probabilities of loss from specific perils.
Models allow risk managers to get a
better understanding of how – and how
often – a potential catastrophe is likely to
occur, which can help them avoid overbuying or underbuying insurance. While
many companies purchase insurance based
on the probable maximum loss (PML), the
PML typically does not include information about the probability that an event
will occur. By using catastrophe models,
risk managers can get a better sense of the
various levels of potential losses, insure
against the chances they can occur, and
develop more effective plans for disaster
recovery and operations planning.
Catastrophe models are also used by
risk managers to improve the quality of
information on which they base critical
business decisions, including the marginal
impact of a property acquisition or sale,
the geographical consolidation or dispersion of operations, and the allocation of
insurance costs among business units.
The sale or acquisition of a property
affects an organization’s risk profile.
Considering the location, value, construction type, and existing portfolio relationship of properties may significantly change
the organization’s overall exposure. Risk
managers are able to use catastrophe loss
analysis to determine whether a renegotiation of insurance coverage is warranted,
then quantify the appropriate rebate or
preferred additional coverage.
Catastrophe modeling provides valuable insight into a company’s geographical distribution of exposures as well as
the regions, perils, and businesses with
the largest marginal impact on losses.
Organizations can use such information
to adjust growth strategies in an effort to
mitigate catastrophe loss potential, such as
determining where a business can expand
without increasing loss potential or where
a business may be particularly vulnerable
to catastrophe losses. Additionally, risk
managers can use the models to allocate
the cost of insurance back to individual
locations or business units, allowing the
organization to evaluate the benefits of
geographically diverse operations or
assets.
Working with their insurance brokers, risk managers often use models to
compare the probable cost of certain risk
transfer and/or retention strategies to help
decide on a reasonable policy deductible
and how best to apply the deductible —
such as whether it should be a percentage
of site replacement cost, a percentage of
aggregate loss, or a fixed sum, as well
as whether it should be applied for each
single event or capped annually.
Most large property/casualty insurers
use catastrophe modeling when underwriting policies. This can work in favor
of those insurance buyers who include
model results with their submissions.
Organizations that share detailed model
results with their insurers can use such
data as a compelling and influential negotiating tool when renewing their policies.
Using Data to Mitigate Risk
Though it is difficult to plan fully for
all consequences of a megacatastrophe,
the more information a risk manager has,
the better prepared an organization will be
when the time comes to rebuild. Almost
five years after Hurricane Katrina devastated the Gulf Coast, the rebuilding process continues. Residents have moved to
different neighborhoods while their homes
are rebuilt, businesses have relocated, and
many of those who kept their jobs through
the tragedy have had to make new arrangements for getting to and from work.
One of the unique consequences of a
megacatastrophe is “demand surge.” The
phenomenon is defined as the increased
cost of construction due to the large
number of properties needing replacement
or repair following a major disaster. After
Hurricane Charley hit southwest Florida
in 2004, many property owners were
informed it would take at least three years
before their properties could be replaced
because of a severe shortage of construction materials and labor. During the back-to-back record-breaking storm seasons of
2004 and 2005 labor costs increased by
more than 34 percent in the southeastern
states of Louisiana, Mississippi, Alabama,
and Florida. The installed cost of common
asphalt shingles in those states rose by 39
percent.
Those are just a few of the many costs
and factors involved in property insurance
repair that risk managers must consider
when planning an effective catastrophe
risk management program. In recent years,
new technology, research, and services
have given risk managers the ability to
access critical construction and claims
cost information that can have a significant
impact on risk management decisions. For
example, risk managers can use such data
to create an accurate insurance-to-value
estimate, which helps match insurance pre-
miums with the calculated property risk.
