What is Catastrophe Modeling?

What is catastrophe modeling in insurance?

Both natural catastrophes— earthquakes, hurricanes, severe thunderstorms, wildfires, and floods—and man-made disasters, including terrorism and extreme casualty events, can jeopardize the financial well-being of an otherwise stable, profitable company. In the case of these rare but severe events, historical loss information is often unreliable in assessing future loss potential – that's where catastrophe models come in. Catastrophe risk modeling is the practice of using computer programs to mathematically represent the physical characteristics of natural catastrophes, terrorism, pandemics, and extreme casualty events. Catastrophe modeling in the insurance industry is used to help insurers estimate potential losses from future catastrophic events—enabling them to set more accurate premiums and better prepare for claims.

How catastrophe risk modeling works

How catastrophe risk modeling works: understanding catastrophe models

Built from the most current scientific data available, Verisk extreme event risk models capture how catastrophes behave and impact insurable assets using sophisticated simulation methods. All Verisk catastrophe models are based upon a specialized framework:

Event Generation: Large catalogs of simulated events capture the frequency, severity, location, and other characteristics of the entire spectrum of plausible catastrophes
Local Intensity Calculation: For each simulated event, the intensity of the hazard is calculated at each affected site
Exposure Data: Information about the property, replacement value, and physical characteristics is input into the model
Damage Estimation: Physical damage is calculated for each affected exposure
Insured Loss Calculation: Policy terms and conditions are applied to estimate insured losses

What Verisk catastrophe risk models provide

Detailed output from Verisk extreme event risk models is the basis for understanding and quantifying catastrophe risk. It is the "currency" by which risk is priced, transferred, and traded, and applications today go far beyond those within the insurance industry. Critical metrics produced by Verisk catastrophe models include:

Article

Average Annual Loss (AAL)

AAL is the loss that can be expected to occur per year, on average, over a period of many years.

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Report

Exceedance Probability (EP)

The likelihood that a loss of any given size (or greater) will occur in the coming year.

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Article

Tail Value at Risk (TVaR)

The expected value of loss beyond a specific exceedance probability.

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Related resources

Learn more about the fundamentals of catastrophe modeling through expert-developed content. Explore trainings, articles, and other materials to find out more about the risks different types of catastrophes pose to businesses and people and the science behind how catastrophe models are developed.

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Modeling Extreme Event Risk

Both natural catastrophes—earthquakes, hurricanes, tornadoes, and floods—and man made disasters, including terrorism and extreme casualty events, can jeopardize the financial well-being of an otherwise stable, profitable company.

Download the brochure