What Is a Catastrophe Hazard?

A catastrophe hazard is a technical term for a high risk of loss from a particularly destructive event—such as a hurricane, flood, or a terrorist attack—for a large group of individuals or families with an insurance policy.

For insurers, catastrophe hazards represent a particularly large risk because of the overwhelming number of claims that may be filed at the same time in the aftermath of a highly destructive event.

Key Takeaways

A catastrophe hazard is a technical term for a high risk of loss from a particularly destructive event—such as a hurricane, flood, or a terrorist attack—for a large group of individuals or families with an insurance policy.

In the aftermath of a highly destructive event, an overwhelming number of claims may be filed at the same time; this presents a high level of risk for an insurance company.

Insurance companies that provide catastrophic coverage must also carry a catastrophe reserve to ensure they actually have the funds to cover a true catastrophe.

How a Catastrophe Hazard Works

Insurance companies that provide catastrophic coverage must also carry a catastrophe reserve to ensure they actually have the funds to cover a true catastrophe.

What qualifies as a catastrophe hazard can be difficult for an insurance company to pinpoint and define precisely. Thus, to protect themselves against catastrophe hazard, some insurers do not provide coverage against catastrophes. To prevent having a large-scale loss due to something like a natural disaster, many insurance companies will build language into their normal clauses that excludes coverage arising from a catastrophic event. In cases of losses due to natural hazards, which are unavoidable losses in the natural world, some insurance companies refer to those types of hazards as an act of God (a term used for its historical reference rather than conveying a true religious leaning by the company).

In cases where insurance will not protect against catastrophes, people who want insurance against acts of nature, war, or terror must purchase separate catastrophe insurance policies.

Example of a Catastrophe Hazard

There are several reasons why insuring against a catastrophe hazard can be very risky for an insurance company: The financial impact of fulfilling the claims that result from a catastrophic event could be higher than the funds available or the timeline needed to fulfill the claims to repair that damage may be impossible based on the nature of a catastrophe.

For example, Hurricane Harvey, which hit Texas in 2017, was an unforeseen catastrophic event that caught many people and insurance companies off-guard. Without catastrophe coverage, many people may not have had everything they needed to replace covered by insurance.

An area that is hit by a catastrophe that arises from nature may also have a long-lasting impact on potential insurance for residents in the future. For instance, if an area was not considered high-risk for a natural disaster—such as a tornado or hurricane—is hit by a natural disaster, insurance companies may reclassify that area as a high-risk area with a catastrophe hazard. Assigning a high catastrophe hazard to residents who have already been through a natural disaster may make insurance rates higher or raise the premiums for existing insurance policies.