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

2. Data needed for exposure rating
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

3. Understand the limits Profile
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

4. Property Loss Curves: Lloyds Salzmann (1960 INA Homeowners data)
Reinsurer Curves (Swiss Re, Munich Re, etc)
Ludwig ( Homeowners and Small Commercial data)
ISO’s PSOLD (Recent Commercial data)
ISO’s PSOLD+ (Recent Homeowners data)

5. Property Loss Curves Advantages/(Disadvantages)
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)

6. Property Loss Curves Advantages/(Disadvantages)
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: )
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

7. PSOLD – Endurance Approach
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.

9. PSOLD – Endurance Classes

10. Property Loss to Layer Calculation
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)

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 Policies 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.

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. Insurance to Value (ITV) – Commercial Insurance
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

18. Insurance to Value (ITV) – Homeowners
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

19. Insurance to Value – Key Questions
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?

20. Insurance to Value – Key Questions
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?

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. Advantages of exposure rating
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.

26. Disadvantages of exposure rating
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