After years of preparation, the future has arrived in homeowners insurance rating.
Over the past decade, users of the AAIS Homeowners Program have seen several refinements to its rating plan. These include separate wind-peril rating in hurricane-prone states, new rating factors for policyholder tenure and claims history, a new earthquake rating plan that incorporates modeled data and rating factors, plus more.
As this article goes to press, several AAIS member companies are testing AAIS’s latest rating innovation: a new by-peril, multivariate rating plan for homeowners insurance.
In essence, by-peril rating allows carriers to rate each risk according to the unique combination and magnitude of hazards affecting it. In place of rating tiers and zones that apply an average loss cost to various risks in a category, by-peril rating provides more specificity, or “granularity.”
In developing the new plan, AAIS actuarial staff has used multivariate analysis to determine, among scores of potential rating variables, which ones are truly predictive of loss, which are uncorrelated with loss, and which ones duplicate the effect of other variables, and should not be double-counted.
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One could say that the by-peril rating plan developed for the AAIS Homeowners Program essentially provides two tiers of rating factors.
Using geographic, demographic, and other types of data, plus traditional insurance premium and loss data, AAIS has expanded the number of rating territories, or zones, for most perils in each state, beyond what appeared in previous rating plans.
For the most part, these territories are delimited by groupings of ZIP Codes.
To illustrate--and to demonstrate the value of by-peril rating--the chart below compares hurricane catastrophe loss costs in the 14 hurricane zones identified in a sample state.
Readers can see a large spread here between inland territories, where the hurricane catastrophe loss costs are only a few dollars, to coastal territories, where the loss costs reach more than $300.
That’s not the end of it, however. In those territories where a peril is deemed to have a “significant” impact on overall loss costs, “sub-zones” have been developed to reflect variations in loss costs within the territories. The sub-zones may be defined by individual ZIP Codes in a larger ZIP Code-delimited territory, or by census blocks.
To illustrate, the chart below shows the variation in hurricane catastrophe loss costs among ZIP Codes in hurricane catastrophe rating territory 3.
While the overall loss cost for the territory is $110, applying the sub-zone factors would have the effect of reducing the loss cost in one ZIP Code to around $75 and increasing it in another to more than $200, thus making for more precise pricing for a significant peril in a particular region of a state.
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When the new AAIS rating plan is filed countrywide this summer, it will be the first by-peril rating plan made available to property/casualty insurers as a standardized program.
The plan will be available to any insurer under a separate affiliation with AAIS. AAIS Homeowners affiliates will continue to receive a traditional consolidated rating plan for the line.
“The future is here,” says Paul Baiocchi, AAIS president and CEO. “With the new
by-peril multivariate rating plan, companies using our program will be able to compete effectively with carriers already using highly refine rating plans.
“The use of peril-specific pricing, along with unbundled analysis of rating variables derived from insurance statistical data and other risk-related data, will give a company greater rating accuracy, better classification of risks, a better competitive position, and improved profitability,” he says. “It will reduce their risk of being adversely selected against.”
“The new homeowners rating plan is the culmination of our strategic vision and planning,” Baiocchi adds. “It leverages our extensive body of statistical data, plus other types of data, and it applies catastrophe modeling and state-of-the-art analytical tools to produce a smart plan.”
Three AAIS initiatives in recent years were particularly important in creating the capability for multivariate by-peril rating:
- The licensing of catastrophe modeling software from EQECAT, one of the world’s leading catastrophe modeling firms;
- The acquisition of geographic, demographic, weather, crime, and other data to supplement AAIS’s database of traditional insurance premium and loss data; and
- The licensing of the “Pretium” statistical software from Towers Watson, a leading international actuarial firm.
In a presentation at the recent AAIS Main Event executive conference, Deborah Summerlin, vice president of insurance lines, explained that the new plan rates homeowners policies on the basis of 10 causes of loss (five catastrophe perils, four non-catastrophe perils, and liability and medical payments).
“The rating algorithm for each peril will be uniform, making the rating plan easy to automate,” Summerlin said.
“While the structure of the plan will be the same in every state, we will be looking at the exposure to loss in each state,” she added. “For example, in California, we may trade out the hurricane peril for brush fire.”
Summerlin noted that the plan will include several “placeholders” (factors of 1.0) where companies would be able to introduce rating factors of their own. Companies will also have an option to reduce the number of rating factors. “The adaptability of the rating plan allows a company to tighten or loosen internal constraints when applying the plan to renewal business or targeting a market,” she said.
To identify and refine rating factors for each of the 10 causes of loss, AAIS actuaries analyzed more than 100 different geographic, demographic, weather, and crime variables to evaluate and select those that have a significant correlation to loss.
“An important part of the value we add is to sort through an extensive body of data to determine what is significant and what is not,” Baiocchi says.
Several “interesting findings” emerged from this analysis, he says:
- Age of home rating credits should vary by peril, rather than be applied as a single credit to the entire policy premium. Thus, by-peril age of home credits are available under the new AAIS by-peril rating plan.
- Some factors correlate to both increased and decreased risk of loss, depending on the peril considered. The number of families in a dwelling, for example, would call for a surcharge under certain perils, a credit under others.
- Amount of insurance relativities also vary by peril. “Even the loss cost for the liability and med pay causes of loss will be subject to adjustment by an amount of insurance relativity factor that reflects the dwelling limit,” Summerlin explained in her presentation.
The new plan also features many deductible options, with losses caused by wind or hail always subject to a percentage deductible ranging from 0.1% to 25%, a range developed to address disparities between seacoast and inland locations.
The flat deductible options for the non-wind causes of loss range from $100 to $25,000 per occurrence; the corresponding rating factors vary by the amount of insurance.
AAIS recognizes that the implementation of by-peril rating involves a range of strategic and operational issues, and that not all companies are prepared to adopt it at once; hence, the continued availability of a consolidated rating plan.
“Introduction of a refined rating plan will, by definition, create some premium dislocation within a book of business previously rated under a traditional rating plan,” Baiocchi says. “A company will need to evaluate the new plan against its distribution of business.
“For that reason, we anticipate that some companies will use the new rating plan for new business only, although others will use it for both new and renewal business.”
AAIS actuarial support will be available to companies that seek to modify rating factors, develop caps on premium changes, or otherwise adjust the plan.
“We will work with individual companies to help them achieve their objectives,” Baiocchi says.
After the AAIS Homeowners by-peril rating plan is filed and approved, AAIS plans to introduce by-peril rating in other lines, starting with Businessowners.
For information on affiliating with AAIS for use of the new rating plan, contact Rick Maka, director of marketing, at rickm@AAISonline.com, or by calling 800-564- AAIS, ext. 222.
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By-Peril Rating
