It seems that hardly a day goes by without some type of disaster in some part of the world. Over the past two years, the scope and magnitude of these events has been astounding. There have been massive earthquakes in Haiti, Chile, New Zealand and Japan, with the last generating a tsunami of calamitous proportions. And in the spring of 2011, a rash of tornadoes in the Midwest and Southern regions of the United States killed more than 550 people and caused an estimated USD17.25 billion in insured losses.

For businesses, natural catastrophes bring enormous risk. An inability to manufacture products or accommodate customers can have a devastating effect on the bottom line. Even events on the other side of the world can affect a company and leave executives scrambling to find critical components or services. As Bryon Ehrhart, chairman, Aon Benfield Analytics, puts it: "A lot of things can go wrong that people don't expect to go wrong."

But planning for the unexpected is easier said than done. Not only must a business prepare for natural and human catastrophes, it must develop a plan for sorting through the aftermath. The ability to use catastrophe modeling, engage in risk-scenario planning and have the right insurance coverage frequently determines whether an enterprise flourishes or founders when the dust settles or the water subsides.

Model planning

Uncertainty is part of life. But recent disasters have demonstrated just how chaotic and painful things can be—even for organizations that plan ahead. The March 11 earthquake and tsunami in Japan, for example, disrupted global supply chains and left many companies reeling. "There are tremendous uninsured losses in Japan," Ehrhart notes. "A lot of people never imagined that an event of this magnitude could take place."

The situation has forced many business executives to reassess their thinking and actions—particularly revolving around risk tolerance levels for damaged or destroyed assets, supply chain disruptions, and loss of earnings. There's a growing recognition that it's vital to build a framework for catastrophe planning into the fabric of the business. "Catastrophe models provide a more complete and accurate picture of risk and possible outcomes and help guide decision making," states Stephen Jaye, a senior analyst for Aon Benfield.

Insurance and reinsurance providers offer sophisticated catastrophe models. For example, Jaye points out that detailed hurricane data extends back to 1851, offering statistical patterns for how often various types of disasters take place and how they vary in magnitude. By overlaying demographic data as well as information about casualty losses, it's possible to understand statistical patterns and probabilities—and engage in effective planning.

In fact, teams of experts—meteorologists, seismologists, mathematicians, software developers and financial experts from around the world—plug in data, information and knowledge in order to develop models for different types of events. This data comes from myriad sources, including governments, trade organizations and previous claims. What's more, these teams of experts constantly add and tweak algorithms in order to build more precise models, explains Steve Jakubowski, president, Aon Benfield Impact Forecasting. "The catastrophe model is at the center of effective planning," he says.

Shaking things up

It's one thing to have powerful catastrophe models available for understanding risk. It's another thing to put them to their best possible use. "It's very easy to overlook one or two key factors and wind up with an incomplete assessment," explains Steve Bowen, senior scientist, Aon Benfield Impact Forecasting. "You may understand your primary risks but not take into account something that drastically increases the risk level. Risk managers must be thorough when they examine their exposures," he points out.