The Lloyd’s Market Association (LMA) has published a new guide on catastrophe risk models today, as it seeks to bring more clarity to the subject, as the use of, range and complexity of catastrophe models has increased.
The guide focuses on uncertainty in catastrophe risk modelling and is targeted at helping anyone who relies upon cat models but does not have a detailed understanding of the uncertainty contained within them to better appreciate how uncertainty can effect model results.
Ken Curtis, Director, Finance & Risk at the LMA explained; “As our reliance on and the sophistication of catastrophe models grows, so does the level of uncertainty inherent in the models. Few outside the cat modelling industry are fully equipped to recognise this, and the consequences it has on assessing and pricing risk. This guide provides an invaluable tool to LMA members and the insurance market generally in understanding this uncertainty.”
The guide provides an explanation of the five main reasons that uncertainty arises in catastrophe risk models:
- non-modelled losses: which can result from regions or perils not included in the modelling assessment, risks that are not considered by a model, or missing exposures
- exposure data: the accuracy of the cat model is reliant on the quality of its input data
- event frequency: historical data on catastrophe is limited and is not always a reliable guide to what events may occur in the future
- risk vulnerability: catastrophe risks may have several different characteristics, such as wind damage and flood, insured risks may have different vulnerabilities to these hazards
- financial calculations: translating risk and frequency into possible claims value and volume.
Insurance and reinsurance companies use catastrophe risk models to make more informed decisions, providing them with tools to analyse catastrophic events and visualise the effects on a portfolio of underwriting business.
The LMA guide, titled ‘Understanding Uncertainty in Catastrophe Modelling for Non-Catastrophe Modellers’, is available for download here.