Report: Recent Advances in Casualty Catastrophe Models Help Insurers

December 21, 2011

A new report says recent advances in casualty catastrophe modeling can help insurers to understand potential exposures to mass torts.

The report, released this month, is titled “The Need for Casualty Catastrophe Models: A Way to Prepare for the ‘Next Asbestos.'” It’s from New York-based consulting and research firm Towers Watson.

“Insurers bound by Solvency II will be required to explicitly estimate the potential impact of mass torts, casualty catastrophes or binary events as part of insurers’ technical provisions,” the report said.

Understanding Potential Exposures to Mass Torts

The report said that even where it is not currently a regulatory requirement, many casualty insurers realize that understanding potential exposures to mass torts is critical for continued financial integrity. It is also an important consideration within a sophisticated enterprise risk management framework.

The report points out that the increased sophistication of natural catastrophe modeling over the past 20 years has allowed property insurers to better measure and manage their catastrophic exposure.

Now, recently developed models are available to help casualty business writers that are exposed to mass torts evaluate and understand their risks.

The report says that an event would usually be considered a casualty catastrophe if total losses and related expenses exceed $50 million or $100 million. In the U.S., many such events occur every year.

The report notes that asbestos is by far the largest mass tort experienced by the casualty insurance industry, and it resulted in a new awareness of the risks facing the financial integrity of insurers. Other examples of mass torts include the financial crisis, Chinese drywall, the BP oil spill, product recalls, fen-phen and the severe side effects of some other pharmaceutical products. Some natural catastrophes, such as the 1994 Northridge earthquake, can also cause mass torts.

Challenges in Modeling Casualty Catastrophes

But there have been challenges in modeling casualty catastrophes, the report says.

First, there are significant differences in opinion over what the next game-changing mass tort will look like: the cause and size, the number of entities involved and insurance available to respond.

For instance, cancer from cell phone use would probably affect only a handful of large companies — telecoms and their manufacturers. In contrast, lawsuits alleging damages due to climate change could impact virtually any company that has contributed to the emission of greenhouse gases.

These differ from natural catastrophes, where it is generally understood that the next big insurance event will involve a tornado, earthquake, flood or hurricane striking a densely populated city in a developed nation. But the report says it is likely that the next mass tort will be due to a peril that is not well understood right now.

Another difficulty for casualty catastrophe modeling is that the ultimate financial effects of an unknown mass tort can remain hidden to an insurer for many years, unreported on financial statements.

But These Modeling Obstacles Can Be Overcome

But the Towers Watson report says these obstacles can be overcome.

Instead of modeling the physical characteristics of an event (such as location, wind speed, diameter or seismic intensity for a natural catastrophe), the insurance-related characteristics of a mass tort event can be modeled using different factors. These include: total losses, number of affected entities, reporting lag, triggered policy years and the potential correlations between these characteristics.

Preparing for Next Asbestos?

The report acknowledges that this casualty catastrophe modeling does not answer the question of what the next asbestos will be, but it does answer the question of how the next asbestos might affect insurers.

The report says it does this by allowing an insurer to better understand the magnitude and properties of latent claims that may affect their liabilities, which can lead to better pricing for future events that may not be reflected in historical data and mitigation of exposure to these events through policy terms.

Key steps include: gathering historical information on casualty catastrophe events; adjusting the ultimate cost of historical casualty catastrophes to a common future point in time; parameterizing the frequency and severity of historical casualty catastrophes by line of business; and simulating future casualty catastrophes by line of business using a frequency-severity approach.

Other important steps include: for each simulated casualty catastrophe, allocating the industry-level ultimate losses to policy year and insurer; reviewing the resulting distribution of casualty catastrophe claims at the industry or insurer level by line of business, by policy year and in total; and conducting sensitivity testing of the model’s assumptions and parameters, and comparing with other empirical estimates from expert judgment and making adjustments if necessary.

The full report can be found at:

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