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

504 ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKINGpany to which differentiation of other rating factorsaccording to modeled losses was not important. Ithas the advantage of not requiring detailed cat modeloutput.2. Loading of simulated expected direct cat losses in placeof actual cat losses in the numerator of the experienceratio, and adjustment of those losses for a cost of capitalcharge calculated directly from assumptions, with notie to the empirical market-determined cost of capital.This method might be required for an entity that has nobenchmarks, such as an insurer that funds catastrophessolely from internal capital, a residual market, or a ratingadvisory organization.3. A blended method, where the loss portion of simulatedcatastrophe costs is reflected directly in the experienceratio, and the cost of capital portion is treated as a fixedexpense reflecting the market charge indicated by thenon-loss portion of reinsurance costs. This is the methodused here, so that f R =( + T)=P.Homan [11] uses the first approach in his treatment of reinsurancecosts in property ratemaking, and Rollins [17] has contrastedthe relative strengths and weaknesses of the three approaches.Already included in formula (2) are the total direct expectedcat losses by removing actual cat losses and adding modeledgross annual losses to each year’s experience ratio. A provisionfor non-loss reinsurance costs in formula (1), in order to providefor all costs associated with risk transfer, should consist of thereinsurance premium, less expected ceded cat losses, as a ratioto direct premium, orf R = P R ¡ (Ĉ ¡ R(Ĉ)) : (4)P