Introduction to Property Exposure Rating

1. Introduction to Property Exposure Rating Thomas Cosenza, FCAS, MAAA August 8, 2007

2. To select the severity curve, the hazard characteristics for subject business is needed. Prospective non-cat gross loss and ALAE ratio for subject business Prospective Subject Premium Current limits profile with SIR/attachment point by premium Data needed for exposure rating

3. Business interruption and/or contents included? Policy limit or location limit. Key locations only or all locations Are locations properly valued (ITV) Are there added or excluded coverage’s Are there excess policies/large deductibles, if so need attachment point Subscription policies Gross or net of facultative purchases Homeowners: Coverage A or all coverages Understand the limits Profile

4. 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) Property Loss Curves:

5. 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) (No publicly available documentation) (Does not vary by occupancy class) Property Loss CurvesAdvantages/(Disadvantages)

6. 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 2,000,000 occurrences 4 Perils : BG1(Fire), BG2(Wind), Special(All Other) and All Perils Special Update will be available in September 2007 (Based on ISO data only) (ISO data limited for large accounts) (Mixed exponential curves allow unlimited loss) (Huge number of curves- How well were they fit?) 3 class groups times 60 size of risk bands Additional curves by subclass and state Property Loss CurvesAdvantages/(Disadvantages)

7. Loss-to-value curves based on PSOLD parameters Use 5 size of risk groups(0-1m,1m-5m,5m-10m,10m-50m, 50m +) 3 Classes(Light, Medium, Heavy) Ignore state differences (data not credible) Cap loss at 125% of total limits and 150% of building & content limits. PSOLD – Endurance Approach

9. PSOLD – Endurance Classes

10. Expected Loss to the Layer =(Premium)*(Expected Ground Up Loss Ratio)*(% Exposed) FLS (First Loss Scale) = (Limited Average Severity)/(Unlimited Expected Severity) FLS(X) = LAS(X)/E(X) Property Loss to Layer Calculation

11. Property Exposure Rating Example – Primary Policy

12. Property Exposure Rating Example – Excess Policy

13. Property Exposure Rating Example • As deductibles (attachment point) as a percentage of TIV increase: • Subject premium tends to decrease • The dollar amount of loss to the layer may not change but the burn as a % of subject premium does. • The closer to pro-rata premium will be needed for excess of loss contracts

14. Excess on Excess is extremely difficult to write. Limits and SIR’s/Attachment Points are less stable than a primary book. Experience may be less credible Difficult to calculate underlying rate changes Policy may cover multiple locations with single limit May be difficult to allocate premium by location SIR’s/Attachment Points are extremely important. To properly exposure rate either a 1) policy listing or 2) limits profile matrix showing limit and SIR’s/Attachment Points by premium is needed. Using an Average SIR/Attachment Point may lead to inaccurate calculations. Excess Policies

15. Excess Policies Average SIR vs Actual

16. Subscription Policy - Example • Actual reinsurance layer is 20% of $5m xs $5m. • Losses above $10m are not relevant.

17. Ranges from 20% to 40% Undervalued Reasons: Underwriters are accepting reported values as 10%-20% under as "close-enough" on new business and when they do spot checks at renewal Values may not be updated for years Renewal values are not being kept current. Average inflation in construction has been running close to 10% over the past few years and renewal updates (if any) has not been adequate. Underwriters are only spot-checking and some are not including any ITV analysis in their workflow at all . Blanket limit can allow individual locations to be underinsured Margin Clauses can somewhat mitigate that issue Insurance to Value (ITV) – Commercial Insurance

18. Per MSB 2006 Study 57% of the homes are undervalued by 21% Reasons: Replacement cost coverage on homeowners decreases incentive for policyholders to insure to value Renewals are undervalued Inspections may not be done for years Policy characteristics change every year Remodeling a $233B industry, accounts for 40% of all residential construction and improvements. Households living in their homes more than 2 years accounted for 86% of total remodeling dollars. Mystery Wings, missing 465 sq ft on 7-10% of records Average cost of Kitchen in top 35 Market? $43,213 Average cost of a Room Addition? $27,028 Insurance to Value (ITV) – Homeowners

19. What models and versions (if any) are being used for ITV analyses? How often is the ITV vendor’s model/cost guide updated? How long does it take the carrier to implement the updates once received from the vendor? How often has the carrier been making updates, quarterly or annually?When was the last update? Are policy values based on Reconstruction or New Construction basis? Has the carrier been using vendor’s recommended settings or have custom factors been applied? Have any changes been made to these factors recently? Who is preparing ITV analyses; agents, engineers, or underwriters? How is ITV analysis integrated into the underwriters’ workflow? On what size buildings do guidelines recommend values be checked? What method is used to update values at renewal? Insurance to Value – Key Questions

20. How far in advance of the renewal date are values updated? What values are used to run the CAT model? Are portfolio values updated before the CAT models are run? What audit procedures have been used to make sure values are kept current on individual risk or on the portfolio? What projections have been included in CAT analyses for inflation and demand surge? Are values used for analyses 100% values or 80% /90% values(co-insurance) or limits exposed? What tools and procedures in place for evaluating contents values? What tools are in place for evaluating business interruption values? How is data quality tied to incentive compensation? How close is close enough? Insurance to Value – Key Questions

21. Exposure Rating - Homeowners • Loss curves are based on Coverage A (Buildings) • Coverage A can range from 40% to 60% of total limit on standard policies. For high value homes Coverage A can be a low as 20% due to high contents coverage.

22. Other Issues – Cat Loads • Cat Models(RMS, AIR, EQECAT) can be used determine loss to reinsurance layers. • Per Risk covers are the most difficult to cat model • RMS has issues capping at the occurrence limit • Alternative Method : Exposure rating using the Cat Loss Ratio (Gross CAT Loss/Subject Premium) instead of the Non-Cat Loss Ratio. • Good for a reasonability check • May overstate cat load due to peril specific sub limits.

23. Other Issues – Relativity Approach • Used for higher layers with little or no experience • Lower more credible experience layers are compared to exposure rating the relativity is applied to exposure rating of higher layer • Good check for fit of exposure curve

24. Example - Experience vs Exposure Rating

25. Relatively easy to do Any excess layer can be priced Use of current limits profile enables “up to date” view of excess layer pricing. Shifts in limits and attachment points over time, which may make experience rating difficult, are irrelevant here. Addresses “free cover” issues. “Free cover” exists when the top of your reinsurance layer exceeds the largest trended loss in your data. Advantages of exposure rating

26. Selected severity curve may not properly reflect client’s subject business Selected gross loss and ALAE ratio may not appropriately reflect exposed risks Exposure rating does not consider client’s actual loss experience in excess layers Disadvantages of exposure rating