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

532 ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKINGKey Factors–Non-Modeled PerilsThe reflection of value insured is probably the single mostimportant rating factor in pricing property insurance. Given itscritical importance, it is one of the most under-represented topicsin the actuarial literature. Background research for this studywas frustrated by little existing guidance on techniques for developingkey factors from experience data for even an indivisiblepremium, and absolutely none on key factor relationships fordistinct perils when rated separately. Most papers on homeownerspricing do not treat the subject at all. Homan [10] providesa clever frequency/severity approach for an all-perils development,but his reliance on industrywide loss cost distributions forthe complement of credibility is not helpful when no analogouscomplement is available by peril. 25 In summary, one is caughtbetween the “rock” of low credibility of experience data by perilwithin small ranges of insured value, and the “hard place” ofno suitable complement of credibility in the form of larger-scalestudies.In response, an approach is developed for AOP and fire perilsbased on accumulations of experience data at successive levelsof value insured. It reflects the value of experience data while facilitatingsmoothing of the indicated loss costs to produce tablesthat square with actuarial theory.Exhibit 12 shows the development for the fire peril. Five calendaryears of experience is segregated by $5,000 ranges of (coverageA only) TVI. First, the average classical all-perils key factorfor the midpoint of the range is shown for reference, alongwith the earned house-years and paid fire losses (with D&CC).Second, the exposure and losses for all TVI ranges up to andincluding the current range is accumulated, and the cumulativeloss cost calculated.25 Homan also includes a treatment of fixed expenses, which is not necessary when anexplicit expense fee is charged–as it is in the fair premium structure developed here.