Issue:  A catastrophe model is a computerized process that simulates potential catastrophic events based on historical events. The simulated events generate scenarios of frequency, severity and location. Catastrophe models have been rapidly evolving since their introduction in the 1980s based in part through technological advances and higher resolution exposure data. Catastrophe models incorporate data, technology, scientific research, engineering methods, and statistical analysis to model complex scenarios and events. Catastrophe models were developed to estimate the probability of loss due to extreme weather events but have expanded to apply to non-weather risks including casualty or liability loss, terrorism, and cyber attacks. 

Cat Model Basics: Catastrophe models are used to quantify the financial impact from a range of potential disasters, looking beyond limited historical loss data. Models are used by the (re)insurance industry to produce estimates of potential loss, based on historical loss events as well as scientific research regarding environmental conditions, current and projected. Models can estimate a range of direct, indirect, and residual losses. Direct losses result from incidents such as damage to physical structures and contents, deaths, and injuries. Examples of indirect loss are loss of use, additional living expenses, and business interruption. Residual loss includes demand surge, labor delays, and inflation in material costs.

There are basic components of a catastrophe model. They are hazard, vulnerability, and exposure. Depending on the source, these modules’ names can slightly vary, but the underlying function of the modules remains the same.

• Hazard: This is where events are simulated to determine the likely frequency and severity or intensity of a hazard. Large catalogs of simulated events are generated, representing a wide-range of probable losses. 
• Vulnerability: To determine the vulnerability or susceptibility of a given event to cause a financial loss, data regarding the built environment must be included for the event location. The vulnerability module quantifies the expected damage from an event based on the building characteristics and event intensity. Damage functions are equations used to compute the amount of damage estimated based on construction and occupancy characteristics of the property at risk. 
• Exposure: The financial module measures the value at risk or the probability of financial loss from an event, based on a given time period. Insured loss estimates are generated based on policy conditions, such as deductibles, limits, and attachment points. 

Catastrophe models produce outputs that can be used by insurance industry professionals in various ways. An exceedance probability (EP) curve calculates the loss for each event in the portfolio, produces either by the sum of all losses (aggregate loss) or the largest event in a given year (occurrence loss) and ranks each event by the probability of the event exceeding the aggregate or occurrence based loss amount. An average annual loss (AAL) can be calculated on an occurrence (largest event in a given year) or aggregate (all events in a given year) basis and represents the loss amount averaged across all years in the event set. In July 2018, the American Academy of Actuaries developed a paper, Uses of Catastrophe Model Output. 

Background: In 1992, Hurricane Andrew caused $20 billion in insured losses, becoming the largest loss event at the time, causing several insurers to become insolvent. This led the insurance industry to adopt catastrophe modeling as a way to improve risk management through better loss estimation. Catastrophe models have continued to evolve to reflect a better understanding of the underlying assumptions, intricacies, and science of a peril and its loss drivers. Models are continually advanced as new events occur, leading to improved knowledge and data.

The 2004 and 2005 Atlantic hurricane seasons had a substantial impact on modeling assumptions. Two consecutive years of record activity and losses brought a new focus on the impact of aggregate losses from multiple hurricanes. Unique to prior hurricanes, Katrina in 2005 resulted in more losses from secondary flooding than the traditional wind generated events. As such, modelers began to incorporate the impact of secondary perils in catastrophe models. Hurricane Katrina also highlighted the impact of secondary factors, such as demand surge, evacuation, sociological risks, and political influence. Models are increasingly using combinations of economic and sociological modeling to incorporate loss amplification resulting from these additional factors.

Status: In 2022, the Climate and Resiliency (EX) Task Force recommended a Catastrophe Modeling Center of Excellence (COE) be established within the NAIC Center for Insurance Policy & Research. The COE provides regulators with technical training and expertise regarding catastrophe models and information regarding their use within the insurance industry. The COE also conducts research utilizing outputs from catastrophe models to assess the risk of loss from natural hazards. A regulator only site has been created to share information, resources and tools. Regulators who would like access to the site should send an email request to Amy Lopez at alopez@naic.org. 

In 2021, the Task Force issued a referral to the Catastrophe Risk (E) Subgroup to evaluate catastrophe perils for possible inclusion in the Risk-Based Capital charge (other than hurricane and earthquake which were added in 2013). Beginning in 2022, modeled loss data for wildfire is being collected for informational purposes only. The Subgroup has formed an ad hoc group to review severe convective storm models. 

The NAIC Catastrophe Insurance (C) Working Group of the Property and Casualty (C) Committee serves as a forum for discussing issues and solutions related to catastrophe models. The Working Group also maintains the NAIC Catastrophe Computer Model Handbook. The Handbook explores catastrophe computer models and issues that have arisen or can be expected to arise from their use. It provides guidance on areas and concepts to allow for better understanding and to stay updated about cat models. The Handbook is currently undergoing review and updates and will be re-branded as the NAIC Catastrophe Model Primer.

On March 23, 2021, the Capital Adequacy (E) Task Force met to discuss various issues, including CAT models that deviate from the primary vendor models: (1) internal company CAT models; (2) vendor CAT models with adjustments or different weights; and (3) derivative models based on the vendor models. Instructions for evaluating internal CAT models are included in the risk-based capital (RBC) instructions. The Task Force discussed that in-depth instructions on the derivative model and the vendor models with adjustments may be necessary.

In July 2021, the Actuarial Standards Board adopted revisions to the Actuarial Standard of Practice No. 38, Catastrophe Modeling (for All Practice Areas) providing guidance to actuaries with respect to selecting, using, reviewing, or evaluating catastrophe models.