Which scenario represents a catastrophe that can threaten solvency?

• A. A routine automobile accident
• B. A single property damage claim
• C. A small health claim
• D. A flood causing many simultaneous claims

Answer: (D)

The key idea is that solvency is threatened when losses from an event overwhelm the insurer’s reserves and capital. Catastrophe risk involves events that cause many claims at once, with high severity and correlation across policyholders. A flood that triggers numerous simultaneous claims creates a large, concentrated hit to the insurer’s finances, testing whether reserves and capital are sufficient or whether reinsurance and risk transfer are needed. This kind of event reduces diversification benefits and can push the company toward insolvency if not adequately hedged.

In contrast, a routine automobile accident, a single property damage claim, or a small health claim tends to produce isolated, smaller losses that fall within expected ranges and can be managed with normal reserves and pricing. They don’t create the kind of heavy, correlated loss spike that characterizes a solvency-threatening catastrophe.