HOMEOWNERS

INSURANCE AN UPDATE

TO VALUE-

Robert J. Kelley

HOHEOWNERSINSURANCE TO VALUE - AN UPDATE BY ROBERT J. KELLEY

H~ography: Company Bachelors' a member of Casualty Char'iered in

Mr. its Degree the

Kelley

is

an Actuary in

II

with

State Illinois.

Farm Fire

and Casualty his

Home Office in Mathematics Ameritan Society Casualty

Bloomington, from Lafayette of Actuaries 1986. He also

He received in 1978.

College in

He became of the of

Academy in

1984 and a Fellow holds the designation

Actuarial Property

Underwriter.

Abstract: critical, Value consider part have the

Homeowners factor in the the of

Insurance ratemaking same while Insurance ratemaking

to

Value process. others

is

a sometimes-forgotten, Some aspects of Insurance

yet to must as a

remained impact

have which

changed. can change

Actuaries quickly,

to.Value, analyses.

of their

Homeowner

A relatively coverage Homeowner coinsurance

new coverage beyond insurance was the the ful1

which, policy

under

certain is

conditions, one example than

provides of how

dwelling today's when 80%

amount is

marketplace

now different

previously

most common benchmark.

This reports paper should

paper

discusses

these

developments to monitor

and provides and measure

guidance ratemaking

and examples impacts.

of The

and methods is written gain

by which

so that practica1

a student insights

or an actuary without being

new to Homeowners burdened with

Insurance difficult

technical

demands.

530

INTRODUCTION

Homeowners an increasingly are the

Insurance

to Value

in the

late

1980's in the

and early ratemaking to adequacy which

1990's process.

has become Insurers to

important to return

consideration Homeowner of certain rate

attempting increasing

levels contracts

and adaptinq additionai

proportion under

Homeowners conditions.

promise

dwelling

coverage

AS insurers measure

move toward rates

profitability, remain competitive insurance

many have

increased are

rates not

in.ccref@, motivated en

so that

and consumers to another assessments

masse to take by insurers for

their

Homeowners

carrier. of dwelling for

Greater coverage

effort:?: needc

to make better often for example, additions norms

or updated revea1 often since in the

policyholders

the highlight policy dwelling coverage cost,

need

additional inadequacies

coverage. brought may bring If closer reduce these to the

Reinspections, about to by dwelling light

coverage

inception. features amounts the impact

They sometimes of being can homes. increased be to

changing result ful1 indicated

reinspections the dwelling's of

in dwelling replacement rate

magnitude

adjustments.

The actuary ratemaking with in respect apartments of

must be alert process. This

to the paper

impact

that

these a status

changes report for

may have on this those

on the subject residing

will

provide (other and

to Homeowners and

insurance units)

than an

insurance intentionally for

condominium should

non-technical the purposes of

review

what

an actuary

monitor

and quantify

ratemaking

$rojections.

531

lncr-eased replacement changing cognizant writings describes presents. certain consumer. unfavorable

sales cost the face

of

contracts

which

essentially under to certain Value. in the

guarantee conditions The actuary insurer's

additional are also be

coverage of

on dwellings Insurance

Homeowners

must

of this to this It negative This carry

resulting out the

distributional ratemaking

change process some of need for for

Homeowners This challenges to be wary and paper it of the

appropriately. the the both pricing actuary the to

coverage will also results paper

and highlights describe which will offer the

may occur severa1

company minimize

suqgestions

these

elements.

THEN AND NOW Manv, but not all. of Head's to Value" 1971 Comments Still probably reminds
ADD~~

The phrase book of the

"Insurance

many of us of George for actuarial Head's

Head's exams. 137i

same name which of Insurance For example,

ve studied

in preparation the

Some aspects treatise. that this

to Value we can still

have remained relate with vary to

same since

Head in

1994 when he notes that the equitable,

term

is "qenerally

associated price... should

the concept with the

adequate,

and reasonable

amount of insurance".'

George

L. Head,

Insurance

to Value, 532

1971,

p. 9.

An important which

item

which identify

relates is clauses, which of

to

Insurance comment known

to

Value

and another

one with have are the with of

we can still

Head's also are

that as to

adjustment inflation automatically to keep to them

clauses coveraqes, update in line index

weaknesses. contractual dwelling inflation. buildinq

Adjustment provisions coverage The costs. amounts adjustment (For

designed policy is

each clause

renewal often tied for if

an externa1

example, next renewal

a home insured to $124,800 a weakness the original

an amount of $120,000 the adjustment clause "None of

would called them can

be increased for

at its

a 4% increase.) for

Head notes if

when he states policy from

compensates only larget?' with a prevent .2

underinsurance any original if the cost 92.3%,

is inadequate: growing

they

underinsurance $120,000 of would policy

proportionately on a home to ful1

(Thus,

was providing the ratio leve1 cost of at

coverage insurance renewal.

replacement cost,

$130,000, remain

replacement would

at this

The policy x 1.134

be renewed

at $124,800,

but the replacement

is now $130,000

or $135,200.)

