Catastrophe Risk Modeling and ApplicationRisk Assessment for Taiwan Residential Earthquake Insurance Pool

Wen-Ko Hsu 1, Dung-Mou Hung 1, , W.L. Chiang 1, C.P. Tseng 1,, C.H. Tsai 2
1

Department of Civil Engineering, National Central University, Chung-li, Taiwan 320, R.O.C.
Department of Information Management, Taiwan Hospitality & Tourism College, Hualien, Taiwan, R.O.C.
3
Department of Logistics Management, Shu-Te University, 59 Hun Shan Rd., Yen Chau, Kaohsiung, Taiwan 82445, R.O.C.
2

Corresponding author: s1342001@cc.ncu.edu.tw

risk sharing entities (including itself). If losses occur,

TREIP collects the appropriate funds from the risk
sharing entities and reimburses the direct insurers for their
payments to the policyholders. This paper established the
event-based earthquake loss model to analysis the TREIP
insurance scheme to find out the loss exceeding
probability curve, both the annual aggregate loss and
standard deviation of loss for each layer. Based on the
analysis result, we can provide the TREIP how to modify
the insurance scheme. The framework of catastrophe
model can be described by figure1. It would be introduced
how the primary components work in the following
sections.

ABSTRACT
Taiwan lies at earthquake-prone area. More than 200
sensible earthquakes occurred every year in Taiwan.
Average annual loss due to 83 disastrous earthquakes
since 1900 is about NT$19 billion dollars which equals to
0.7% GDP. Therefore, the Taiwan Residential Earthquake
Insurance Pool (TREIP) was created by the Taiwan
Ministry of Finance (MOF) to facilitate a risk sharing
mechanism between private insurance companies and the
Government covering insured residential earthquake
losses.
In this paper, we have built up an event-based
seismic hazard assessment and financial analysis model
for earthquake disasters. As we know, low occurrence rate,
tremendous loss and high uncertainty are characteristics
of earthquake disasters. For the above issues, the model
we built integrates knowledge from many fields including
earth science, seismology, geology, risk management,
structural engineering, the insurance profession, financial
engineering and facility management. The model use the
Monte Carlo simulation technology can construct an
annual exceeding probability curve, which relates
probability to size of loss, the specific event loss and
allows for the evaluation of different insurance and
reinsurance programs

Stochastic Earthquake
Event Generator

Hazard Analysis Procedure

Vulnerability Analysis
Procedure

KEY WORDS
Earthquake, Risk assessment, Insurance, MonteCarlo simulation

5.00%
4.50%

Event Loss / Total Sum Insured %

4.00%

1. Introduction

Financial Analysis

3.50%
3.00%
2.50%
OEP-20050930
2.00%

Procedure

1.50%
1.00%
0.50%
0.00%
0

100

200

300

400

500

600

700

800

900

1000

Return Period (yr)

Figure1 Framework of Earthquake Loss Model

Earthquake risk, a long-time concern in Taiwan, is

increasingly being recognized as a concern in insurance
industry and government. The Taiwan Residential
Earthquake Insurance Pool (TREIP) was created by at
April, 2002 the Taiwan Ministry of Finance (MOF) to
facilitate a risk sharing partnership between private
insurance companies and the Government covering
insured residential earthquake losses. TREIP collects
premium for the earthquake risk from the insurance
companies and redistributes the premium to the various

2. Catastrophe model for earthquake risk

There are four primary components within
earthquake loss assessment and management model. 1.
Stochastic earthquake event generator, which uses a
collection of relevant inventory and analysis parameters
for the development of seismic damage assessment and
loss estimation. 2. Hazard analysis procedure, can assess
the intensity of ground shaking, maximum surface
1

such as year built, number of stories, and seismic code

zones. Based on the seismic resistance of buildings,
vulnerability analysis procedure can assess the probability
of each damage state to structure and content.
Spectral Acceleration

acceleration with the attenuation function in Taiwan and

soil condition. 3. Vulnerability analysis procedure, can
calculate the probability of different damage state to
structural and content. 4. Financial analysis procedure,
can assess loss include the direct and indirect economic
losses. It also can provide the loss exceeding probability
curve and dynamic financial analysis result.

