthquake Authority	108	(7)
Formation of the CEA	108	(1)
Rate-Setting Procedures	109	(6)
Future Research Issues	115	(1)
Open Issues for Using Catastrophe Models to Determine Rates	115	(2)
Summary	117	(1)
References	118	(1)
Insurance Portfolio Management	119	(16)
Weimin Dong
Patricia Grossi
Introduction	119	(1)
Portfolio Composition and Catastrophe Modeling	120	(5)
Portfolio Composition	120	(1)
Catastrophe Modeling -- Bottom-up Approach	121	(3)
Portfolio Aggregation	124	(1)
Portfolio Management Example	125	(2)
Understanding Risk	126	(1)
Underwriting and Risk Selection	127	(1)
Special Issues Regarding Portfolio Risk	127	(5)
Data Quality	128	(1)
Uncertainty Modeling	129	(1)
Impact of Correlation	130	(2)
Summary	132	(1)
References	133	(2)
Risk Financing	135	(30)
David Lalonde
Introduction	135	(1)
What Risks Should Be Financed?	136	(3)
Level of Risk	137	(1)
Probable Maximum Loss (PML)	138	(1)
Risk Financing Mechanisms	139	(19)
Generating Funds Internally	139	(2)
Risk Transfer -- Reinsurance	141	(2)
Risk Transfer -- Securitization	143	(2)
Securitization Structures	145	(11)
Dealing With Basis Risk	156	(2)
The Costs of Risk Transfer	158	(1)
Evaluation of Risk Financing Schemes	159	(4)
Analyze Current Risk Profile	160	(1)
Customize Decision Model	160	(1)
Establish Performance Measures, Constraints, Critical Function	160	(1)
Develop Risk Management Alternatives	161	(1)
Evaluate Alternative Strategies	161	(1)
Select, Implement, and Monitor Strategy	162	(1)
Summary	163	(1)
References	164	(1)
PART IV -- Risk Management Strategies Using Catastrophe Models	165	(70)
The Impact of Mitigation on Homeowners and Insurers: An Analysis of Model Cities	167	(22)
Paul Kleindorfer
Patricia Grossi
Howard Kunreuther
Introduction	167	(2)
Framework of Analysis	169	(2)
Construction of Model Cities	171	(4)
General Model Structure	171	(1)
Mitigation Measures	172	(1)
Books of Business for the Insurance Companies	172	(2)
Insurance Company Premium and Asset Levels	174	(1)
Incorporating Uncertainty Into Analysis	174	(1)
Insurer Decision Processes	175	(3)
Impact of Mitigation on Losses and Insurer Behavior	175	(3)
Homeowner Decision Processes	178	(3)
Factors Influencing Mitigation Adoption Decisions	178	(3)
The Interaction of Mitigation Decisions and Insurance Decisions	181	(1)
Implications for Workable Public-Private Partnerships	181	(5)
Role of Building Codes	183	(1)
Long-Term Mitigation Loans	184	(1)
Lower Deductibles Tied to Mitigation	184	(2)
Conclusions	186	(1)
References	187	(2)
The Impact of Risk Transfer Instruments: An Analysis of Model Cities	189	(20)
Howard Kunreuther
Paul Kleindorfer
Patricia Grossi
Introduction	189	(1)
Framework for Evaluating Alternative Strategies	189	(2)
Evaluating Different Strategies for the Insurer	191	(2)
Impact of Indemnity Contracts on Insurer Performance	193	(4)
Excess-of-Loss Reinsurance Using Strategy 1	194	(2)
Comparison of Performance Across Insurer's Strategies	196	(1)
Catastrophe Bonds As Additional Sources of Funding	197	(8)
Structure of Catastrophe Bond for Oakland	198	(3)
Impact on Insurer's Performance in Oakland	201	(2)
Performance of Catastrophe Bonds Across Different Regions	203	(1)
Multi-Region Catastrophe Bonds	204	(1)
Extensions of the Analysis	205	(1)
Conclusions	206	(2)
References	208	(1)
Extending Catastrophe Modeling To Terrorism	209	(26)
Howard Kunreuther
Erwann Michel-Kerjan
Beverly Porter
Introduction	209	(1)
September 11, 2001: Impacts on Terrorism Insurance	210	(1)
The Nature of Terrorism Coverage	211	(4)
Insurability Issues	212	(1)
Expanding Capacity Through Catastrophe Bonds	212	(1)
Potential Role of Catastrophe Bonds	213	(2)
Comparison of Terrorism Risk with Natural Disaster Risk	215	(1)
Terrorism Risk Insurance Act of 2002	216	(2)
Public-Private Risk Sharing Under TRIA	216	(2)
Challenge for Insurers and Firms: Quantifying the Residual Risk	218	(1)
Catastrophe Models for Terrorism Risk	218	(9)
Terrorism Hazard	219	(3)
Inventory	222	(1)
Vulnerability	222	(2)
Workers' Compensation Loss	224	(2)
The ISO Advisory Loss Costs	226	(1)
Low Insurance Demand for Terrorism Coverage	227	(2)
Empirical Evidence	227	(1)
Heuristics and Biases	228	(1)
Future Research Directions	229	(3)
Vulnerability Analyses	229	(1)
Risk Perception	229	(1)
Interdependencies	230	(2)
References	232	(3)
Glossary	235	(6)
Index	241