Introduction to Property Exposure Rating

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 (1984-1988 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: 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

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.

8

Example of PSOLD Size of Loss Curves

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

110.0%

Percent of Losses<=PIV

Per

cent

of I

nsur

ed V

alue

(PIV

)

With Mid-Low TIV(1M-5M) PSOLD-Based Curves

With Mid TIV (5M-10M) PSOLD-Based Curves

With Mid-High TIV(10M-50M)PSOLD-BasedCurvesWith High TIV(50M+) PSOLD-Based Curves

With Low TIV (0-1M) PSOLD-Based Curves

9

PSOLD – Endurance Classes

Light Medium HeavyApartments Restaurants and Bars StorageOther Habitational Other Mercantile Wearing ApparelPublic Buildings Churches Chemical ManufacturingOffices and Banks Schools Metal ManufacturingHospitals and Nursing Homes Recreational Facilities Other ManufacturingBuildings Under Construction Hotels and Motels HPRMotor Vehicle Risks Other Non-ManufacturingFood ManufacturingWood Manufacturing

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)

TIVPolDed

FLSTIVPolLmt

FLS

TIVPolDedtLayPolLmtMin

FLSTIV

PolDedtLayLayLmtPolLmtMinFLS

Exposed

)Re,()Re,(

%

11

Property Exposure Rating Example – Primary Policy

TIV

PolDedFLS

TIV

PolLmtFLS


FLSTIV


Exposed

)Re,()Re,(

%

Ded/SIR TIV Policy Limit Premium

Ground Up Loss

Ratio0 5,000,000 5,000,000 100,000 50%

Layer Limit 1,000,000Layer Retention 1,000,000

Percent of Percent ofInsured Losses

Value (PIV) <= PIV5.0% 46.8%10.0% 59.2%15.0% 66.9%20.0% 72.4%25.0% 76.6%30.0% 80.0%35.0% 82.7%40.0% 84.6%45.0% 86.6%50.0% 88.3%60.0% 91.4%70.0% 93.5%80.0% 94.9%90.0% 96.4%100.0% 100.0%

000,000,50

000,000,5000,000,5

000,000,5000,000,1

000,000,5000,000,2

%

FLSFLS

FLSFLS

Exposed

%2.12

%0%100

%4.72%6.84

%0%100

%0.20%0.40%

FLSFLS

FLSFLSExposed

100,6%50000,100%2.12Pr%2.12 LRemssesExpectedLo

12

Property Exposure Rating Example – Excess Policy

TIV

PolDedFLS

TIV

PolLmtFLS


FLSTIV


Exposed

)Re,()Re,(

%

000,000,5000,500

000,000,5000,000,5

000,000,5000,500,1

000,000,5000,500,2

%

FLSFLS

FLSFLS

Exposed

%4.20

%2.59%100

%0.80%3.88

%10%100

%0.30%0.50%

FLSFLS

FLSFLSExposed

120,6%50000,60%4.20Pr%4.20 LRemssesExpectedLo

Ded/SIR TIV Policy Limit Premium

Ground Up Loss

Ratio500,000 5,000,000 5,000,000 60,000 50%

Layer Limit 1,000,000Layer Retention 1,000,000

Percent of Percent ofInsured Losses

Value (PIV) <= PIV5.0% 46.8%10.0% 59.2%15.0% 66.9%20.0% 72.4%25.0% 76.6%30.0% 80.0%35.0% 82.7%40.0% 84.6%45.0% 86.6%50.0% 88.3%60.0% 91.4%70.0% 93.5%80.0% 94.9%90.0% 96.4%100.0% 100.0%

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

Primary Policy Excess PolicyDeductible 0 500,000

Ground Up Premium 100,000 60,000Expected Loss to 1m xs 1m Layer 6,100 6,120

Burn as a % of Subject Premium 6.1% 10.2%

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

SIR Policy Limit Total TIVTotal Gross

PremiumLoss Ratio

Expected Loss

1,750,000 5,000,000 20,000,000 7,710 50% 1,0311,750,000 5,000,000 20,000,000 7,710 50% 1,0311,750,000 5,000,000 20,000,000 7,710 50% 1,0311,750,000 5,000,000 20,000,000 7,710 50% 1,0311,750,000 5,000,000 20,000,000 7,710 50% 1,0311,750,000 5,000,000 20,000,000 6,729 50% 9001,750,000 5,000,000 20,000,000 6,729 50% 9001,750,000 5,000,000 20,000,000 6,729 50% 900

