Natural disaster? This is how huge your financial loss can be

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I want to make the world more resilient to natural disasters and climate change by improving the knowledge of these phenomena. I’m currently working on the Oasis Loss Modelling Framework for my PhD. This is a non-for-profit organization which is developing an open source catastrophe modelling service for use by (re)insurance companies, financial institutions, and public bodies.

With Oasis we make the insurance sector more resilient to climate changes

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Currently,  several  catastrophe modelling software systems are on the market. These are used by insurance companies to set premiums and reserves on the risks of natural catastrophes; some examples are RMS, AIR and EQECAT. But the problem with these systems  is that they’re like a ‘black box’. You don’t know exactly how they work; you enter some inputs like geographic location, type of catastrophe (e.g. hurricane, earthquake) and type of building (e.g. steel, concrete) and you receive information about the loss distribution, without knowing anything about how it was calculated.

A new European regulation states that insurance companies need to clearly show how the models they use to compute their solvency requirement work. Only in this way can the regulators check if an insurance company has enough capital to be solvable. Under this new regulation, the probability of an insurance company going bankrupt must not exceed 0.5%.

Insurance companies need to understand the potential risks before they know how much capital they need. These companies can use Oasis as a benchmark – it enables comparison  with other models. Indeed, the great advantage of Oasis is that you can see what’s going on inside: you can see the exact code.

 In many cases companies overcharge, because they haven’t got a clue of the actual risk they are insuring. That’s why, in line with Oasis’ aims, I’m also working on a separate project on the development of a data set which focuses on large commercial risks. It contains not only risks related to climate change, like the probability of flooding in the Netherlands or earthquakes in Italy, but also man-made risks like fire and explosion, about which very little is known.

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The dataset allows end users to validate models for international commercial property analysis. It also provides a statistical basis for distinguishing between physical damage and business interruption losses. Let’s say there was an electrical failing in a building and the damage was limited. But the business was interrupted for a while, because of the failing, so the actual financial loss was much greater. That’s what we mean by  ‘the business interruption’.

 We are creating a dataset which distinguishes between these risks, because (re)insurance companies may have to cover all of these financial problems. We also look at different types of buildings and businesses. What risk does aa hospital face when confronted by a catastrophe? And is this the same for a bank or hotel? Some companies may only be small, but they can have a higher probability of being damaged. We have to take all of these differences into consideration.

Practical Examples

Regarding the Oasis software; there are currently more than 25 companies involved in the project, testing the model. The open access version of Oasis should be available at the end of 2015.

Why is this so important

It is important as it will  make the reinsurance market fairer. Usually (re)insurance companies tend to overcharge because they are not aware of the real risks. With our dataset, they can more precisely calculate their risks and adjust their solvency capital. It’s also valuable for regulators at the European commission to be able to validate the methodologies of reinsurance companies.

 Moreover, Oasis creates knowledge in a simple way and can really help companies and governments make better decisions. For the insurance sector, innovation is mainly about a better risk understanding. So you need to create knowledge, which is easy to understand, easy to use and easy to implement. Oasis has the ability to change the problems around climate change, making the insurance sector more resilient to it, by improving their knowledge. That’s what I love about it. Additionally, Oasis can be used by academics who need to gain insights into the losses and damages caused by catastrophes.

Biography

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My research focuses on insurance and risk management. For my PhD, I have been working on a theory for insurance contract design under (sub)optimal policyholder behaviour. I am also investigating the determinants of hedging demand in the insurance sector, more precisely reinsurance demand, and whether risk transfer may give rise to systemic risk. Finally, I am studying the properties of the loss distribution of large commercial risks worldwide, for different types of property and risk, and how solvency capital requirements should be set.

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Social and Commercial opportunities

The results are of immediate use to insurers and reinsurers carrying out pricing, reserving, and capital modelling exercises in the commercial risk space. Governments can also use Oasis, for instance to price catastrophe bonds they issue to hedge against natural phenomena. The commercial opportunities for other companies are also huge, for instance for companies which develop models to predict flooding and fire loss. Oasis can be used for everything related to catastrophes, so the business opportunities are huge.

My expertise

Oasis, reinsurance companies, insurance, climate changes, risk management, econometrics