Catastrophe Hazard

What Is a Catastrophe Hazard?

In the insurance industry, a catastrophe hazard is a type of risk that could make a large number of policyholders file claims simultaneously. Common instances of catastrophe hazards incorporate quakes, cyclones, or acts of terrorism.

Catastrophe hazards can be especially exorbitant for insurance companies. Hence, numerous insurance policies will contain conditions indemnifying the insurer against losses coming about because of this type of risk.

How Catastrophe Hazards Work

One of the fundamental assumptions behind most insurance underwriting is the possibility that the individual risks looked by the policyholders are not highly connected with one-another. At the end of the day, insurance companies generally expect to be that, in the event that an event happens that makes one of their customers file a claim, that equivalent event won't increase the probability of a second or third customer filing claims too. This is an important consideration for insurance companies on the grounds that, in the event that these assumptions hold true, it permits the insurance company to reduce their overall risk by diversifying their insurance contracts across a large pool of policyholders. On the off chance that, on the other hand, their risks were largely related, adding additional customers wouldn't reduce their overall risk.

According to this viewpoint, catastrophe risks, for example, natural disasters or acts of war represent an extreme risk to insurance companies. All things considered, on the off chance that a single serious climate event hits a specific community, numerous or even each of the policyholders inside that community could have to file a claim simultaneously. Contingent upon the size of the catastrophe, these combined claims may be more than the insurance company planned for, possibly compelling them into bankruptcy. Consequently, numerous insurance contracts explicitly exempt the insurer from covering these sorts of risks. To get this insurance, they need to purchase it separately either as an add-on or as another policy. Given the potential costs included, guaranteeing these types of catastrophe hazards can require extremely large premiums.

In addition to excluding these risks from insurance contracts, another way that insurance companies look to reduce their exposure to catastrophe hazards is via carrying a catastrophe reserve fund. In the event that a catastrophe hazard happens, the insurance company can draw down this fund and use it to cover the sudden flood of claims. Besides, assuming another catastrophe happens in a region that didn't experience one before, that region may be designated as a high-risk area and become exempt from coverage in ongoing contracts.

Real World Example of a Catastrophe Hazard

One recent illustration of a catastrophe hazard happened in 2017, when Hurricane Harvey crushed numerous networks all through Texas. This was an unanticipated catastrophic event that surprised many individuals and insurance companies. Without catastrophe coverage, many individuals might not have had all that they expected to supplant covered by insurance.

An area that is hit by a catastrophe that emerges from nature may likewise lastingly affect possible insurance for occupants later on. For example, in the event that an area was not considered high-risk for a natural disaster — like a twister or hurricane — is hit by a natural disaster, insurance companies might rename that area as a high-risk area with a catastrophe hazard. Doling out a high catastrophe hazard to inhabitants who have previously had to deal with a natural disaster might make insurance rates higher or raise the premiums for existing insurance policies.

Highlights

• Frequently, policyholders requirements to purchase special add-ons or policies to protect against these risks, possibly requiring extremely high premiums.
• At the point when these risks are insured, they can demonstrate very exorbitant for the insurer.
• A catastrophe hazard is a type of risk that is generally not covered by insurance contracts.