Property Ratemaking - an Advanced Approach Exposure Rating

June 6-7, 2005 Property Ratemaking - an Advanced ApproachExposure Rating Steve White, FCAS MAAA, Guy Carpenter

Property Exposure RatingTypes of Exposure Rating Curves Section 1

Property Loss CurvesHistory • Lloyds • Salzmann (1960 INA Homeowners data) • Reinsurer Curves (Swiss Re, Munich Re, etc) • Ludwig (1984-1988 Homeowners and Small Commercial data) • ISO’s PSOLD (Recent Commercial data) • ISO’s PSOLD+ (Recent Homeowners data) • MBBEFD (Astin paper by Stephan Bernegger)

Property Loss CurvesAdvantages/(Disadvantages) • Lloyds Curves • (Very old data) • (Does not vary by amount of insurance or occupancy class) • (Underlying data is largely unknown (marine losses? WWII Fires?)) • Salzmann (Personal Property) • Based on actual Homeowners data • Varies by Construction/Protection Class • (Very old data – from 1960) • (Does not vary by amount of insurance) • (Building losses only and Fire losses only) • (Salzmann recommends not using them, only meant as an example) • Reinsurer Curves (Swiss Re, Munich, Skandia, etc) • Documented study (some curves) on personal & commercial reinsurance business • (Old data) • (Does not vary by amount of insurance or occupancy class)

Property Loss CurvesAdvantages/Disadvantages • Ludwig Curves (Personal and Commercial) • Based on actual Homeowners and Commercial data, (but uses Hartford small commercial property book – may not be good for large national accts) • Varies by Construction/Protection Class for HO and Occupancy Class for Commercial • Includes all property coverages and perils • (Old data: 1984 - 1988) • ISO’s PSOLD • Recent Data – updated every 2 years • Varies by amount of insurance, occupancy class, state, coverage, and peril • Continuous Distribution (no need for Interpolation) • (Based on ISO data only)

Property Loss CurvesAdvantages/Disadvantages • ISO’s PSOLD+ • First Update to Homeowners Property since Ludwig study • Varies by amount of insurance, policy form, state, and construction • Continuous Distribution (no need for Interpolation) • (Based on ISO data only, New untested outside of ISO) • MBBEFD • Loss Distribution from Physics • Found to be useful for Property Loss Distributions • Continuous Distribution (no need for Interpolation) • (Relatively unknown in the US)

Property Exposure RatingFirst Loss Scale Methodology (“FLS”) Section 2

First Loss ScalesA Quick Review of FLSs The FLS is also non-decreasing (non-negative 1st derivative), similar to ILF The FLS is also non-decreasing at a decreasing rate (non-positive 2nd derivative) E(X), the unlimited average severity of X

First Loss ScalesCalculations - Detailed Policy Limits

Using First Loss ScalesOther Issues/Observations • Curves do not vary by Insured Value • Need to match peril and type of policy • Interpolation between points on the common first loss scales

Property Exposure RatingWorking with PSOLD Section 3

PSOLDCalculations wi varies by: 2 - Coverage (B+C, B+C+I)(B only, C only dropped in 2004) 4 - Peril (BG1, BG2, Special Causes, All) 22 - Occupancy Class 60 - Amount of Insurance (AOI) 2 - Net of Deductible vs Ground Up 50 – State Deductible Distributions

PSOLD MethodologyInterpreting a single policy LAS in an AOI Ranges in PSOLD Alternate PSOLD • Is the movement from one AOI range to the next a step Function or a smooth progression? • Consider three policies, two within a single AOI range and the third in the next highest AOI range but close in value to the second policy • Should two different policy limits within a single AOI range have the same LAS or should the difference in policy limits be reflected? • PSOLD currently calculates the LAS at a single point, the minimum of the loss limit and 1.5x(upper bound of the AOI range) for all policies in the range.

PSOLD MethodologyPSOLD LAS Calculations over Single AOI Range (“Dtl”) LAS for an Mixed Exponential For Coverages B, C and B+C PSOLD constrains the LAS Calculation PSOLD has two Ranges of Interest

PSOLD MethodologyAlternate LAS Calculations over a Continuous AOI Range (“Grp”) Calculating the LAS over a continuous range adds one more degree of complexity Which simplifies to

PSOLD MethodologyAdvantages of the Alternate LAS Calculations • Different policy limits within the same AOI range will get different LAS • Smoother transition as you move from one AOI range to the next • Since this impacts the unlimited average severity for the policy, it will change the allocation of losses to the layer for any exposed policy • An additional enhancement would be to adjust the wi’s as you move within an AOI range

PSOLD MethodologyWeighting between AOI Ranges • If a range of Insured values spans more than one AOI Range. You need to combine the results of the Individual AOI ranges • In PSOLD any AOI group included within the range will be given full weight • An improvement would be to only Include an AOI range in proportion To the percentage that the range is Covered • This was fixed in the 2004 ISO PSOLD Software

PSOLD MethodologyWeighting between Occupancy Classes In PSOLD, when using more than one Occupancy class on a single policy group, the relative weight assigned to each occupancy class is based on the occupancy counts in the underlying industry data base. An improvement would be to allow the user to define the weights between the occupancy classes so that you can more accurately reflect the individual ceding companies exposure

