CAT Risk

What is Cat Risk?

Catastrophic Risk and Catastrophe Insurance, briefly explained

Who Insures Cat Risks?

It is said that Catastrophe Insurance is insurance for certain “low probability high cost events.” Events that are typcally excluded from typical homeowners insurance. The Catastrphofic risks, CAT for short include: Flood, Earthquake, Hurricane, riot, and even terrorist events.

A Definition of Cat Catastrophic Risk:

According to Cairn, Catastrophic Risk is “one where a large number of people are exposed to the risk of a large loss by reason of the occurrence of a peril.” It expands on this definition: “It could be a natural calamity in the form of earthquakes, floods, draughts or even terrorism attack resulting in loss of life, destruction of infrastructure on a large scale. ” An exceptionally sad example of this is “The September 11 attacks.” Cairn Source.

Stanford University defines Catastrophic Risk somewhat differently: “threats to large cities, regions, ethnic groups, entire societies, human civilization, or humanity itself.” They cite some different examples: “climate change, pandemics, ecosystem collapse, famine, nuclear war, genocide, earthquakes, asteroid impacts, and uncontrolled or hostile artificial intelligence.” Stanford Source.

The risk management challenge is that many of these “Catastrophes” are not covered by typical insurance policies. Especially in the personal lines space. Land Movement, including earthquakes, floods are typically excluded from homeowner’s policies. War and warlike acts are often excluded as well.

What is clear is that earthquakes are considered a form of Catastrophic Risk.

Events that cause Catastrophic Risk are sometimes known as Catastrophic Events, or Cat Events, or Cat Loss for short. Insurers that are involved in this risk may be known as Cat Coverage.

How Catastrophic risks are different than Typical Risk Events:

According to Cairn, “Catastrophic risks, both natural and man-made, are fundamentally different from most other insurance risks…” And there are two main ways:

Catastrophic events occur relatively infrequently 

Flood, Earthquakes, Terrorist events – all in all are infrequent compared to dog bites, limbs falling over, and small kitchen fires. These are all examples of more common homeowner and other property insurance claims. Another common property claim is internal water damage.

The severity of loss resulting from Catastrophic Events differs from more traditional insurance risks:

There are two main reasons why cat events are different than normal claims:

1. Loss Severity is not as easily predicted.
2. Cat Losses tend me be quite large. “Catastrophic risks can produce losses of sufficient magnitude as to render insurers insolvent.”

Between these two differences – Cat Risks require different underwriting decisions and financial backing. This is likely one of the main reasons that common insurance policies do not cover many of them. Remember the definition of Catastrophic Risk. It is “one where a large number of people are exposed to the risk of a large loss by reason of the occurrence of a peril.”

How Catastrophic Coverage May be Different:

For our purposes on this blog lets look at the two biggest catastrophic risks that are not covered by homeowners insurance but that can typically be purchased by their own policies: Flood and Earthquake.

Limited Property Coverages via Cat Coverage Insurers:

How do insurers that cover these risks manage their book of business differently than say a typical home insurer: The first major difference you will see if that both NFIP Flood and CEA Earthquake policies curtail total coverage by means of either, or, and larger deductibles and limited coverage. Both achieve this differently. Flood Insurance typically caps coverage at $250,000 in building coverage and $100,000 in personal property. Earthquake insurance, which may cover far more in building coverage value, typically provides coverage with a 15% deductible. On a One Million dollar home that can result in a $150,000 deductible.

Another way that coverage is limited is with less generous endorsements. This is not a home insurance blog, so we will spare you some of the real details to this. Suffice it to say that a home burning down will often have more coverage, by means of the endorsements than an earthquake insurance policy may. The same is typically also true for flood insurance.

Another real difference is the limited scope of coverage. Whereby a home policy might cover you for everything [or at least a whole lot of things] less the deductibles, NFIP Flood and CEA earthquake have narrow definitions of what they will cover.

Those are just a small amount of the coverage differences. You get the point.

With Cat Coverage – Sometimes the Insurers are Different:

One thing that is more common in Cat Insurance is that the insurers are not as likely to be public corporations. Often they are state based enterprises. Both the CEA and National Flood Insurance Plan fit this bill. The CEA is a Private Public enterprise and the NFIP is essentially part of the federal government.

There are of course private insurers [public corporations and what not] that underwrite floods and earthquakes. However often these insurers jhave more stringent underwriting criteria and tip toe in [and out] of the marketplace.

Which Cat Risks are Covered by Common Property / Home Insurance Policies?

Few, if any cat risks are typically covered by common personal lines property policies. It is somewhat difficult to say this categorically, because it does depend on each individual policy and of course the exact situation. But Earthquake and Floods are typically excluded. War is almost always excluded. Nuclear War, double excluded. Polution – often exlcuded. Famine – not sure how the coverage might kick in? We won’t get into coverage from disease.

Other cat risks are potentially so much of one off situations – there may not be case law to back up claims of coverage. Does your home insurance policy cover you from an AI risk? Aliens blowing up your house with a laser? A magnetic storm crush your duplex?

A Differenct Financial Solvency Model:

Cat Insurers are modeled differently. Since the risks out there are so large, can hit so many clients, the financial backing must be greater. Explaining how these insurers are different from a financial backing standpoint, could be the point of another article. But we will skip this subject for now. I will just say that these insurers are expected to be able to bring much more cash to the table AND to be able to handle a large claim.

Another note on this subject though is that not all Cat Insurers are able to be part of the Various State Guarantee funds which are typically associated with homeowners insurance. This is often referred to as being an admitted insurer. Many Flood and are nonadmitted insurers. However many earthquake providers are admitted insurers, at least in California.