Schrödinger’s cat inhabits a thought-experiment designed to reveal the paradox of quantum properties. A hypothetical cat is sealed in a windowless box, in which there is a device that will administer a lethal poison, according to whether a single atom undergoes radioactive decay. Should the atom decay the cat will be dead. If the atom survives so will the cat. Only the quantum state of the atom is completely unknowable. So, the cat — in principle at least, is half dead and half alive. The simultaneous state of being both alive and dead is called a “superposition”.
While quantum behavior is not an average insurance coverage, (at least until future quantum computer cyber cover emerges), there are situations in the world of risk modeling that come close to Schrödinger’s cat — or perhaps that should better be Schrödinger’s “Cat” (short for Catastrophe)?
Catastrophe models, conceived in the 1970s and created at the end of the 1980s, have proved to be a “disruptive technology” in reshaping the catastrophe insurance and reinsurance sectors. The first wave of disruption saw the arrival of fresh capital, to found eight new “technical” Bermudan catastrophe reinsurers. The “Class of 1993” included Centre Cat Ltd., Global Capital Re, IPC Re, LaSalle Re, Mid-Ocean Re, Partner Re, Renaissance Re and Tempest Re. Using catastrophe models, these companies were able to set up shop and price hurricane and earthquake contracts without having decades of their own claims history. While only two of these companies survive as independent reinsurers, the legacy of the disruption of 1993 is Bermuda’s sustained dominance in global reinsurance.
A second wave of disruption starting in the mid-1990s saw the introduction of catastrophe bonds: a slow trickle at first but now a steady flow of new structures, as investors who knew nothing about catastrophic loss came to trust modeled risk estimates to establish the bond interest rates and default probabilities. Catastrophe bonds have subsequently undergone their own “Cambrian explosion” into a diverse set of insurance-linked securities (ILS) structures, including those in which the funds go back to supplement reinsurer’s capital. Again, this disruption in accessing novel sources of pension and investment fund capital would have been impossible without catastrophe loss models.
When we set out to design the latest generation RMS High Definition (HD) flood loss models we identified five key challenges:
a) Resolution: Neighboring properties separated by a few feet in elevation can have dramatically different flood risk costs. However, the finer the model resolution, the bigger the hazard and loss files — and the slower the modeling. We needed an objective way of determining the best trade-offs around model resolution.
b) Duration: Once groundwater levels are raised, more precipitation can set off another round of flooding. The climatology can persist, bringing;
- a succession of storms on the same path, or
- a fixed long lasting atmospheric river, or
- a procession of rain bands from a stalled circulation parked at the coast as from Hurricane Harvey.
Flooding episodes can endure for days and weeks, but reinsurers want a predetermined definition of event duration. The model needed to provide the flexibility to explore how event duration affects results.