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

ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKING 529of fixed reinsurance costs be reduced as well? If so, should itbe reduced in proportion to the mean or should the reduction betempered? Recall that formula (12) assumes that fixed reinsurancecosts are proportional to the standard deviation of modeledlosses. Even if one believes this assumption is valid at the individualrisk level, it is entirely possible that a reduction in meanlosses could decrease S L less than proportionally, or even increaseit. Alternatively, other seemingly intuitive assumptions–for example,that the coefficient of variation of modeled losses wouldremain constant when a mitigation regime were applied–wouldlead to a fully proportional reduction in fixed reinsurance costs(and therefore class factors that are identical to the raw loss costrelativities).Under the assumption that non-loss reinsurance costs are truly“fixed” even in the presence of mitigation, the class factors maybe derived from the loss cost relativities using formula (10),where ® is the relative loss cost, X is the permissible loss ratiofrom Exhibit 1, and F R is the fixed reinsurance cost ratio fromthe same exhibit. For example, a loss cost reduction of 20% fora device, along with a permissible loss ratio of 65% and a fixedreinsurance cost ratio of 10% would lead to a class factor of(1 ¡ 20%) £ 65% + 10%½ = = :827:65% + 10%In addition to the key issue of reductions in fixed reinsurancecosts, the public domain studies have been silent on severalimportant issues for ratemaking:² Should this mitigation class plan apply to losses from otherwind (non-hurricane storms containing tornadoes, hail, and severestraight-line wind)? If not this plan, what about a modifiedalternative? Other wind causes of loss were not considered.² Should this mitigation class plan apply equally to owners,renters, and condominium policy forms? It stands to reasonthat the factors should be modified when contents coverage is