Casualty catastrophe risks remain (mostly) out of reach of ILS capital

The practice of successfully and accurately modeling casualty or liability catastrophe risks is something that continues to prove difficult for insurance and reinsurance firms, making them most likely a slow area of expansion for ILS and alternative capital.

As the unpredictability, increased frequency and severity of events continues, and technological limitations restrict our understanding and analysis of casualty catastrophe risks, it could be some time before alternative reinsurance capital has a strong presence in the sector.

A recent two-part report by Guy Carpenter’s GC Capital Ideas department, titled “Casualty Catastrophe Risk Modeling: Part I & Casualty Catastrophe Risk Modeling: Part II,” focuses on the complexity of creating an adequate modeling platform for casualty catastrophe events, while stressing the importance it holds for re/insurers and investors alike.

For the alternative capital section of the reinsurance market, including insurance-linked securities (ILS), reinsurance linked investments and catastrophe bonds, a lack of clarity and certainty is something that is likely to ensure they largely keep their distance from the sector.

As the GC report explains; “Casualty catastrophes, unfortunately, do not follow patterns – unlike property catastrophes. The geographies, natural conditions and other indicators of hurricanes, earthquakes and other property disasters offer some relative sense of predictability.”

There’s also a risk to insurers and reinsurers that liability-based (casualty) catastrophe risks can have a negative impact on balance sheets and affect solvency in a less predictable way than property risks. Emerging, underestimated and unmodeled risks are a dangerous addition to firms’ portfolios, if not handled with care, deterring traditional reinsurance firms investors and with the potential to lead to negative ratings.

It’s clear that something similar to the vast array of historical exposure data available for property catastrophe risks would be equally beneficial for casualty re/insurers. But the sometimes hidden nature of casualty risks means that past data is significantly scant in comparison, making it “very challenging to identify, model, prioritize, evaluate and integrate a large set and broadening array of scenarios.” Even with the data at hand, casualty catastrophe risks could be considerably less well-understood than property catastrophe risks anyway.

However, casualty catastrophe risks are becoming, albeit slowly, a better understood and more proficiently assessed aspect of risk modelling, as GC explains; “It is becoming possible to model the accumulation of an increasing number of casualty risks, whether technological, crystalizing or aggravating, both knowable and manageable.”

As casualty catastrophe events have increased in frequency and severity in recent years, most notably the 2008 financial crisis that caused economic damages surpassing $1 trillion, so to have the desires to be able to successfully factor them into insurance and reinsurance businesses portfolios.

Recent developments within enterprise risk management (ERM) and casualty-specific catastrophe models show that the industry is moving in the right direction with this.

GC amplifies this; “The more complex the casualty risks and regulations carriers face, the more they are recognizing that improving their underwriting and ERM practices could in some cases even yield competitive advantage.”

Some ILS and alternative capital is now targeting some specific casualty sector risks, however we are unaware of any specific attempts to give investors access to the risk of large casualty catastrophe events, although some of these risks may slip into certain ILS market structures that are dabbling with casualty risk.

One day it is expected that some alternative capital structures will take on portions of these casualty type exposures. But the industry will need better modelling, better data, a better understanding of the causes and potential outcomes of these events, and perhaps an ability to break down the exposures of a major casualty catastrophe event separating the liability from the specific outcomes some of which may be better understood on their own.