Ever since “fire” rating bureaus were first
developed in the U.S. in the mid-1800s, the rating of
property/casualty insurance has relied heavily on the use of “historical”
loss experience.
The past served as the principal guide to the
future. Companies sought to drive forward by looking in the
rear-view mirror.
Hurricane Andrew starkly revealed that past loss
experience could be wholly inadequate to project future loss
exposure, and the industry has been working ever since to develop
better methods for determining the true extent of exposure.
Some of the fruits of those efforts are evident
in changes in AAIS manuals now being filed or prepared for filing.
AAIS is revising its manuals to introduce two
important new features:
These enhancements, which are being implemented
countrywide in AAIS property lines, were first introduced with a
filing of revised rating information for the earthquake peril in
Kentucky. Earthquake information has since been filed in other
states, and similar filings are scheduled for the terrorism and
hurricane perils.
The enhanced rating information incorporates
data provided by the three major U.S. catastrophe modeling firms:
EQECAT, Oakland, Calif.; RMS, Newark, Calif.; and AIR Worldwide,
Boston, Mass.
The “cat” modeling firms draw upon diverse
sources of data on weather, geography, soil conditions, humidity,
and other factors not traditionally used in insurance to develop
prospective loss costs.
“Catastrophe modeling and other innovations
bring a lot of information from outside the industry into the rating
process,” said Paul Baiocchi, AAIS president, in a recent address
before a Chicago area chapter of the CPCU Society. “More and more
you are going to see external data used in the process of selecting
and pricing risks.”
In years past, a company’s competitive
position depended on the volume of data available to it, Baiocchi
told the group.
That’s less true today, he said, noting that
“with the accuracy and availability of the new types of external
data, any player nimble enough and smart enough can get a
competitive advantage.”
Among other things, catastrophe modeling data
has allowed AAIS to add or refine earthquake rating criteria, such
as building height and year of construction.
AAIS is also using catastrophe modeling data to
revise its terrorism rating information. While AAIS’s surcharges
for terrorism coverage are currently expressed as a percentage of
premium, the new terrorism rating information for some lines of
insurance will be expressed as loss costs.
Rating information will be introduced for acts
of domestic terrorism, and rating territories will be introduced for
terrorism in some states, particularly those with large urban areas.
Modeling firms are also contributing information
for a series of rating variables to be used in the development of
AAIS hurricane rating information in coastal states. Territories
will be redefined and rating information within territories modified
to reflect the enhanced rating information.
“Except for enhancements to the earthquake and
terrorism rating procedures, there will be no change to AAIS rating
methods due to the use of catastrophe modeling,” says Kimberley
Ward, AAIS chief actuary. “For most lines, the new catastrophe
data will be built into the loss costs.
“Catastrophe modeling substitutes very
credible information for historical rating information that is based
on infrequent events whose severity is very volatile and uncertain,”
she says. “The incorporation of modeled loss costs is a big value
added benefit for our members.”
There is a widespread movement within the
property/casualty industry to redefine territories by ZIP Codes,
rather than political subdivisions (cities, counties, etc.). This
arises because many companies are using “geocoding” applications
to refine their underwriting and rating of risks.
Geocoding applications draw on a variety of
external sources of geographic data to establish the location of a
property in relation to coastlines, fault lines, flood plains, and
other geographic features related to property/casualty risk.
Much of this information is based on ZIP Codes,
so the definition of territories on the basis of ZIP Codes makes it
easier to import and utilize data from different sources.
Given that, it is now easier to define and
revise rating territories for more precise risk pricing.
For example, in the Kentucky earthquake filing,
AAIS was able to increase the number of earthquake zones from three
to six in personal lines, and from four to six in commercial lines.
Also, the use of ZIP-Code based territories
should help
reduce the number of errors made in rating
accounts. In many regions, ZIP Codes provide a more precise
geographic location
than a county or
municipality.
The U.S. Postal Service (USPS) makes changes in
a large percentage of its ZIP Codes each year. To address that, AAIS
plans to update its territories periodically to include new or
modified ZIP Codes in its territorial definitions.
Most ZIP Code modifications will result in no
change to the loss cost rating information for a specific location.
However, each change reported by the USPS will be examined to
determine if persons or property in a ZIP Code would experience a
territorial assignment change as a result of a ZIP Code change.
As AAIS provides ZIP Code-based territories and
updated catastrophe loss costs, it continues to convert its rating
information from tables of pre-calculated loss costs to a factor
rating format.
Factor rating has already been implemented in
the AAIS Homeowners, Mobile-Homeowners, and Farmowners programs.
Factor rating is currently being developed for the AAIS
Businessowners Program.
“The general idea behind factor rating is that
there is a published base loss cost that is modified by a series of
factors to determine the final loss costs for a particular risk,”
Ward says.
Companies can easily incorporate the
enhancements to AAIS’s rating information into their own systems,
as rating
factors, ZIP Code-based territories, and rating
relativities will be available on AAISdirect in Microsoft Excel
format.
“The downloadable data files provide important
value to
The Evolution in Rating 