Total 58,735 7,858

Burn as a % of Premium 13.38%


PremiumLoss Ratio

Expected Loss

0 5,000,000 20,000,000 7,710 50% 626500,000 5,000,000 20,000,000 7,710 50% 561

1,000,000 5,000,000 20,000,000 7,710 50% 7961,500,000 5,000,000 20,000,000 7,710 50% 9392,000,000 5,000,000 20,000,000 7,710 50% 1,2852,500,000 5,000,000 20,000,000 6,729 50% 1,1223,000,000 5,000,000 20,000,000 6,729 50% 1,6823,500,000 5,000,000 20,000,000 6,729 50% 1,682

Total 58,735 8,693



PremiumLoss Ratio

Expected Loss

0 5,000,000 20,000,000 7,710 50% 6260 5,000,000 20,000,000 7,710 50% 6260 5,000,000 20,000,000 7,710 50% 6260 5,000,000 20,000,000 7,710 50% 6260 5,000,000 20,000,000 7,710 50% 6260 5,000,000 20,000,000 6,729 50% 5460 5,000,000 20,000,000 6,729 50% 5460 5,000,000 20,000,000 6,729 50% 546

Total 58,735 4,767


Using Average SIR

Using Actual SIR

Using No SIR

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Subscription Policy - Example

Actual reinsurance layer is 20% of $5m xs $5m.

Losses above $10m are not relevant.

Limit 10,000,000 Insured % 20%

Reinsurance Layer 1m xs 1m

Ground Up Loss Loss to Insured

Loss to Reinsurance

Layer10,000,000 2,000,000 1,000,000

9,500,000 1,900,000 900,000 9,000,000 1,800,000 800,000 8,500,000 1,700,000 700,000 8,000,000 1,600,000 600,000 7,500,000 1,500,000 500,000 7,000,000 1,400,000 400,000 6,500,000 1,300,000 300,000 6,000,000 1,200,000 200,000 5,500,000 1,100,000 100,000 5,000,000 1,000,000 - 4,500,000 900,000 - 4,000,000 800,000 - 3,500,000 700,000 - 3,000,000 600,000 - 2,500,000 500,000 - 2,000,000 400,000 - 1,500,000 300,000 - 1,000,000 200,000 -

500,000 100,000 -

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

1. What models and versions (if any) are being used for ITV analyses?

2. How often is the ITV vendor’s model/cost guide updated?

3. How long does it take the carrier to implement the updates once received from

the vendor?

4. How often has the carrier been making updates, quarterly or annually?

When was the last update?

5. Are policy values based on Reconstruction or New Construction basis?

6. Has the carrier been using vendor’s recommended settings or have custom

factors been applied? Have any changes been made to these factors recently?

7. Who is preparing ITV analyses; agents, engineers, or underwriters?

8. How is ITV analysis integrated into the underwriters’ workflow?

9. On what size buildings do guidelines recommend values be checked?

10. What method is used to update values at renewal?

20

Insurance to Value – Key Questions

11. How far in advance of the renewal date are values updated?

12. What values are used to run the CAT model?

13. Are portfolio values updated before the CAT models are run?

14. What audit procedures have been used to make sure values are kept current

on individual risk or on the portfolio?

15. What projections have been included in CAT analyses for inflation and demand

surge?

16. Are values used for analyses 100% values or 80% /90% values

(co-insurance) or limits exposed?

17. What tools and procedures in place for evaluating contents values?

18. What tools are in place for evaluating business interruption values?

19. How is data quality tied to incentive compensation?

20. 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.

Homeowners Policy Amount 1,000,000 Reinsurance Layer 500k xs 500k

Coverage A Limit

Total Gross Premium Loss Ratio

Expected Loss

Burn as a % of Premium

400,000 2,000 50% 107 5.3%500,000 2,000 50% 183 9.2%600,000 2,000 50% 235 11.8%

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

Reinsurance Layers 10m xs 5m15m xs 15m

1m xs 1m Exposure Rating 3.06%1m xs 1m Experience Rating 2.40%

Relativity 78.4%


Relativity Method 0.85%


Relativity Method 0.21%

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Example - Experience vs Exposure Rating

Large Account

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

0 - 10M 10M - 15M 15M - 20M 20M - 50M 50M - 100M

SelectedExperBurn

SelectedBurn

2006PSOLDIndustry

Middle Market + Regional

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

0 - 5M 5M - 10M 10M - 300M

SelectedExper Burn

SelectedBurn

2006PSOLDIndustry

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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

Documents

Introduction to Property Exposure Rating