Catastrophe risk modeling in 2021: A delicate dance

One of the most important parts of assessing and managing perils is catastrophe risk management, especially as climate change threatens to tighten its grip. For insurers, reinsurance represents an important way to help balance the coverage equation.

Here are some pressing reinsurance concerns in 2021.

Reinsurance and COVID-19

The pandemic has pushed insurers and reinsurers to think more carefully about “black swan” events that we didn’t think were likely to happen. This challenged many of us in the industry to develop new ways to identify, assess, mitigate and manage these risks, a process in which reinsurance plays a big role.

My colleagues and I worked with other professionals in multiple insurance functions to discuss potential exposures, how reinsurance might respond, and how else we could mitigate the risk. Given the heightened awareness and focus on topics like communicable disease and cyber events, coupled with the hardest reinsurance market since 9/11, the biggest challenge we had was to secure proper levels of coverage and capacity given our own retention appetite on certain covers. Meanwhile, reinsurers were focusing on coverage and wording topics — even more so than pricing — especially for lines exposed to pharmaceutical, cyber and contingency risks.

The ways in which we handled reinsurance business had to change dramatically. The industry managed quite well in the end, but the slow pace of renewals was due to the combination of remote working and a hard market.

Catastrophe modeling challenges

The pandemic has shown us that the exercises insurers conduct to identify and assess potential risks can sometimes miss the magnitude and frequency of similar global events. The industry for some time has been developing ways to assess cyber risks and understand what kind of damage the next wide-reaching cyberattack could do to their portfolios. When we invited several vendors to show us how they go about it, we found that the topic is multi-faceted. Depending on what you focus on (pricing, accumulation analysis, etc.), the model outcome can widely vary.

For insurers, the issue is more daunting because we must take this information and make a decision on how we shape coverage, how we price it and which loss mitigation controls to consider. These complex manmade accumulation events are particularly difficult to model because there are human factors — unlike modeling damage from a hurricane — both in the cause and prevention of the events and the claims in the aftermath of an event.

Another modeling challenge for the industry is understanding the impacts of climate change. Not only are the weather and rising sea levels hard to predict, but there’s also the human behavioral change, for example, the way urbanization is causing a greater potential for flood damage, and the way growing abstraction of fresh river water and groundwater is resulting in increased drought risk. The industry is only beginning to learn how to encompass all of these factors into a perfect model.

Climate change happens gradually, so the accuracy of a prediction for any given year is more difficult to rely on. I think what insurers can do amid the uncertainty is actively focus on working with customers on preventative measures and steering our portfolio composition with these numerous not-yet-well-quantified risks in mind. 

Hyeji Kang (Hyeji.Kang@allianz.com) the global head of Reinsurance and Catastrophe Risk Management at Allianz Global Corporate & Specialty. The original version of this piece first published in the Spring/Summer 2021 issue of the AGCS Global Risk Dialogue and is republished here with permission.

See also:

• Technologies for the emerging risk landscape
• Modeling cyber risk in the age of pandemics
• Models for private-public commercial pandemic insurance