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

ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKING 507² Rating factors by peril, which adjust each base rate for riskclass and territory differences in expected costs;² A single policy expense fee (to cover all fixed underwritingexpenses other than reinsurance).Recall the classic formula for policy-level fair premium, expandedto separate non-loss reinsurance costs from other expensesnot varying with direct premium:P = X + F + F R + vP (5)where P represents fair premium dollars, X is the expected losscost, F represents the fixed underwriting expense dollars associatedwith the policy, and F R represents the associated fixedreinsurance cost dollars. Given the choice to structure our ratingplan so that the fair premium is collected via a combination ofbase rate (B) and expense fee (E):P = B + E (6)solving for P in formula (5) and setting it equal to (6) yields:X + F R1 ¡ v + F1 ¡ v = B + EThis formula suggests a natural decomposition, designating baserates to cover losses and fixed reinsurance costs, and expense feeto cover only fixed underwriting expenses, so that:B = X + F R(7)1 ¡ vE =F1 ¡ v : (8)In developing base rates for non-modeled perils, X is determineddirectly from experience data. For modeled perils, it isdetermined from the model output. Later, a choice will be madeand justified to recover all fixed reinsurance costs in the base ratefor the hurricane peril. F R is determined from the reinsurancedata described above. Finally, recovery of all fixed underwriting