1. Advanced Property Ratemaking Sean Devlin CARe Meeting June 6-7, 2005

2. 2 GE Insurance Solutions June 6-7, 2005 Agenda  Audience Pre-requisites  Pro Rata/ELR determination  Primary “Price”  Experience Rating  Exposure Rating  Weighting of Methods  Conversion of Loss Cost to Pricing  Summary and Questions

3. 3 GE Insurance Solutions June 6-7, 2005 What Do I Assume You Know? Basic Property Insurance/Reinsurance Knowledge  TIV and its components  Primary ratemaking for property (CAS Exams)  Coverage forms  Routine reinsurance contract terms Cat modeling basics  The vendor models  See my other presentation for further information Yes, a shameless plug  Use multiple models for each account Basic exposure and experience rating  Steve will “deep dive” into exposure rating

4. 4 GE Insurance Solutions June 6-7, 2005 ELR Determination Foundation of Exposure Rating Which ELR to use?  Must match your curve in exposure rating  Preference: Eliminate cat as much as possible  Options for ELR: Full LR No cat whatsoever Exclude certain cats Methodology  Equivalent to primary ratemaking, except  Need for factors to back out certain cats to match exposure curve, if the match isn’t already made

5. 5 GE Insurance Solutions June 6-7, 2005 Pro Rata Ratemaking Determining your ELR Breakout components  Basic LR – very stable small, non-cat events  Risk LR – losses subject to a per risk Layer Breakout into layers, like per risk rating Appropriate blend of experience & exposure  Small Cat LR(s) – experience rate vs. model  Modeled Cats Why breakout?  Inuring reinsurance or contract features  Understand the drivers of the ELR  Appropriate targets for quoting business

6. 6 GE Insurance Solutions June 6-7, 2005 Pro Rata Ratemaking Determining your Target Loss Ratio

7. 7 GE Insurance Solutions June 6-7, 2005 Pro Rata Ratemaking (Cont’d) Cat Losses Hurricane losses (RMS WS)  Earthquake  Fire Following  Winterstorm  Wildfire  Extratropical wind  Terrorism  Other – what could happen? Further details – see my other presentation Shameless plug #2

8. 8 GE Insurance Solutions June 6-7, 2005 Pro Rata Ratemaking (Cont’d) Trend Parameters Cost of contracting labor Size of homes increasing Deductible impacts on frequency and severity Data – shifts in and out of E&S market Excess business Non-standard classes Demand surge

9. 9 GE Insurance Solutions June 6-7, 2005 Pro Rata Ratemaking (Cont’d) Final Rating Determine loss distribution – convolute or simulate  Lognormal – for parts  Large loss component - optional  Cat should be different distribution use vendor output “curve” for other cat losses Apply contract terms – READ THE SLIP This is very important for various reasons:  Loss sensitive features  Caps on per risk/per occurrence  Knowing your upside vs. downside  Some ROE/RORAC models depend on this

10. 10 GE Insurance Solutions June 6-7, 2005 Pro Rata Ratemaking (Cont’d) Special Considerations Pro Rata on XS  Consider effect of leveraged trends  Effect estimated by applying loss distribution  Distribution can be actual data or approximate  Losses develop slower  Rate change is difficult to monitor  More cyclical than other lines Parameters applied on subject business, not all  Important for surplus – typically not split out  Know what business is in the price monitoring Watch for shifts in segments  Split up in homogenous groups to remove bias

11. 11 GE Insurance Solutions June 6-7, 2005 Note on Primary “Price” Price Monitoring Reports Typically created to measure price lift circa 2000 Know what is (isn’t) captured  Filed rate changes  Schedule modification factors  Experience modification factors  SIR/Limit  Terms and conditions  New business Test for bias  Trend or shift in adjusted loss ratios  Discuss with client changes  More important for high capacity eaters

12. 12 GE Insurance Solutions June 6-7, 2005 Note on Primary “Price” Effect of missing uncaptured price Typically underestimated the magnitude of change Softening Cycle:  Underestimating decreased rates  Underestimating reserves  Calendar year results lag true results  Delays recognition of results  Softening prolonged– damage is slowly realized Hardening Cycle:  Underestimating increased rates  Overestimating reserves  Calendar year results lag true results  Delays recognition of results  Hardening prolonged– success is slowly realized

13. 13 GE Insurance Solutions June 6-7, 2005 Primary “Price” (cont’d)