2.1 Stochastic Earthquake Event Generator

An representative earthquake event set is important
to an eventbased earthquake model .For this reason, we
collect the historical distribution of the epicenters of
earthquakes in Taiwan during 1900 to 2004 from the
Taiwan Central Weather Bureau. It includes 43 seismic
zones, 21 shallow seismic sources, 7 deep seismic sources,
and 15 subduction zone seismic sources [1]. There are
also 42 active faults in the event generator [2]. The rate of
occurrence of different magnitude events is estimated
based on a Gutenberg-Richter [3] frequency-magnitude
relationship. The earthquake occurrence rate is modeled
by the Poisson model. There are 17,710 hypothetical
earthquake events distributed across all sources in the
generator and each event includes the parameters which
the other analysis procedure need such as location, depth,
magnitude, directionetc.

Demand Spectrum
(Sa,Sd)

Capacity Curve

P(DdsSd)

Spectral Displacement

Spectral Displacement

Probability

Sd

0.6
0.5
0.4
0.3
0.2

2.2 Hazard Analysis Procedure

0.1
0

To asses the intensity of ground shaking for each

simulated earthquake event is the purpose of the hazard
analysis procedure. As described in the following diagram,
we can calculate the Peak Ground Acceleration (PGA) for
the location of the building.
In analysis procedure, all crustal sources use the
attenuation developed by Loh [4] while the subduction
sources use Young et al.[5]. For the site effect, we also
consider soil classifications are rock, weak rock / dense
soil, stiff soil, and soft soil. Soil map inferred from the
analysis of records of Free-field Strong-Motion Stations
of Taiwan Central Weather Bureau and Geologic Map
from Taiwan Central Geological Survey, MOEA .
Geotechnical data is derived from geologic maps
published by the Taiwan Ministry of Economic Affairs at
1:50,000 and 1:250,000 resolutions.

Damage State

Figure 2 Assessment for the probability of each damage

state

2.4 Financial Analysis Procedure

Before the beginning of the financial analysis, we
must build the event loss table by the procedures we
described above. As the described the following diagram,
we can create the event loss table in the form include
event id, annual mean rate and mean loss for each event.
Portfolio
Stochastic Earthquake
Event Generator

2.3 Vulnerability Analysis Procedure

Event Table

According to the result of the hazard analysis

procedure, we can obtain the capacity curve of building.
Then, using the response spectral method described in the
right diagram, a specific group of (Sd, Sa) can be
determined. Finally, we can get the probability of each
damage state of building. To Calculates the mean damage
ratio and coefficient of variation to buildings, contents,
and the resulting loss of use, the earthquake loss model
includes four major elements: construction classes;
occupancy classes; additional building classifications

18,852
hypothetical
earthquake
events

Hazard
Analysis Procedure

Vulnerability
Analysis Procedure

Magnitude
& Hypocenter

ID

Annual Mean Rate

Loss$

CV

#0001

0.010

0.65 Billion

2.00

#0002

0.002

#0003

Figure 3 Building the event loss table

2

Policy conditions
Deductible, Limit

The direct and indirect economic losses caused by

the simulated earthquakes can be estimated using the
financial analysis procedure. Damage to assets is
converted to monetary losses by ratio of repair/rebuilt cost.
However, depending on the terms of the policy, the loss is
shared by more than one party. This part of the modeling
reflects the workings of a policy or treaty; it is included as
an integral part of the overall modeling approach because
of the intimate interaction between the insurance structure
and damage to the physical buildings or assets.
After the event loss table was created, we can use the
Monte Carlo simulation to establish aggregate or
occurrence loss exceeding probability curve. First, we use
the Poisson distribution to describe the earthquake
occurrence times. According to the occurrence rate of
each event, we can get the occurrence times N in every
simulation and simulate the accumulative probability of
severity distribution randomly. Therefore, we can
generate the loss exceeding probability curve like the
following diagram.

Second, this approach utilizes advances in computer

technology and modeling techniques to provide almost
instantaneous feedback to decision makers, allowing for
the evaluation of numerous operating alternatives.
The specific innovations to the planning process that
are incorporated in DFA modeling are:
1.
DFA provides a probability distribution of likely
outcomes, rather than a single expected value
forecast.
2.
DFA incorporates the correlations among lines of
business, between loss reserve adequacy and rate
adequacy, and between the investment and
underwriting sides of insurance operations.
3.
By utilizing the technology of personal computers
and common software, DFA models can be run by
the users many times with different assumptions
and different parameters, in order to see the effect
that changes in the model or in operations can have
on the results.
Investment
Generator

