1. Catastrophe Modeling Personal Lines Perspective
Jodi Healy Ratemaking Seminar March 28, 2003

2. Outline
Background
ASOP #38
Pricing
Capital Management

3. Background
Use of catastrophe models provides credible, scientific loss estimates based on the simulation of thousands of potential scenarios.
Hurricane and earthquake catastrophe models are commonly used and widely accepted.
Florida Hurricane Commission
California Earthquake Authority
Rating Agencies
Most State Departments of Insurance

4. Background Terminology
AAL = Average Annual Loss or long-term average loss; typically used in pricing.
PML = Probable Maximum Loss or the estimate of a catastrophic loss that will be met or exceeded a given percentage of the time; typically used in capital management.

5. ASOP #38
Provides guidance in using models and states that actuaries should:
Determine appropriate reliance on experts
Have a basic understanding of the model
Evaluate whether the model is appropriate for the intended application
Determine that appropriate validation has occurred
Determine the appropriate use of the model

6. Pricing Overall rate indication typically includes:
Modeled AAL for hurricane and/or earthquake
Less any applicable reinsurance recoverables
Plus cost of reinsurance

7. Pricing – Overall Indication
Indicated State Rate Change =
Non-Cat Loss Ratio + Cat Loss Ratio + Fixed Expense Ratio - 1
Variable Permissible Loss Ratio
Cat Loss Ratio =
Average Annual Loss – Reinsurance Recoveries + Reinsurance Premium
Premium at Present Rates
Notes: Loss ratios include loss adjustment expenses Cat loss ratio may include non-modeled losses if state has exposure to non-modeled perils.

8. Pricing – Considerations
Reinsurance Allocation
Recoveries can be calculated by applying reinsurance program directly to modeled losses.
Reinsurance premium can be allocated using recoveries as a base.
Allocate premium by layer if at all possible.

9. Pricing – Considerations
Exposure bases
Exposure bases for modeled loss data, reinsurance recoveries and reinsurance premium may not be consistent; they should be trended to a common exposure date.
Total Insured Value is a good estimate of exposure covered in contract and can be used to adjust data to appropriate base.

10. Pricing – Other Applications
Territory Relativities
Deductible Relativities
Wind/Hail or Hurricane
Earthquake
Wind/Hail Ceding Credits
Wind/Hail Ceding Assessments
Risk loads

11. Capital Management
Modeling is used to estimate size of PML.

12. Capital Management Scenario 1 Scenario 2
Modeling is used extensively to structure reinsurance contracts.
2,000
Layer 90%
Layer 75%
1,500
Layer 75%
Layer 75%
1,000
Layer 50%
Layer 75%
500
0.0
Scenario 1
Scenario 2
Net PML / Surplus = ?
Net PML / Premium = ?
Reinstatement Needed?

13. Capital Management
Modeling is used to estimate cost and efficiency of reinsurance contracts.
Cost of risk load = Estimated Premium – Expected Recoveries

14. Capital Management
Modeling is used to monitor growth in PML.

15. Capital Management Modeling results used to assess PML impact of:
Increasing amounts of insurance
Ceding to windpools
Adding new policies
Changing deductibles

16. Summary
Catastrophe models are an integral component of personal lines pricing and capital management.
They are widely accepted and used within the industry.
ASOP #38 provides guidance to actuaries using models.