Catastrophe modeling (also known as cat modeling) is the process of using computer-assisted calculations to estimate the losses that could be sustained due to a catastrophic event such as a hurricane or earthquake. Cat modeling is especially applicable to analysing risks in the insurance industry and is at the confluence of actuarial science, engineering, meteorology, and seismology.
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Natural catastrophes (sometimes referred to as "nat cat") include:
Other catastrophes include:
The input into a typical cat modelling software package is information on the exposures being analysed that are vulnerable to catastrophe risk. The exposure data can be categorized into three basic groups:
The output is estimates of the losses that the model predicts would be associated with a particular event or set of events. When running a probabilistic model, the output is either a probabilistic loss distribution or a set of events that could be used to create a loss distribution; probable maximum losses (PMLs) and average annual losses (AALs) are calculated from the loss distribution. When running a deterministic model, losses caused by a specific event are calculated; for example, Hurricane Katrina or "a magnitude 8.0 earthquake in downtown San Francisco" could be analyzed against the portfolio of exposures.
Some cat models allow the user the option of including demand surge in the loss estimates, which is post-event inflation. After a large disaster, construction material and labor can temporarily be in short supply, so construction costs are inflated. The larger the impact of the event on the local economy, the larger the effect of demand surge. For example, an event that causes a $5 billion insurance industry loss might cause demand surge to increase construction costs by 5%, while an event that causes a $40 billion insurance industry loss might cause demand surge to increase construction costs by 25%.
Recently, an effort to create and disseminate open multi-hazard cat risk modelling tools was initiated by the Alliance for Global Open Risk Analysis (AGORA).
Additionally, the insurance industry is currently working with the Association for Cooperative Operations Research and Development (ACORD) to develop an industry standard for collecting and sharing exposure data. To date, the industry has been operating on closed, proprietary data formats.
Insurance Information Institute, 19 March 2009
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