Managing the Catastrophe Risk

The catastrophic losses caused by Hurricane Andrew and the Northridge Earthquake are leading many actuaries to reconsider their pricing formulas for insurance with a catastrophe exposure. Many of these formulas incorporate the results of computer simulation models for catastrophes. In a related development, many insurers are using a geographic information system to monitor their concentration of business in areas prone to catastrophic losses. Wh’l i e insurers would like to diversify their exposure, the insurauce-buying public is not geographically diversified. As a result, insurers must take on greater risk if they are to meet the demand for insurance. This paper develops a risk load formula that uses a computer simulation model for catastrophes and considers geographic concentration as the main source of risk. We then show how this risk load formula can be used to develop a coherent strategy for managing the catastrophe risk. 11