While insurers’ use of models to analyze and quantify risk is well established in the property space, it’s becoming increasingly important in the casualty space. The use of models in this area has grown significantly in the past five years, as companies recognize the looming specter of large, unforeseen losses that may threaten insurers’ balance sheets and future earnings.

Executive Summary

Offering analogies to property-catastrophe modeling, Verisk SVP and Actuary Eric Gesick explains the basics of developing a framework for liability-catastrophe modeling. In the liability world, perils can be corporate activities, product flaws or operational losses instead of storms and earthquakes, and more specific named perils can include defective auto parts or contaminated foods rather than Atlantic hurricanes or West Coast wildfires.

The framework that Gesick defines can be used to classify both systemic and emerging risks.

In Part 2 of this two-part article, Gesick will demonstrate how this framework described here in Part 1 can be used to classify different types of emerging risks.

Part 1 of 2

“Liability catastrophes”—large-scale events triggered by a common underlying cause that can affect multiple organizations and corporations, industries, coverages and policy years—can ripple through global supply and distribution chains and result in widespread liability losses across multiple divisions within insurance companies and across insurers.

Unlike natural catastrophe risks, which are predominantly driven by well-understood natural processes, liability risks depend on complex human dynamics and how they interact with a constantly evolving legal, social, technological, financial and economic landscape. As a result, the liability catastrophe event space is inherently volatile, which has heretofore limited the ability of models to accurately capture the full breadth of the risk.

In addition, liability events can transpire over years or even decades, and typically manifest as reserve inadequacies when management recognizes that previously established reserves are insufficient to cover the developing liability claims that are far beyond initial expectations.

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