WOODWARD, JOSEPH H. "Workmen's Compensation Reserves," Ibid., Vol. I, pp. 112-130.

FLYNN, B. D. "A Method Proposed for the Calculation of Liability and Workmen's Compensation Claim Reserves," Ibid., Vol. I, pp. 131-140.

RUBINOW, I. M. "Liability Loss Reserves," Ibid., Vol. I, pp. 279-290.

FONDILLER, RICHARD. "Office Practice in the Valuation

of Compensation Losses," Ibid., Vol. II, 427-446.

CHAPTER XXII

*NSURANCE OF THE CATASTROPHE HAZARD'

In insurance, as in other forms of business enterprise, an excess of disbursements over income is fatal to success, and security against the consequences of events which abnormally increase disbursements is a matter of primary interest to insurers and to policyholders. The largest and most variable item in the disbursements of an insuring organization is that attributable to "losses," payments on account of the occurrence of events against which insurance has been granted. Premiums, which are supposed to provide resources to meet loss payments, are calculated on the basis of the theory that past losses furnish an approximately accurate guide to the future. Hence an abnormal excess of actual losses over expected might bring about such an increase of disbursements as to lead to embarrassment or insolvency for the insurer and to inadequate protection for the insured.

Any event which causes a loss sufficiently great to embarrass an insuring organization and to endanger the security which it offers to policyholders is known

1

The greater part of this chapter is a reprint of an article by the author on the same subject, which was published in the Annals of the American Academy of Political and Social Science, Vol. LXX, March, 1917.

as a catastrophe. The point at which losses resulting from a single event become sufficiently large to classify the event as a catastrophe varies between insurers; the larger the income account, the larger the loss which can be experienced without serious disturbance. It varies also in the minds of insurance officials; the 'more conservative the management, the lower the point. Wherever the point may be, adequate protection of the policyholder demands that the insurer take measures to secure itself against such catastrophe losses.

Susceptibility to catastrophe varies greatly between different classes of risks and is dependent upon the probability of. a single event causing a serious loss. A single mine accident may cause deaths and injuries which entail abnormally large payments under a compensation law; an equivalent accident could not occur to the widely scattered drivers of a taxicab company. The employees of a factory operated by steam power are subject to an explosion hazard which does not exist in an electrically operated plant.

Further, the catastrophe hazard bears no necessary relation to the average losses on a given class of risks. One class may show a heavy loss experience due to a large number of individual losses, no one of which is unusually serious. In another, losses may occur only occasionally, but each loss may be extremely heavy, approaching or reaching the point which places it in the catastrophe group.

No one form of security against the catastrophe hazard has become standardized, each insurer adopting whichever of the available agencies seems best or

most expedient-its decision resting on considerations of the size and character of its business and its underwriting practices. Three general methods are in active use; refusal to assume risks involving a catastrophe hazard, accumulation of reserve funds from which extraordinary losses may be paid, and shifting catastrophe risks to other insurers through reinsurance.

Limits. The simplest and most obvious method of dealing with the catastrophe hazard is to avoid it altogether by refusing to accept liability for losses beyond a certain amount on a given risk or group of risks. Employer's liability insurance is written with standard limits of $5,000 and $10,000; the $5,000 limit applying to liability for the injury of any one man, and the $10,000 limit applying to liability for injuries arising out of any one accident.2

Examples of this type of practice could be cited from practically every form of insurance. It is the individualistic method of meeting the problem, each insurer assuming whatever risk it can safely carry and leaving the remainder to be placed with other insurers or retained by the policyholder. Its application forces large concentrated interests to seek their insurance from several insurers and increases the complexities attendant on a settlement of loss.

Accumulation of Catastrophe Reserves.—Every insurance organization maintains a surplus from which, if necessary, unusual demands may be met. Even with careful attention to the limitation of risk there is

2 An increase in these limits involves the payment of additional premium, the amount of which is partially determined by the susceptibility of the risk to the catastrophe hazard.

a possibility of unusually heavy losses due to general conditions, and occasionally risks which underwriters have considered as "separate and distinct" may be shown to be connected in an unforeseen manner. Proper management requires a fund which will provide financial reënforcements with which to meet such losses.

Some organizations assume risks which are known to involve a catastrophe hazard on the theory that, while a catastrophe loss may embarrass them if it must be met from a single year's income, they will be able to meet such losses successfully if spread over a term of years. These insurers accumulate a "catastrophe reserve" by setting aside an appropriate amount. Depletion of the reserve to meet extraordinary losses is corrected by new accumulations in following years. The state workmen's compensation funds are required by law to maintain such reserves which, with one exception, are their sole immediate resource for meeting catastrophe losses. For example, in New York ten per cent of the premiums received by the fund is to be set aside until a total of $100,000 is reached, after which five per cent is to be set aside until the fund is large enough to cover the catastrophe hazard.

Reinsurance.-Reinsurance is the latest and most favored method of dealing with the catastrophe hazard. The practice of limiting risks is objectionable to policyholders who prefer to place as much insurance as possible with one company, provided it offers ample security; and also to insurers who desire to offer coverage for large risks and thereby increase the attractiveness of their agency contracts. The practice of re