Today we have part two of our our series on Catastrophe Models by catastrophe modeler Nick Lamparelli. You can read part one here.

“You stop sending me information, and start getting me some.” Gordon Gekko

In this, the second part of our series on CAT models, we will go into the guts of a catastrophe (CAT) model and explain how they are constructed, assumptions embedded in them, and the financial consequences of these assumptions.

The foundation of actuarial premium setting generally sits on two pillars:

1. How often can we expect losses to occur (the frequency of loss), and
2. How large will those losses be (the severity of loss)

For much of the history of property and casualty insurance, frequency and severity were statistically inferred from claims history. The problem arises that these pillars of insurance collapse when we try to quantify losses that arise from large and significant events…