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

ARCHITECTURE FOR RESIDENTIAL PROPERTY INSURANCE RATEMAKING 535implies that the key factor table is linear with respect to TVIfor the modeled perils. The hurricane base premium for a given$200,000 house is twice that for an identical $100,000 house.A further discussion of the appropriateness of this assumptionappears in the ISO [12] filing to partition wind base premiums, aspart of their statutory compliance filing of the Florida mitigationclass plan. The note the ISO key premiums are nearly linear forthe wind peril.To some, the assumption may appear to be an unacceptableoversimplification and a weakness of using simulated catastrophelosses in pricing. For a heavily reinsured company, the argumentover whether the key factor table should be driven bythe linearity of modeled loss costs is largely academic. Marketreinsurance costs are increasingly driven by the distributionof modeled losses, and the retailer of insurance must reflect its“wholesale” cost for each risk, as charged by the reinsurer, toavoid economically irrational underwriting.A linear scale of key factors for both hurricane and other windperils is thus reasonable. The key factors vary by policy formonly because the base value insured differs by form. In Florida,one practical effect of the separation of key factors by peril ishigher hurricane rates for high-valued homes. These homes weresignificantly subsidized by application of sub-linear key factorsto indivisible premium, of which a plurality (if not a majority)is typically hurricane premium.Deductible Factors–Non-Modeled PerilsUnlike key factors based on the aggregate loss cost distribution,deductible factors depend solely upon the loss severitydistribution. An excellent review of general deductible pricingtheory appears in Hogg and Klugman [9], and familiarity withthe “loss elimination ratio” (LER) as the kernel of the deductiblerating factor is assumed. This study provides strong evidence thatthe LER profile varies greatly by peril. In addition, one mightexpect that the LERs should vary significantly across many other