Event Loss Table

Interest(CIR)
Generator

Catastrophe
Generator

Severity distribution

Occurrence Rate

Proba bility

Underwriting
Generator

100%

0%

Simulate M times
Simulate Occurrence ?
(Poisson Model ) N times

Investment
Cash Flow

Loss $

Underwriting
Cash Flow

Simulate Loss ?
L1, L2, ., LN

Occurrence N times
AEPk = L1+ L2 + . + LN
OEPk= Max (L1, L2, ., LN)

Balance sheet Provider

Figure 5 Framework of Dynamic Financial Analysis

AEP1, AEP2,, AEPM
OEP1, OEP2,, OEPM

2.5 Example of TREIP Analysis

Figure 4 Flowchart for building the loss exceeding

probability curve

TREIP have 1,383,731 policies until September 31,

2005. The aggregate liabilities are NT$ 1.8 trillions and
takeup rate are 18.19%. TREIP collects premium for the
earthquake risk from the insurance companies and
redistributes the premium to the various risk sharing
entities (including itself). If losses occur, TREIP collects
the appropriate funds from the risk sharing entities and
reimburses the direct insurers for their payments to the
policyholders. The insurance scheme includes six layers is
like the figure 6. TREIP has four tiers totally NT$50
billion as its capacity. The coinsurance in Taiwan retain
the first NT$ 2 Billions. Second layer is foundation layer.
TREIP commissions the Central Re to be an administrator
for the management of funds from the government to the
private insurance and ultimately to policyholders. The
third layer is reinsurance layer and the third layer had a
Cat Bond for the first US$ 100 million. The government
then provides additional resources of NT$ 10 billion in
excess of NT$ 40 billion. The scheme sets a cap limit of

After the losses for all locations in a portfolio are

calculated, the financial analysis procedure allocates the
losses to different participants, i.e., insured, insurer, and
re-insurer through various insurance and treaty structures.
Because there are many sources of uncertainty in
modeling
(from
attenuation,
vulnerability
and
incompleteness of data), the loss at the location level is
treated as a random variable.
In financial analysis procedure, we also create
dynamic financial analysis model (DFA).It represents an
enhanced approach to the traditional planning function. It
provides a far more effective tool for forecasting future
financial and operating conditions of a risk manager than
prior methods for two primary reasons. First, the
interactions between the underwriting and investment
sides of the insurance business are formally integrated.
3

NT$50 billion. In the event that losses exceed the capped

amount, the losses paid to policyholders will be scaled
down.
Government

4th Tier

2nd Layer Reinsurance

20% Domestic

80% overseas

3rd Tier

1st Tier

10 billion

10 billion

50

Government

40

Second layer
reinsurance
First layer
reinsurance

US$ 100 million

Cat Bond

Taiwan Residential
Earthquake Insurance Fund

18 billion

Domestic Insurers Coinsurance

0.36%

276.0

10

0.46%

214.7

30

10

0.59%

168.9

23.2

6.8

0.72%

137.7

Cat Bond

20

3.2

0.81%

123.0

Found

18

4.33%

22.6

Coinsurance

1.
2.
3.

4.
5.

4.50%

6.

Event Loss / Total Sum Insured %

4.00%

7.

3.50%
3.00%

8.

2.50%
OEP-20050930

2.00%
1.50%
1.00%
0.50%
0.00%
200

300

400

500

600

700

800

900

The TREIP premium and expense flow diagram

shows how the policy premium is collected from the
insured and ultimately received by TREIP and how
expenses are distributed.
According to the figure 8 and our assumptions, the
surplus of foundation layer can be simulated by using
Dynamic Financial Analysis (DFA) model of the
economic analysis procedure. The assumptions details are
as followed:

5.00%

100

Return
Period
(year)

2 billion

Figure 6 The TREIP insurance scheme

For each policy, we can obtain the zip-code level
location and characteristics of building such as building
type, building height and built year. The premium for
each policy are NT$1459. Otherwise, the claim of TREIP
policy will be paid in an amount equal to the policy limit
(NT$1.2 millions) if the building is no longer habitable or
the damage ratio exceeds 50%. In addition, a further
NT$180,000 of reimbursement is provided per household
for Contingent Living Expenses. So we need to have a
threshold trigger in the vulnerability analysis procedure.
With the parameters described above and TREIP
portfolio, we can use the earthquake loss assessment and
management model to simulate the loss exceeding
probability curve and penetration probabilities for each
layer like the charts below. In figure 7,it shows that the
loss ratio is about 3.75% based on 500 year return period.
It means that it will occur once event of the loss ratio are
greater than 3.75% in 500 year. In Table 1, it shows the
current scheme can grantee the event loss in 276.0 years
return period.

