Stochastic optimization of insurance portfolios for managing exposure to catastrophic risks

A catastrophe may affect different locations and produce losses that are rare and highly correlated in space and time. It may ruin many insurers if their risk exposures are not properly diversified among locations. The multidimensional distribution of claims from different locations depends on decision variables such as the insurer's coverage at different locations, on spatial and temporal characteristics of possible catastrophes and the vulnerability of insured values. As this distribution is analytically intractable, the most promising approach for managing the exposure of insurance portfolios to catastrophic risks requires geographically explicit simulations of catastrophes. The straightforward use of so-called catastrophe modeling runs quickly into an extremely large number of ‘what-if’ evaluations. The aim of this paper is to develop an approach that integrates catastrophe modeling with stochastic optimization techniques to support decision making on coverages of losses, profits, stability, and survival of insurers. We establish connections between ruin probability and the maximization of concave risk functions and we outline numerical experiments.