Gradually rates that

becoming

outdated, assume explaining more have

however, 80% coverage". this

is

Head's It is that

comment: is the over

"Fire

insurance experiencc

traditionally one factor

author's time or

change

insurers near

havc

successfully protection. cost and of levels.

provided Insurers

consumers refined the their need the

with

complete, of

complete, replacement appropriate ratio has

methods to purchase

estimating these to more value

communicating

coveraqe

As a result,

average

insurance

Ibid., Ibid.,

p. 31. p. 24. 533

increased are still

over

the

last for

ten

to fifteen

years

even

though

many rating

plans 80% and

designed

policyholders

who purchase

any amount between

100% of replacement

cost.

The movement usually under indicated insurance

toward

higher

ratios

of insurance premium rating that wise, than plan.

coverage it does

to replacement losses is

cost

generates today's rate

more additional Homeowners To demonstrate

and expenses a diminished percentage of

typical need.

The result

an increasing consider

average

to value

is financially of

an example on is a
home

of a policyholder with a $125,000

who purchases replacement

$103,750 cost.

dwelling

coverage ratio

The insurance

to value

83%.

NOW assume $103,750 additional expenses, the higher

that

the

policyholder resulting

increases

the

dwelling ratio for

coverage of 91%, for premium-related is left of

from an

to $113,750 annual

in an insurance of $30. After

to value deducting

premium that claims

we determine amount of

$24 of this generated

additional by the

premium extra

to pay for dwelling

$10,000

coverage.

To complete or actual In this additional with could the

the analysis, claim data

the

actuary

is in need of a loss claims that the If for

distribution this $10,000

curve layer.

to estimate

the dwelling

case

let's

assume we can determine claim payouts will

frequency we combine

is 0.20% that this estimate which

dwelling $10,000

occur.

(= $113,750 this

- $103,750)

maximum increase the for

in severity

result the

from

particular

situation, increase in loss

followinq this policy:

calculation

determines

maximum estimated

Estimated

additional

loss

.0020

$10,000

$20

Based related certainly at the

on this

analysis, which

the is

additional for

$24 the

(already estimated venture

reduced extra for

fOr

premiumclaims while

expenses) makes this same time

available

$20 of

a profitable better

underwriting coverage for

the company,

providing

the

policyholder.

Guaranteed Insurance Policies under are

ReDlacement to Value which promise conditions increasingly the policy cost, if what typical

Cost

Coveraae

is

Accelerating

the

Move

to

100%

or guarantee

ful1

dwelling

replacement

cost

coverage and

certain becoming that

are now available popular. coverage because This

from most Homeowners policy for provision

insurers

understandably to 100% of exceed the

requires the policy greater brought average The value subject

be purchased dwelling cost to claim

an amount equal will loss replace of turns it.

replacement amount than the

settlements of the to book

the replacement was thought Homeowner that is

at the time ful1

out to be It to has an

be the

cost

insurer's probably to their later these

overa11

business

coverage must

amount remain

95% or higher changes for

of replacement to insurance

cost. to This

actuary

attuned measure explored

related ratemaking

and appropriately will be further

impact in this

purposes.

paper.

535

WHY IS THIS SUBJECI IKPORTANT?

The Casualty and Casualty commonly changes changing of

Actuarial Insurance to

Society's Ratemaking"

"Statement includes The "Mix stated of

of Principies numerous referentes Business" to Value. in

Regarding considerations to certainly Changing the

Property which

apply in the

ratemaking. entitled

distributional apply to a

paragraph

cross-section to Value process, Such

of policies' may such arise

Insurance from

percentages (or of CAS the and

Insurance

changes expanded are

underwriting program in the

reunderwriting) in-forte statement heading other risks.

as a new or

reinspection also In listed

"Operational

Changes" considerations.

among the "Policy

ratemaking the This

addition, coverage to the

beneath limits

Provisions", provisions.

considerations situation is

include applicable

policy

guaranteed sections Insurance in to is

replacement the Value critica1

cost

coverage. and the premiums, ratemaking

Based on the applicability fact that a change and expenses, in the

of severa1 leve1 of

CAS Statement will affect to the

losses process.

analysis

of such changes

However, demonstrate

the actuary some effort

should

not be reviewinq

these

ratemak i ng matters noted

just

to

was made to abide in the Casualty As Business

by the considerations Actuarial Society's Michael Decision in underwriting quantifiable. J.

in the

CAS Statement. Paper entitled "The effect Program

As stated "The Actuary

1993 Discussion
Millers

Manager", Pricing

article states: or the

"How to Successfully on loss ratios

Manage the from

Process" rules

. . . a change program are al1

introduction

of a new insurance

536

The best rely

managed

insurers in
an

do attempt effort to keep

to quantify their

these

changes, results

rather on target".'

