What Is Catastrophe Modeling?

Catastrophe modeling is a strategy that is often included in the overall risk management process of a business. The idea behind this particular tool is to project the extent of losses that would occur to a business in the event that certain types of natural or other disasters were to take place. Modeling of this type involves the use of a number of different technologies, and is often used by insurance companies to set rates and define risk levels for providing insurance coverage in various geographical locations.

The underlying premise of catastrophe modeling is to understand the degree of risk involved with establishing and maintaining a business operation within a given locality. The modeling process calls for analyzing available data to determine what type of catastrophes have a higher probability of occurring, and what the impact of those catastrophic events would be on the ability of the company to remain in operation. For example, if the operation is located in an area that is at risk of experiencing a hurricane, the catastrophe modeling will consider different scenarios involving frequency and strength of the disasters, and what would likely occur in terms of damages to the facility itself. At the same time, allowances for ancillary factors such as damage to raw materials, downtime for the operation, and even the availability of electricity to power the operation will be taken into consideration.

Even as businesses utilize catastrophe modeling to assess the viability and risk of establishing operations in specific geographical locations, insurance companies will also use this approach to determining if it is feasible to offer coverage for certain types of disasters in that area, and how much risk is assumed by offering that coverage. Doing so makes it easier to decide if the potential business volume is worth the risk, even if the premiums charged for the catastrophic insurance are considerable. In some cases, insurance companies may decide that withdrawing from that particular location and not providing coverage is in the best interests of the company and its current client base.

The process of catastrophe modeling can be used to assess the impact of any number of disaster situations. Along with hurricanes, the modeling can focus on assessing the potential damage from an earthquake, a tornado, lightning storms, fires, and flooding. Taking the data into consideration can help companies already in the area take adequate steps to protect their facilities, allow businesses moving into the area to be more selective in where they locate, and help insurance companies decide what types of disaster or catastrophic insurance can reasonably be offered in the area, and at what cost.