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Looking Danger in the Eyes

Natural catastrophes don't just have to be passively accepted anymore. Individual NatCat analyses offer companies the opportunity to accurately assess their critical Cat risks and better prepare themselves against future damage.

Martin Tietz, Cat Coordinator and Property Expert for the region Germany & Central Europe at AGCS, explains the details of the risk assessment.

Hardly a week goes by without an extraordinary act of nature reported again in the media from anywhere across the globe. In particular, natural catastrophes such as the floods in Thailand (2011), the "Haiyan" typhoon in the Philippines (2013), and the repeated earthquakes in Chile stick in our minds because they bring home the extent to which human beings, and ultimately the global economy, are threatened by natural forces. Presently, alongside obvious changes to our climate, the high concentration of people in exposed urban areas and the globalization of industry make for an increase in the potential danger.

For companies, this development means that natural hazards need to be taken into consideration in risk management to a greater extent.

Natural hazards 2nd out of the largest global risks

Natural catastrophes ranked second on the 2014 risk radar of globally oriented companies. This was the conclusion reached by the most recent issue of the Allianz Risk Barometer, an annual study carried out since 2012 and whose findings are based on surveys of more than 400 insurance experts in 33 countries.

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Image 1: Excerpt from the Allianz Risk Barometer 2014; Source: Allianz

Companies can seek professional support in questions of risk management with regard to natural hazards, for example, by way of:

  • visualization of the customer's portfolio with the aid of a variety of tools (risk location mapping).
  • zoning and classification of insurance locations in hazard zones.
  • targeted assessment of the expected damage in individual risk scenarios.

When summarized, these outputs make up a structured "Cat analysis", which illustrates the individual hazards and expected damages of a customer portfolio.

Incorporating natural hazards into risk management

There are no hard or fast rules for the Cat analysis, as every company is unique in the exposures it faces. Alongside different modes of operation and distinctive features of manufacturing processes of varying degrees of complexity, internationality and the number of insured locations play major roles here. Dependence on particular suppliers and multi-link supply chains increase the complexity (and breakdown susceptibility) of a production process.

The company's ability to influence the level of risk posed by natural hazards in any way is similarly varied and individual. Physical protection against earthquakes is normally more difficult to implement than protection against floods, for example. Selecting the right location in areas prone to tropical storms is also a challenge.

A significant aspect of the risk management process in any case is an evaluation of the NatCat risks with regards to the company and its ability to supply goods.


Risk assessment strategies

The conventional method used to assess risk - by means of concrete claims experience - is not an appropriate means for Cat analysis, as in this case the number of losses incurred is insufficient. Furthermore, the probability that the same event will occur again in exactly the same way is very slim. No two earthquakes are the same; the location and depth of the seismic center as well as the intensity of the quake are always different. Small variations in the determining factors can lead to marked differences in the way the quake manifests itself.

A viable alternative is to model the risks by attempting to depict the potential damage as realistically as possible using a number of defined scenarios. This type of modeling combines scientific expertise (meteorological, seismological and geographic) with empirical values derived from the field of engineering, out of which mathematical calculations can be developed.

At AGCS, risk modeling has been used for several years now for the purposes of internal accumulation control and in underwriting. Our expert knowledge in this area has since been passed on to our customers, in the form of individual natural hazard analysis for the exposed risk locations in the respective customer's portfolio.

The analysis is based on "accumulation lists", which are produced by the customer and contain information on addresses and geocodes, limits of indemnity, operating modes of the different locations, etc. This data is processed internally and, with the help of a modeling tool, the expected and potential damage in respective damage scenarios is calculated. The quality of the data plays a decisive role in these calculations; small variations in the geocoding can lead to significantly different results when investigating the risk of a flood, for instance (see image 2).

 

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Image 2: example for geocode quality (source: Google Earth with AGCS amendments)

Additional information about the buildings in question, for example, building type, construction year or number of floors, can also be used to refine the results. This is because whether or not a site remains intact after an earthquake depends not just on the intensity of the quake, but also on the site's individual structural condition, technical facilities and any goods that may be stored there.

Structure of the Cat analysis

The first section of the Cat analysis is a general one, where the basic approach to the investigation is explained and the modeling components described.

In the second section, the individual scenarios (e.g. an earthquake in California, or windstorm in the USA) are analyzed specifically for the customer's sites. In addition to mapping the insurance locations, the danger zones and the value distribution in these zones are also illustrated.

The actual modeling then shows the projected expected damage and the probability of it being incurred, the average annual damage that can be expected, as well as the specific insurance locations that contribute significantly to the customer's exposure.

A crucial point here is that all of the analysis data is calculated on a "ground-up" basis, meaning that it is calculated without taking underwriting limitations (limits and deductibles) into account at all. This way, the customer can identify how severely potential damage may hit his/her company, and what the probability of such an event occurring actually is.

Ultimately, the analysis serves to check the purchased insurance cover against the level of cover required and to optimize it if necessary. Are the limits sufficient? Do capacities need to be purchased later, perhaps? Or can other limits be reduced as a result of decreased exposure?


Further areas of application

The analysis can also be beneficial for communication within the company: it puts the risk manager in a position where he/she can clearly illustrate the different points of exposure and potential damage to decision-makers who don't work in the area of insurance. For example, in the event that an impending natural event threatens to cause severe damage, company directors and officers can quickly be informed about the potential damages in the areas concerned.

The analysis also provides support in terms of the way in which the company or insurer's loss control engineers steer the risk management process. The decision as to which sites are to be inspected in a certain cycle traditionally depends on how high the limit of indemnity is, the mode of operation, or specifically the risk of fire. If it is then established that a relatively small location that would never normally be inspected actually contributes significantly to the company's exposure to natural hazards, this can then be incorporated into the inspection strategy. The information obtained from the inspection can be integrated into the analysis later on, and the results thereby refined.

Challenges

The aim of the analysis is to provide support to insurers and companies to minimize any surprises by unexpected events. In addition, it can be a great help when making decisions regarding how certain risks are handled.

Aside from analyzing individual risks (one or more sites in a customer portfolio and the internal impact on production connected with these), the largest challenge a company faces is obtaining an overall view of its cumulative exposure, which is characterized by a dynamic and globally interconnected supply chain. While acquiring the relevant data from within the company often proves to be very difficult, it is even more difficult to obtain the necessary information from suppliers or buyers and assign realistic value-added figures to this data.

Our expert

Martin Tietz is a Senior Underwriter in the area of Property and also supports the UW team as the "Regional Cat Coordinator".

e-Mail: martin.tietz@allianz.com