Attachment
Penetration
Layer Amount
Point
Probability
(NT$ Billion)
(NT$ Billion)
(%)

Layer

6.6 billion

1st Layer Reinsurance

2nd Tier

Table 1 Exhaustion probabilities in different layer

1000

Return Period (yr)

Figure 7 Loss exceeding probability curve

Premium rate will not change as the result of a

earthquake event.
8.0 percent of policy premium is paid to the primary
insurers as commission.
17.5 percent of policy premium (20 percent of 85
percent net premium) is paid to the primary insurers
as compensation for retaining the first claims layer.
2.5 percent of policy premium is paid to CRC to
cover administration expenses.
2.5 percent of policy premium is paid to Foundation
to cover the claims for the second claims layer.
2.5 percent of policy premium is allocated to cover
fluctuating reinsurance costs in the future.
The interest of Cat Bond is 4.5% of the capacity.
The issue cost are NT$ 67 million.
TREIP is a tax-exempt entity.

Direct Insurers

2.5% percent
(8.0 % commissions + 17.5
premium to manage
% premium to cover
insurance exposure)
2.5 %
CRC
premium
(TREIP asset
manager)

100 % premium

100 %
premium

4.5%
Capacit
y

An event-based probabilistic seismic risk assessment

model was established for TREIP. Based on the request of
TREIP, the risk assessment analysis results were provided
to TREIP as reference for capacity adjustment,
reinsurance arrangement, exercise plan of claim process.
To TREIP portfolio, current insurance scheme only
can grantee the event loss occurs once in 276.0 years
return period. TREIP should increase the earthquake
protection capacity, but it also means the cost of insurance
will increase. It can design several schemes and use the
model we built to see how much the cost increase. Finally,
the optimal solution will balance between the earthquake
protection capacity and cost of insurance.
In this paper, Poisson model was used to simulate the
occurrence rate of the stochastic earthquake event. As we
know, Poisson model is a time-independent model.
Nevertheless, the behaviour which earthquake event
occurs is time-dependent in fact. In the future, we should
have a further research.
The model of optimal reinsurance and retention
arrangement strategy for TREIP is under development
based on the results of the risk assessment model.

Reserve for
fluctuating
reinsurance costs

Cat Bond
(3.4bnX20bn)

Policyholders

1.8%
Capacity

Reinsurance
Layer I
(6.6bnX23.4bn)

1.4%
Capacity

Reinsurance
Layer II
(10bnX30bn)

Government
(10bnX40bn)

Surplus
of
premium

Acknowledgements
These materials are provided by Taiwan Residential
Earthquake Insurance Pool.

Foundation
(18bnX2bn)

Figure 8 TREIP Premiums and Expense Flow Diagram

References

After 100,000 times simulation, we can obtain the

net cash flow of the foundation layer like the chart below.
100%

2005

90%

2006

[1] Lin B. S, Lee C.T., Cheng C .T ,Strong GroundMotion Attenuation Relationship for
Subduction Zone Earthquakes in Taiwan, 9th Conf. on
Geophysical Society, China, 2002, 24-31.
[2] An introduction to active faults in Taiwan.( Taiwan
Central Geological Survey, MOEA, 2000)
[3] Gutenberg, B., Richter, C. F., Frequency of
Earthquake in California, Bull. Seism. Soc. Amer. 1991,
Vol. 34, p185~188.
[4] Loh, C.H. Z.K. Lee etc. Ground Motion
Characteristics of the Chi-Chi earthquake of September
21, 1999,Journal of Earthquake Engineering and
Structural Dynamics , 2000,p 876-897.
[5] Young , Subduction Slabs in Taiwan Region, Jour.
Geol. China, 40, 1997 , 653-670.

2007

80%

2008

70%

2009

60%

2010
2011

50%

2012

40%

2013

30%

2014

20%
10%
0%
-5

10

15

20
(NT$ bn)

Figure 9 Probability of Adjusted Cash Flow in each

projection year.

3. Conclusion
Because of the concern for uncertainty and
engineering model, the earthquake loss assessment model
can provide more information than the traditional method.
For example, the loss exceeding probability curve can
offer the policymaker to determine the earthquake
protection capacity according to their tolerance of risk.
On the other hand, the traditional method only can give us
the single value for the possible maximum loss due to
earthquake disaster.
5