2004 CAS RATEMAKING SEMINAR

INCORPORATING CATASTROPHE MODELS IN PROPERTY RATEMAKING (PL - 4)

PRICING EARTHQUAKE INSURANCE

DAVE BORDER, FCAS, MAAA

PRICING EARTHQUAKE INSURANCE

Overview

Earthquake Ratemaking Earthquake Modeling Uses of Earthquake Models Whose Fault is it?

EARTHQUAKE RATEMAKING

Earthquake insurance is typically a separate optional coverage

Wide usage of deductibles Fire Following exposure Great variation of pricing

» Territorial» Construction

EARTHQUAKE MODELINGComparison with Hurricane

Separate coverage vs. package coverage

Historical data – Future reliability Frequency estimates – Landfall vs.

Fault Rupture Damage estimation – Advances in both

areas

EARTHQUAKE MODELINGAdvantages

Many years of seismological data» Many good sources of geological and seismological

data» Paleoseismology – Science of identifying and dating

past earthquakes by geological studies Damageability information by construction type Current distribution of insured exposure to risk

EARTHQUAKE MODELINGAlphabet Soup

Many sources of historical information» USGS – United States Geological Service» CDMG – California Division of Mines and Geology» SSA – Seismological Society of America» EERI – Earthquake Engineering Research Institute» AGU – American Geophysical Union» SCEC – Southern California Earthquake Center

MODELING BASICS

Simulate location and magnitude of earthquake» Gutenberg-Richter Magnitude» Modified Mercalli Intensity (MMI)

Estimate components of earthquake Estimate event intensity Damage estimation

EARTHQUAKE MODEL

For each simulated earthquake:» Establishes probability of occurrence» Establishes focal depth and rupture length» Determines shaking intensity and liquefaction» Determines damageability ratios

Calculates expected damageability ratios at a location for all simulated events» Distance from rupture» Soil conditions

REVIEW OF MODEL

Consistent with guidelines in ASOP 38 (Using Models Outside the Actuary’s Area of Expertise)

Level of geographic detail available to run the model

Is current book of business representative of future book?

MODEL OUTPUT

Very similar to hurricane output Average Annual Losses and Mean

Damageability Ratios (MDR’s) by:» Zip code or portion of zip code in a territory» Building / contents / ALE coverage» Construction type» Occupancy type

ADDITIONAL CONSIDERATIONS

Aftershocks Debris Removal Demand Surge Loss Adjustment Expense

» More internal damage» Additional adjusters needed

USES OF EARTHQUAKE MODEL

Determination of earthquake rates» Territorial determination» Deductible pricing

Manage catastrophe exposure» Underwriting criteria» Deductible usage» Reinsurance usage

Damage estimation following an event

TERRITORIAL CONSIDERATIONS

Known fault lines Blind-thrust faults Cascading faults Seismic zones with estimated frequency

TERRITORIAL RATEMAKING

Model – AAL’s and MDR’s based on percentage deductible» Select Deductible requirement» Price alternative deductibles as appropriate

Group zip codes into territories» Cluster based on MDR’s» Reasonability check based on known fault configuration

Different loss costs by construction type

EARTHQUAKE RATEMAKING

Convert loss costs into rate» Incorporate provision for expenses

– Agent commission– Other variable and fixed expenses

» Profit provision– Great variability of results

Determine overall indicated change

SPECIAL CONSIDERATIONS

State facility established (CEA)

Losses impacting primary policy caused by earthquake» Fire Following» Sprinkler Damage

FIRE FOLLOWING EARTHQUAKE

Fire Following losses are typically covered under primary policy» Must provide modeler with full set of exposure data» Broader exposure set than Earthquake policies

Damage ratio should be incorporated into package rate» Replace actual fire following losses » Low significance in most areas

WHOSE FAULT IS IT?

Arguments exist regarding variation of rupture intensity» Smoothing provides good estimate, or» Each fault has a single rupture point

Return time consideration in annual pricing» Price to the average, or» Consider time since last occurrence

RETURN TIME ARGUMENTS

Increasing time since last event decreases time until next occurrence

Increasing time since last event increases time until next occurrence

Appropriate to use average annual loss

ADDITIONAL REFERENCES

Pricing the Earthquake Insurance Using Modeling» Debra Werland and Joseph Pitts» 1997 Winter Forum

U.S. Earthquake Frequency Estimation – Ratemaking for Unusual Events» Stuart Mathewson» 1999 Winter Forum