2004 CAS RATEMAKING SEMINAR

1. 2004 CAS RATEMAKING SEMINAR INCORPORATING CATASTROPHE MODELS IN PROPERTY RATEMAKING (PL - 4) PRICING EARTHQUAKE INSURANCE DAVE BORDER, FCAS, MAAA

2. PRICING EARTHQUAKE INSURANCE Overview • Earthquake Ratemaking • Earthquake Modeling • Uses of Earthquake Models • Whose Fault is it?

3. EARTHQUAKE RATEMAKING • Earthquake insurance is typically a separate optional coverage • Wide usage of deductibles • Fire Following exposure • Great variation of pricing • Territorial • Construction

4. EARTHQUAKE MODELINGComparison with Hurricane • Separate coverage vs. package coverage • Historical data – Future reliability • Frequency estimates – Landfall vs. Fault Rupture • Damage estimation – Advances in both areas

5. EARTHQUAKE MODELINGAdvantages • Many years of seismological data • Many good sources of geological and seismological data • Paleoseismology – Science of identifying and dating past earthquakes by geological studies • Damageability information by construction type • Current distribution of insured exposure to risk

6. EARTHQUAKE MODELINGAlphabet Soup • Many sources of historical information • USGS – United States Geological Service • CDMG – California Division of Mines and Geology • SSA – Seismological Society of America • EERI – Earthquake Engineering Research Institute • AGU – American Geophysical Union • SCEC – Southern California Earthquake Center

7. MODELING BASICS • Simulate location and magnitude of earthquake • Gutenberg-Richter Magnitude • Modified Mercalli Intensity (MMI) • Estimate components of earthquake • Estimate event intensity • Damage estimation

8. EARTHQUAKE MODEL • For each simulated earthquake: • Establishes probability of occurrence • Establishes focal depth and rupture length • Determines shaking intensity and liquefaction • Determines damageability ratios • Calculates expected damageability ratios at a location for all simulated events • Distance from rupture • Soil conditions

9. REVIEW OF MODEL • Consistent with guidelines in ASOP 38 (Using Models Outside the Actuary’s Area of Expertise) • Level of geographic detail available to run the model • Is current book of business representative of future book?

10. MODEL OUTPUT • Very similar to hurricane output • Average Annual Losses and Mean Damageability Ratios (MDR’s) by: • Zip code or portion of zip code in a territory • Building / contents / ALE coverage • Construction type • Occupancy type

11. ADDITIONAL CONSIDERATIONS • Aftershocks • Debris Removal • Demand Surge • Loss Adjustment Expense • More internal damage • Additional adjusters needed

12. USES OF EARTHQUAKE MODEL • Determination of earthquake rates • Territorial determination • Deductible pricing • Manage catastrophe exposure • Underwriting criteria • Deductible usage • Reinsurance usage • Damage estimation following an event

13. TERRITORIAL CONSIDERATIONS • Known fault lines • Blind-thrust faults • Cascading faults • Seismic zones with estimated frequency

14. TERRITORIAL RATEMAKING • Model – AAL’s and MDR’s based on percentage deductible • Select Deductible requirement • Price alternative deductibles as appropriate • Group zip codes into territories • Cluster based on MDR’s • Reasonability check based on known fault configuration • Different loss costs by construction type

15. EARTHQUAKE RATEMAKING • Convert loss costs into rate • Incorporate provision for expenses • Agent commission • Other variable and fixed expenses • Profit provision • Great variability of results • Determine overall indicated change

16. SPECIAL CONSIDERATIONS • State facility established (CEA) • Losses impacting primary policy caused by earthquake • Fire Following • Sprinkler Damage

17. FIRE FOLLOWING EARTHQUAKE • Fire Following losses are typically covered under primary policy • Must provide modeler with full set of exposure data • Broader exposure set than Earthquake policies • Damage ratio should be incorporated into package rate • Replace actual fire following losses • Low significance in most areas

18. WHOSE FAULT IS IT? • Arguments exist regarding variation of rupture intensity • Smoothing provides good estimate, or • Each fault has a single rupture point • Return time consideration in annual pricing • Price to the average, or • Consider time since last occurrence

19. RETURN TIME ARGUMENTS • Increasing time since last event decreases time until next occurrence • Increasing time since last event increases time until next occurrence • Appropriate to use average annual loss

20. ADDITIONAL REFERENCES • Pricing the Earthquake Insurance Using Modeling • Debra Werland and Joseph Pitts • 1997 Winter Forum • U.S. Earthquake Frequency Estimation – Ratemaking for Unusual Events • Stuart Mathewson • 1999 Winter Forum