A Modern Architecture for Residential Property Insurance Ratemaking

This paper argues that obsolete rating architecture is a cause of decades of documented poor financial performance of residential property insurance products. Improving rating efficiency and equity through modernization of rating and statistical plans is critical to the continued viability of the products. In particular: --The overall rate level should reflect an appropriate provision for the cost of capital held for catastrophic events, and the cost of capital should be allocated appropriately in development of rating factors. --The indivisible premium concept should be replaced with peril-based rating, and rating factors developed or adjusted to apply to peril-specific partial base rates. --Catastrophe simulation and geographic coding technology, incorporating non-historical experimental data sets, should be applied to the development of base rates, territory boundaries and factors, and classification plans. --Rating for the numerous miscellaneous exposures and coverage options, as well as maintenance of statistical plans, should be aligned with the peril rating concept. The author develops an architecture and techniques for ratemaking that satisfy the above precepts for the homeowners product in a hurricane-prone state. The transition from indivisible to divisible base premium facilitated by this architecture is illustrated in case study fashion, with practical implementation challenges and solutions discussed. Many ideas are transferable to ratemaking for other residential and commercial property products.