14. 14 GE Insurance Solutions June 6-7, 2005 Primary “Price” (cont’d) “Uncaptured Rate” change

15. 15 GE Insurance Solutions June 6-7, 2005 Primary “Price” (cont’d) Calendar Year results understated during soft market Actual peak of soft market Should be hardening here

16. 16 GE Insurance Solutions June 6-7, 2005 Experience Rating Premium Side Same as pro rata, mostly Splitting up business into exposed and not exposed In split business, parameters may be different Exiting class? Reflect all premium affected if excl. Loss Side Capping at policy limits – TIV and loss both trend Losses should be on same basis as exposure rating Reflective of per risk definition – READ the slip Two methods to calculate burning cost  Empirical - weighted  Fit distribution Split quoted layers into sub layers to add credibility

17. 17 GE Insurance Solutions June 6-7, 2005 Exposure Rating (cont’d) General Considerations ELR must reflect the data underlying loss curve What curve to use  PSOLD – becoming a standard  Lloyd’s curve Reversals exist A premium calculator for facultative  Ludwig curves – outdated  Other company curves – basis unknown  Understanding of the data and assumptions is key Understand the basis for companies profiles

18. 18 GE Insurance Solutions June 6-7, 2005 Exposure Rating (cont’d) What is in the companies profile? Limits – don’t assume, ask if unsure  Business interruption and/or contents included?  Policy limit  Location limit  PML  MFL  Key location  Limits or values for layered business  ITV issues Other coverages Excess policies Subscription business

19. 19 GE Insurance Solutions June 6-7, 2005 Exposure Rating (cont’d) What is in the companies profile (cont’d)? Any perils excluded? Homeowners  Form (HO-2,3,4,5,6)  Coverage A only or all coverages Farmowners  Multiple diverse buildings on a farm  One TIV Smell test for reasonability, especially:  Order of magnitude of some TIV  Premium allocation

20. 20 GE Insurance Solutions June 6-7, 2005 Exposure Rating (cont’d) PSOLD Data from 1992-2002 Can separate business by  Occupancy – 22 groups, diff. strongest btw. Manufacturing Non-manufacturing HPR Little differences between groups  State – not a big driver  Include/Exclude Cats >$100M industry loss  Include/Exclude WTC  Include/Exclude Business Interruption Based on 1.8M occurrences, after scrubbing

21. 21 GE Insurance Solutions June 6-7, 2005 Exposure Rating (cont’d) Issues With PSOLD Not all segments represented evenly by PSOLD Loss history is thin for some groups Losses above $5M in the database are thin  # of losses > $5M is  # of losses > $10M is Refer to a list of large industry losses for more input Blanket policies small amount of database US business only – applicable abroad?  HO – US homes are built out of “cardboard”  Factory in US similar to one in UK?  Main street business in US same as France?

22. 22 GE Insurance Solutions June 6-7, 2005 Exposure Rating (cont’d) Don’t Trust the Black Box Check the output for reasonability Contract Match:  Definition of risk One Building (possibly less) Multiple Buildings at one location Entire Policy Company has sole determination  Exposure profiles  Loss curve  Dual trigger contracts – cat and risk combined  Scope of coverage READ THE SLIP

23. 23 GE Insurance Solutions June 6-7, 2005 Weighting of Methods General Considerations Actual vs. Expected counts to layer (significant) Actual – Needs to be adjusted for volume Severity differences – may need to subdivide layer Make sure that both methods reflect the same risk No loss = no weight to experience? Not necessarily Deficiencies in exposure data or curves Past experience indicative of future Do not be afraid of splitting quoted layer into parts

24. 24 GE Insurance Solutions June 6-7, 2005 Conversion to Pricing General Considerations Create loss distribution – even if “not needed” Adjust for treaty features – AAD, swing rate, etc. Understand upside and downside of deal “Unpriced” capacity – blown limit, cat on tail of curve Is the rate on line appropriate “Red Zone” catastrophe utilization Treaty correlation to book  Layered/Subscription business  Catastrophes Soft Factors Check yourself for naive capital – cheap cat cover

25. 25 GE Insurance Solutions June 6-7, 2005 Key Takeaways Understand the data inputs Understand your models and parameters Understand strength and weakness of the models Proper match to treaty terms – READ THE SLIP Reflect true primary price Rate for everything Include the untested exposure Work with your underwriter Question everything – Assume nothing at face value THINK - Don’t Just Go Through The Motions