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

494 ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKINGmodels to replace historical cat losses. In addition, several authorshave tackled aspects of the problem of incorporating simulatedcat losses into the overall rate level and rating factor calculations,notably Walters and Morin [18] and Burger et al. [3]. 4A few features of cat models 5 are particularly relevant and areexploited in populating the new rating architecture:1. They are peril-specific–one model may be used for hurricanes,another for severe thunderstorms (including tornadoand hailstorm), and yet another for earthquake analysis.It is thus natural to segregate covered perils forratemaking in such a way that the cat model can be usedto build the rates for each peril separately and adequately.2. Cat models are fundamentally exposure rating tools–loss costs can be generated from any set of relevant data,whether actual or experimental. Scenarios can be contrivedand tested to develop rating factors, reducing theneed for complex normalizations of experience data.3. Some vendors offer models that output the complete empiricaldistribution of event losses. From this, annuallosses are easily aggregated. Therefore, in addition to expectedlosses, we can generate moments, percentiles, andmore sophisticated risk metrics for any modeled property(whether real or experimental) or aggregation thereof.These metrics are critical in deriving proxies for cost ofcapital and allocating risky expected losses to class andterritory.4 The reader unfamiliar with cat models should thoroughly peruse these references, asneither their descriptions of the design and operation of cat models nor their justificationsfor the use of modeled losses in ratemaking are repeated here. However, the treatmentof base rate and rating factor development here is generally consistent with previousliterature and often builds upon concepts formalized by these authors.5 All simulated cat losses used in this paper were derived from the CLASIC/2 catastrophemodels for Atlantic Hurricane and U.S. Severe Thunderstorm (“other wind”),products of AIR Worldwide Corp.