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Catastrophe
exposures unlike non catastrophe exposures, are usually
infrequent, producing no losses on most years and large
losses in a few years (This definition no longer seems
to hold good, and that baffles the insurers). Even in
their new incarnation, they are different from non catastrophe
risks as they have metamorphosed into events causing
large and frequent losses. Managing catastrophe risks,
therefore, offers very different challenges to an insurer.
Another major difference is that catastrophes also cause
losses on many heads of exposure through one single
event i.e., correlated losses. In case an insurer covers
a large number of policyholders with the potential of
exposing the insurer to correlated risk, the insurer
would need to accumulate a large amount of capital and
should either find a way to bear the cost of holding
the capital, or, should create a contingency plan to
meet claims from its exposures, if any. The return on
capital should be commensurate with the risk, factoring
in correlated exposure and infrequent occurrence of
large events.
Yet
another distinctive feature of catastrophe risk management
is that the entire process of insurance has to be monitored
from time to time during `no loss' periods failing which,
companies would not be able to calibrate changing levels
of risk, perhaps covert, that exist at such times, as
well.
Catastrophes
pose major financial risks to insurers, such as risk
of insolvency, a drastic decrease in profits and statutory
surplus, a compulsion to sell off assets to meet sudden
claims and a consequent downgrade in ratings. That is
why they should formulate proper strategies for a risk
management policy. Insurance companies set predetermined
risk bearing capacities for themselves. For example,
it could be in terms of a maximum reduction in surplus
from either a single event or multiple events in a year.
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