Homeowners Indications – Getting It Right

1. Homeowners Indications –Getting It Right Mark Homan CAS Ratemaking Seminar March 7-8, 2002

2. Key Issue – Cat Loads • Ex-cat losses are the largest component • Expenses are the next largest • Catastrophe Losses may be the smallest component • Cat Losses represent the largest source of volatility and uncertainty in HO rates

3. Determining the Cat Load • Traditional Method was Excess Wind • Historical period was insufficient for determining expected hurricane loads • Hurricane loss models produce the best answer available for future losses • Not all regulators will approve filings using models • Alternative: utilize cat load in reinsurance

4. Pragmatic Approach • Models give best answer available • Loading reinsurance costs is a practical alternative providing reasonable indications • Many states specifically allow for the explicit reflection of reinsurance costs

5. Transactional Cost Approach • Add reinsurer’s expenses and profit to expense load • Explicit approach; likely to increase regulatory scrutiny • Simplest approach • Capable of reflecting all costs • Difficult (impossible?) to determine expense and profit

6. Net Loss plus Reinsurance Approach • Adjust losses for recoveries; add reinsurance premium as expense • Still an explicit approach • Avoids need to determine reinsurer expense and profit • Requires adjustments to historical losses • More accurate loss provision for larger events

7. Current Situation Expected Recoveries Reinsurance Threshold • Historical Loss Provision

8. Net Loss plus Reinsurance Reinsurance Costs Expected Recoveries Removed Reinsurance Threshold • Historical Loss Provision

9. Basic Steps • Allocate Reinsurance Premium to States • Adjust Historical Losses to Net of Recoveries • Split Reinsurance Premium by Form • Breakdown Reinsurance Expense into Fixed/Variable Portions • Develop Indication

10. Risk Load • Additional Margin to cover volatility in results • Viewed in various ways: • Extra return to cover higher risk • Buffer to absorb uncertainty • Additional profit to assure positive return • Due to volatility, risk load is present in catastrophe reinsurance

11. Allocating Premium to States

12. Adjusting the Excess Wind Load

13. Excess Wind (cont.)

14. 50 Year (& greater) Event

15. Final Excess Wind Factor

16. Splitting Premium to Form

17. Splitting to Form (cont.)

18. Expense Breakdown

19. Expense Breakdown

20. Territorial Indications • Issue - Allocation of Reinsurance Premium to Territory • Alternative Approaches • Reinsurer Supplied Information • Judgemental • Damage Rate Indices • Modelled Losses

21. Loss Adjustments • As in statewide indication, historical territorial losses are adjusted to net • Excess wind factor is applied • Can also be adjusted to reflect individual territorial expectations • Load in reinsurance costs • Develop territorial rate index to allocate statewide rate change

22. Territorial Example - State A

23. Remaining Issues • Not a perfect method; still have areas to investigate • Volatility of reinsurance costs - is smoothing needed? 3 year average? • Allocating reinsurance costs by other rating variables beyond territory • Adjusting for loss factors not reflected in models, etc.

24. Conclusion • Net Loss plus Reinsurance is recommended approach where models are not accepted • Provides reflection of loss costs and risk load as contained in reinsurance premium • Still may need use of models to determine gross loss provision

25. Speaker Contact Information Mark Homan AVP & Actuary, Personal Lines Pricing The Hartford Hartford Plaza, T-1-55 Hartford, CT 06115 Phone: 860/547-2015 Fax: 860/547-2013 E-mail: mhoman@thehartford.com