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

ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKING 523Territory Factors–Modeled PerilsExhibit 9 presents one method of determining hurricane territoryrating factors that incorporate an allocation of fixed reinsurancecosts. Most actuarial techniques for the development ofrating factors use only the mean loss cost to modify the baserate. This method uses the modeled mean loss costs by territoryto modify the loss portion of the base rate, and the standard deviationof these loss costs to modify the fixed reinsurance costportion of the base rate.Recalling formula (7), F R denotes the fixed (non-loss) reinsuranceexpense dollars per policy. The bulk of non-loss reinsurancecosts reflect some measure of risk as perceived by the reinsurer.Many risk metrics (as functions of the possible loss outcomes ona portfolio of policies) exist, and it is beyond the scope of this paperto capture the essence of the (considerable) actuarial debateover the best metric for reinsurance premium development. Theassumption used here is simple and squares with observations ofthe global reinsurance market:whereF R = K £ S L (12)S L = the standard deviation of the modeled annual losses–readily available by location or in geographical aggregate fromthe cat model;K = an empirical scale factor that relates the volatility in modeledlosses to the actual non-loss ceded reinsurance premium.In other words, assume that reinsurers charge for cost of capitalin proportion to the standard deviation of annual losses. Whilereinsurance pricing models tend to be proprietary, there is longstandingsupport in both actuarial literature [8] and market practiceto brand this assumption reasonable.We choose the scale K i identically for each territory so that theexposure-weighted F R by territory, based on S L , balances to the