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Catastrophe Risk Management

Defining the Characteristics of a PML Study

Nathan Gould | March 1, 2007

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Probable maximum loss (PML) studies have long been a staple in the insurance, real estate, and financial industries for quantifying the risk due to extreme hazards and the resulting financial losses.

The use of PML studies that provide probabilistic methods of estimating natural hazards and the magnitude of the resulting estimated losses have combined to alter the nature of the PML that is used today.

Deterministic versus Probabilistic

PML studies that have been a staple in the insurance and financial industries to help quantify the risk due to earthquake and extreme wind loads have often focused on using a deterministic event, as opposed to a probabilistic event, to quantify the natural hazard risk. The fundamental difference between a deterministic and probabilistic analysis is that a deterministic analysis does not consider the probability associated with a hazard, whereas a probabilistic analysis incorporates the hazard probability.

In a deterministic analysis, a controlling fault (earthquake) or hurricane (extreme wind) for a site is specified. An event with specified parameters (such as magnitude for earthquakes or wind speed for hurricanes) for the desired return period is assumed to have occurred. This approach can be expected to generate a conservative "worst-case" scenario for loss, especially when combined with a 90 percent confidence level on the loss estimate. Deterministic events may include either scenario or historic events. From an extreme wind perspective, the historical analysis will typically focus on a relatively recent period of time (i.e., the past 100 years).

In contrast, a probabilistic evaluation considers a statistical combination of all the events that have the potential to occur, but have not necessarily been observed at the site. As an example, a probabilistic hurricane evaluation should include a robust statistical distribution of the main storm parameters that can be developed from historical data. This distribution can then be used to simulate climatologically plausible hurricane tracks from genesis to decay. A probabilistic analysis should result in a more complete and realistic evaluation of the potential loss.

Selection of Return Periods

The event of choice for the standard earthquake PML has historically been an event with a 475-year return period, which can also be expressed as an event that has a 10 percent chance of exceedance in 50 years. There are many thoughts as to the origin of the classic 475-year return period event; however, this return period has long been used to define design basis earthquake in several of the primary building codes in the United States that preceded the new International Building Code (IBC).

The 2006 IBC (through reference to the ASCE 7-05 Standard) uses two-thirds of the maximum considered earthquake (MCE) ground motion as the design earthquake. The MCE ground motions are typically defined as the maximum level of earthquake ground shaking that is considered reasonable for typical structures to resist. For many parts of the United States, the MCE will correspond to an event with an approximate 2,500-year return period (2 percent chance of occurrence in 50 years). The selection of a 2,500-year return period has resulted in significant impacts in building code requirements in many regions of the United States and—if also projected into PML studies—can be expected to have a similar effect on the resulting projected losses.

The selection of a wind event for hurricane loss evaluations has varied greatly over the past years. One traditional approach was to use deterministic events that had wind speeds corresponding to the 50-year and 100-year mean recurrence interval (MRI) event, which reflected older wind design standards for new buildings. These standards typically used the 50-year MRI as the basis for design wind speed for ordinary buildings and the 100-year MRI as the basis for the design wind speed of buildings with a higher level of importance. Other approaches have ranged from the simplistic, such as using an event with a return period equal to that used for the classic seismic PML, to high level site-specific analyses to determine controlling wind events over a full range of return periods.

Return Period vs. Normalized Loss

Is a Site Visit Required?

An often-asked question is whether a visit to the facility under review is required. There are PML studies that are performed without a site visit. These are typically referred to as "desktop" studies, and they involve using only the information that can be sent to the reviewers. The material provided typically includes design drawings, a property condition assessment report, and financial information related to the facilities insured value. However, this information alone may not be adequate to provide a complete picture of the important characteristics of the facility relative to the risk assessment. Issues such as significant architectural and/or structural upgrades or renovations, architectural/structural deterioration, and site infrastructure often need to be observed and reviewed at the site.

In addition, for seismic and wind hazard evaluation, there are critical hazard-specific issues that should be addressed during the site visit. For a seismic evaluation, these issues include site-related conditions such as slope stability and ground surface faulting. For an extreme wind evaluation, areas of potential water inundation, and sources of wind-borne debris are items that are often reviewed during the site visit.

Summary

Performing a seismic or extreme wind risk assessment for a facility requires knowledge not only of the hazard, buildings, and infrastructure at the facility under consideration, but also requires an understanding of how the risk assessment and corresponding loss data will be utilized. Issues relating to probabilistic and deterministic loss, return periods to reviewed, site visits, and other differentiating factors should be discussed and understood by all parties involved prior to commencing an assessment.


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