PSOLD MethodologyAdditional Exposure Percentage PSOLD uses the following additional exposure percentage • Building Only – 50% (no longer produced in PSOLD 2004) • Contents Only – 50% (no longer produced in PSOLD 2004) • Building+Contents Only – 50% • Building+Contents+Business Interruption – Unlimited You may want to select a different percentage due to any of the following • Stacking of Excess Policies – you do not want the policies to overlap • Margin Clause – contractually limits exposure greater than the limit • Company Experience • Judgment

PSOLD MethodologyStacking and Participation Additional consideration when dealing with stacking an participation • The selected AOI group should be based on a full value on the insured risk (same AOI group as if the risk was fully covered by a single policy • All stacked policies should have the same AOI group • When stacking, assume additional coverage % is zero or the policies will overlap

PSOLD+ MethodologyNew Homeowners Curves Available Shortly • Newest update of Homeowners Curves since Ludwig • Curves vary by • Insured Value (values don’t go as high as the commercial curves) • State (excludes TX) • Policy Form (Homeowners, Condo, both) • Construction (Brick, Frame, both) • (Does not include Protection Class)

PSOLDOther Issues/Observations • Limited Credibility for very Large Insured Values • TIV Scale Produced by PSOLD • Gross Limited Average Severities “consistent” across AOI ranges by Net of Deductible curves are not • Due to different mixture of deductibles

Stacking and Participation Section 4

Stacking and ParticipationParticipation • Participation allows you to correctly model the situation where a contract only covers a proportional share of the underlying loss. • It is most common in a subscription type market like Lloyds, but it is also useful for modeling some facultative business. Example • Assume the following: • Write 25% participation on a $1M Contract. • You reinsure a 200K xs 200K layer • In order to get a loss that will expose the Reinsurance Cover • You must have a loss to the primary contract greater than 800K (200K / 25%) • The largest loss you can have exposing the layer is 250K (25% of 1M) or 50K to the layer • Actually, you would take 25% of losses ceded to an 800K xs 800K reinsurance layer. But since the primary policy is $1M, it is effectively 25% of 200k xs 800k.

Individual Contracts Stacking and ParticipationStacking Stacked Contracts Stacking is where an insurer issues multiple excess contracts covering the same underlying risk • Assume someone writes a series of policies covering the same risk, 100K x 100K (Yellow), 300K x 200K (Blue), 500K x 500K (Red) and 1M x 1M (Green) • If all are written at the same level of participation then effectively it is the same as a single 1.9M xs 100K (Purple) policy with the given participation • In practice, not all contracts are at the same participation and not all contract are written (can be thought of as participation=0%, this is sometimes called ventilation)

Stacking and ParticipationStacking Reinsurance Layer Now Assume there is a 500K x 500K reinsurance contract covering these contracts • If the contracts are assumed to be independent, then you would only cover the 500K x 500K layer on the 1M x 1M policy. No other policy would expose. • If the contracts are assumed to be stacked, then you would cover the 500K x 500K layer on the 1.9M x 100K policy. • There can be significantly greater exposure to the Reinsurance Contract under the stacked assumption

Stacking and ParticipationStacking Stacking is Generally thought of as an International Issue, but… • Stacking can be used in the Facultative Markets • Stacking can be used to model Umbrella written over a company’s own underlying policies • Stacking is commonly used in combination with participation in a subscription market like Lloyds

Stacking and ParticipationPartial Participation without Stacking 25% Share 50% Share 100% Share

Stacking and ParticipationPartial Participation with Stacking • Assume someone writes a series of policies covering the same risk, 100K x 100K (Yellow), 300K x 200K (Blue), 500K x 500K (Red) and 1M x 1M (Green). • Your participation on each is: 100K xs 100K (100%), 300K xs 200K (100%), 500K xs 500K (50%), 1M xs 1M (25%) • These policies are stacked • You reinsure a 500K xs 500K layer • In order to get a loss that will expose the Reinsurance Cover • You must have a loss to the excess contracts greater than 600K (100K / 100% + 300K / 100% + 100K / 50%) • The largest loss you can have exposing the layer is 900K (100K * 100% + 300K * 100% + 500K * 50% + 1M * 25%) or 400K to the layer 25% Share (250k) 50% Share (150k) 50% Share (100k) 100% Share (300k) 100% Share (100k)

MBBEFD Section 5

MBBEFD Curves • Contains the Maxwell-Boltzmann, Bose-Einstein, Fermi-Dirac distributions. • Curves used in Physics but found to be useful for Property Severity curves • 1999 ASTIN Paper by Stephan Bernegger of Swiss Re • Two parameter distribution. In Paper a single parameter version is presented where both parameters are defined as function of a new parameter c. Many of the Swiss Re Y scales are reasonably approximated using values for c. • Fits many of the common first loss scales reasonably well

MBBEFD Curves The FLS(x) for the MBBEFD curve type where x is the Limit/TIV is as follows: When b=0 or g=1 ProRata When b=1 and g>1 When bg=1 and g>1 else (b>0 and b<>1 and bg <> 1 and g>1)

Property Ratemaking - an Advanced Approach Exposure Rating