Reinsurance and Man-Made Catastrophes

The purpose of reinsurance is to financially help the ceding insurer when they face very high losses which are linked to a catastrophe. However, it is important to note that reinsurance companies do not consider all catastrophes to be the same.

There is a very clear and marked distinction between natural calamities called “nat-cats” and man-made catastrophes. Almost, every reinsurance policy will cover the damage arising from nat-cats. However, the same cannot be said about man-made catastrophes.

As a student of reinsurance, it is important for us to understand the difference between nat-cats and man-made catastrophes and how it impacts the reinsurance policy. This article will provide a detailed analysis of the same.

What are Man-Made Catastrophes?

Natural events like hurricanes, floods, and earthquakes which cause extensive damage and result in huge losses to the reinsurance industry are called natural catastrophe events. However, there are other similar events that can cause huge losses to the insurers as well as the insured. Such events do not arise because of an act of nature. Rather, they occur because of man-made events.

The September 11 terrorist attacks which took down the twin towers in New York is an example that can help explain the phenomenon of man-made catastrophes. This event caused massive losses to insurance companies which ran into billions of dollars. However, the cause was entirely man-made. There have been several such events since then. Events such as cyber security threats, strikes, pollution-related accidents, bridge collapses, riots, etc. can all be classified as man-made catastrophes.

It is important to note that sometimes there can be a thin line between natural catastrophes and man-made catastrophes. The recent Covid-19 pandemic is a perfect example of such an event.

Now, the Covid-19 virus may have evolved naturally. However, it was the spread of the virus across the globe that was causing huge losses. This spread was not a natural occurrence. Instead, it was caused by human beings when they traveled to different places across the globe.

Features of Man-Made Catastrophe

Man-made catastrophes are inherently very different as compared to nat-cats. This is the reason why the reinsurance industry considered them to be separate. Some of the distinct features of man-made catastrophes have been listed below in this article.

1. Always Evolving: Man-made catastrophes have a human element. This makes them significantly different from natural catastrophes. This is because of the fact that natural catastrophes are predictable. It is also possible to create plans to mitigate them. However, when it comes to man-made catastrophes, they are always evolving.

   For example, cybercriminals learn more and more details about how corporations are trying to protect their data. Based on the newly obtained information, they change their plans. Hence, each time, a different kind of cyber attack is launched. On the other hand, floods have continued to happen in the same manner for centuries. Hence, it is possible to minimize the impact of floods whereas the impact of a cyber attack is difficult to mitigate.

2. Limited Use of Empirical Data: Reinsurance uses extensive data in order to create models which can then be used to accurately understand the risk posed by natural disasters. Needless to say, these models heavily rely on data. Now, when it comes to natural disasters, there is a huge volume of empirical data available.

   Records have been kept for more than a century in most countries of the world. Also, most of these records are digitized and easily available for analysis. This is not the case with man-made catastrophes.

   The types of man-made catastrophes are continuously evolving. Also, their impact is also rapidly changing. As a result, there are very fewer data available on the same. This makes it difficult to design any models or make any meaningful predictions about the same.

3. No Geographical Limitations: Another important point of distinction is that natural disasters are mostly limited to a certain geographical area. This is not the case with man-made catastrophes.

   For instance, there are certain areas in the world that are prone to hurricanes. Similarly, there are other areas that are prone to earthquakes. However, when it comes to man-made catastrophes such as terrorism, there is always a chance that an adverse event can take place in almost any country of the world.

   It is also possible that several adverse events take place simultaneously in many different parts of the world. It is for this reason that reinsurance companies find it more difficult to cover man-made catastrophes.

4. Smaller Customer Base: Lastly, it is also important to note that the customer base for buying insurance policies for man-made catastrophes has been historically smaller. Very few companies have been willing to pay a premium to protect themselves against such events. As a result, the premium for every company has traditionally been higher.

   The Covid-19 breakout has created a lot of awareness about the need to purchase insurance and reinsurance policies that protect against man-made catastrophes. However, still, the customer base for such policies is quite small as compared to the ones for natural catastrophes. This also means that there are fewer service providers which underwrite such policies.

The fact of the matter is that man-made catastrophes are quite different as compared to natural catastrophes. Reinsurance companies are aware of these differences and the challenges that come with underwriting man-made catastrophes. It is for this reason that such covers are offered separately and not merged with the cover for natural catastrophes.