Estimate of the highest loss an insurer or reinsurer is likely to sustain on a given risk or portfolio, under realistic but not absolutely worst-case adverse conditions.
The Probable Maximum Loss (PML) is an estimate of the highest loss an insurer can sustain on a risk or portfolio, under realistic catastrophic conditions but excluding absolutely extreme scenarios. It differs from the Possible Maximum Loss (PML in its other usage), which corresponds to the worst absolute scenario regardless of probability. PML is used as a sizing metric: it determines the reinsurance capacity to purchase, the catastrophe program attachment point and the reserve requirement. In practice, PML can be defined under two conventions. The probabilistic actuarial convention ties it to a percentile of the loss distribution (for example the 250-year loss, i.e. the 99.6th percentile, the level required by Solvency II). The underwriting technical convention, often called EML (Estimated Maximum Loss), is a deterministic estimate based on engineering scenarios (maximum realistic fire spread, minimum structural resistance). In both cases, PML serves as a common language between insurers and reinsurers when negotiating treaties. An overestimated PML leads to unnecessarily expensive reinsurance purchases; an underestimated PML exposes to uncovered catastrophic losses.
When underwriting a chemical plant in Rotterdam, the underwriter estimates the EML at 60% of the total insured value of 500 million euros, i.e. 300 million, based on an explosion scenario with fire spreading across half the site. This EML determines the facultative reinsurance capacity required: the insurer retains 20 million and places 280 million in fac with five reinsurers.
PML, EML, probable maximum loss, estimated maximum loss, sinistre maximum possible