PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

A MODERN ARCHITECTURE FOR RESIDENTIALPROPERTY INSURANCE RATEMAKINGJOHN W. ROLLINSAbstractThis paper argues that obsolete rating architectureis a cause of decades of documented poor financial performanceof residential property insurance products. Improvingrating efficiency and equity through modernizationof rating and statistical plans is critical to the continuedviability of the products. In particular:² The overall rate level should reflect an appropriateprovision for the cost of capital held for catastrophicevents, and the cost of capital should be allocatedappropriately in development of rating factors.² The indivisible premium concept should be replacedwith peril-based rating, and rating factors developedor adjusted to apply to peril-specific partial baserates.² Catastrophe simulation and geographic coding technology,incorporating non-historical experimentaldata sets, should be applied to the development of baserates, territory boundaries and factors, and classificationplans.² Rating for the numerous miscellaneous exposures andcoverage options, as well as maintenance of statisticalplans, should be aligned with the peril rating concept.The author develops an architecture and techniquesfor ratemaking that satisfy the above precepts for thehomeowners product in a hurricane-prone state. Thetransition from indivisible to divisible base premiumfacilitated by this architecture is illustrated in casestudy fashion, with practical implementation challengesand solutions discussed. Many ideas are transferable to486