Reimagining History – Counterfactual Risk Analysis

Just under ten years ago, as the global financial crisis was unfolding, the book The Black Swan emerged as the most quoted critique of the financial modeling for rare events. The author, Nassim Taleb — the poster boy of sceptics — asserted that these could not be imagined, let alone predicted. Over the past decade, whenever an unmodeled catastrophe has occurred, such as the magnitude 9 earthquake and tsunami that struck Tohoku, Japan on March 11, 2011, catastrophe risk modelers have been reminded of these elusive “black swans”.

Ever since the publication of The Black Swan, I have challenged myself to develop a framework within which such events might be imagined. The solution lies in reimagining history. Since Copernicus, we no longer perceive the Earth as being specially located in the universe. Yet, the anthropocentric viewpoint has maintained that the historical past is somehow special, rather than being just one realization of what might have happened. Most events have either happened before, almost happened before, or might have happened before.

Mark Twain observed that “History doesn’t repeat itself, but it does rhyme.” The 2011 Tohoku earthquake was not the repeat of the 869 Sanriku earthquake, but it was similar in respect of its tsunami footprint. Instead of treating past events as fixed, they can be simulated stochastically, to generate counterfactual scenarios. This process of stochastically simulating past events can be undertaken for all perils, natural and man-made.

A study of counterfactual risk analysis was commissioned by Trevor Maynard, head of innovation at Lloyd’s. The outcome is a Lloyd’s report, which has just been featured in The Economist. This report introduces the concept of the downward counterfactual — an alternative version of history, where things turned for the worse. To give a cyber risk example, if the WannaCry ransomware virus had been spread before the Microsoft patch in March 2017, the global economic loss might have been an order of magnitude higher.

Catastrophe risk modeling is still in its infancy; RMS(one)® will take us to the next level. The Berkeley development psychologist, Alison Gopnik, has observed that children pretend so much because they are learning so much. We need the imagination of children to learn more about “black swans”. Reimagining history is an important new lesson for the insurance industry.

Catastrophist, RMS
Gordon is a catastrophe-risk expert, with 30 years’ experience in catastrophe science, covering both natural and man-made hazards. Gordon is the chief architect of the RMS terrorism risk model, which he started work on a year after joining RMS in December 2000. For his thought leadership in terrorism risk modeling, he was named by Treasury & Risk magazine as one of the 100 most influential people in finance in 2004. He has since lectured on terrorism at the NATO Center of Excellence for the Defense against Terrorism, and testified before the U.S. Congress on terrorism-risk modeling. As an acknowledged, international expert on catastrophes, Gordon is the author of two acclaimed books: “The Mathematics of Natural Catastrophes” (1999) and “Calculating Catastrophe” (2011). Dr. Woo graduated as the best mathematician of his year at Cambridge University and he completed his doctorate at MIT as a Kennedy Scholar and was a member of the Harvard Society of Fellows. He also has an Master of Science in computer science from Cambridge University.

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