Average annual loss (AAL)
The expected annual loss of a portfolio from a given peril, read from a catastrophe model's output: the foundation of the technical price of a risk whose large losses have almost never been observed.
Average annual loss is the expected loss a portfolio suffers in one year from a given peril, as a catastrophe model computes it by averaging the losses simulated over tens of thousands of fictitious years. It answers a question a portfolio's own history cannot: what a risk costs on average when its major losses occur once a century and have therefore almost never been observed during the insured period. It forms the catastrophe part of the pure premium, to which the underwriter then adds a load for volatility, the cost of the capital tied up and expenses. Its weakness is that it flattens the shape of the distribution: two portfolios with the same average annual loss can have very different tails, one losing a little every year, the other nothing for ninety-nine years and then a great deal in the hundredth. That is why it is always read alongside the exceedance curves and a measure of dispersion.
Hypothetical case: a homeowners portfolio is simulated over 10,000 years. The simulated losses add up to 42 billion euros, an average annual loss of 4.2 million. On the same simulation, the 200-year return period loss is 180 million, more than forty times the average: it is that gap, not the average, that drives the capital.
AAL, average annual loss, expected annual loss
Follow the research
One letter a week. First, the week's underwriting note, when one is published: a dated, argued decision, signed by Paul Bernardski. Then what the observatory published on cyber risk, political risk and insurance. No account, no tracking.
No spam, one-click unsubscribe, no data ever sold.