than

on hunches,

financia1

Miller

continues this

severa1 projection, the

sentences but

later: in so doing affect

"The actuary
must be

is uniquely

qualified the changoir. not just th<-

to prepare going rate

aware of al1 results,

on within change".

company which

the

financia1

It the

is therefore actuary the

obvious must consider

that

to conform these impacts. items the

with

accepted It is also the of

ratemaking highly actuary's insurer.

principies, advisable financia1 to

quantify projections

impacts and to

of

these improve

to

enhance

further

management

the

WHY IS MONITORING INSURANCE TO VALUE CRANGES PARTICLJTAFZY IMPORTANT NOW? Consider rates.
ma

the For

following the last

observations. severa1 years,

Companies Homeowners

want

to

have for

competitive the vast claim their rates

many

insurance

jority

of insurers have been

has not been a profitable deteriorating, exposure these with to facts

market.

Non-catastrophe have learned than that their that

trends previously

and many insurers catastrophes in mind, it's is

perceived With

greater not

contemplated. insurers

surprising premium

have been faced

a need for

Homeowners

increases.

'

Michael J. Miller, ilCharacteristics of Decision Processes", Casualtv Actuarial Discussion Paper Proaram, p. 206. p. 207.

Successful Societv

Pricing 1993

5 Ibid.,

Because obtain shopping writings.

of rate for

a desire adequacy another

for in

competitiveness a way or that

on rates, won't send

many their impact

insurers current their

want

to

customers new policy

company

significantly

One of rating average increases company's change Value, outcome certainly upward appreciate will latter
-^-l:-+;LIYLI

the need leve1

methods for of

an insurer

can

employ rate

to

reduce increases

the is

magnitude to

of

its its

additional Insurance

Homeowners to Value.

improve such

As previously standpoint can better

noted,

coverage help the

help

the consumer results.

from a protection If the actuary these

and usually the levels accuracy of

financia1 indications

of rate to

by quantifying will premium hearing be very effect the

increasing to the

Insurance One possible

the is

information that appreciate the

helpful is actuary's

insurer. and of

significant, report result, shows

management need

will for

a smaller

rate

adjustments. just as much, a negligible would

+ho limited

Another is that premium make it

oremium

potential the analysis

which the in the that

management quantified short they run.

should change This be

have only analysis --__

=hvr+ ----_

impact, to
imQact

at least management

clear

should programs.

of some underwriting

MONITORING INSURANCE TO VALUE How to Beain The actuary calculated to help increased reinspections process. should first become aware and the available make these of how dwelling systems coverage which During of amounts are utilizec periods of oz are

and updated, agents

or aids

and underwriters of, or

determinations. inspections tools

numbers

more extensive, business, is additional

new business, brought

of existing More information

are often

to th< and morc

usually 538

obtained

on new writinqs,

frequent study changes otherwise procedures. quickly

and in-depth these developments

reviews

of existinq attempt

business

occur.

The actuary

must:

and then

to quantify from these

resulting actions which based

additional would not

in premiums, be measured It is

losses or

and expenses would not

be measured to obtain

as soon available

on current more

can be just to obtain

as important new information.

information

as it

As an example, business replacement hiqh probability rate for

consider which the Also, that

the

situation dwellinq a very

where

rates

are

based is

on a book 85% of

of

averaqe assume

coveraqe early will

amount

ful1 '-1

cost.

projection

can be made with The previously since

in a year will

the average likely

move to 90%.

indicated additional actuary's insurer's

adjustment usually estimates plan

be reduced, the additional matters can

as shown earlier, losses be quite

the The

premiums advance entire

exceed of

and expenses. valuable to

such

the

of operation.

Michael

Walters

(1974

Proceedings Insurance Proqram, describing

Paper

"Homeowners in the Issues", which

Insurance

Ratemaking") Actuarial authored

and Mark Homan ("Homeowners Society well Discussion written to Paper

Pricing" "Pricing analyses ratemakinq in averaqe

1990 Casualty Vol. II) have

papers the entire

provide

comprehensive premium This can be

approaches projections paper

Homeowners chanqes

process, amounts ratemaking of

including insurance. data provide improve which

based

on past

provides

some additional the standard to

means to analyze approach track

used to augment (e.g. monthly)

and in some cases changes which can

a fast-track ratemaking

means

projections.

539

Be Aware and Broad-Minded The actuary the averaqe should leve1 be watchful of Insurance analysis indexes. of developments, to Value but which would
may cause

chanqes

to be

not

immediately of dwelling

r-eflected coverage

by a typical or inflation

of historical These

chanqes

in amounts include:

developments

miqht

1.

More frequent

or more extensive
room

personal additions

inspections and renovations, features

and reinspections or a change are present More in

of dwellings.(Remodeling, the frequency unnoticed additional systems, and attics with until patios, decks, are exposures.) which the

additional is and

dwelling

can go

dwellinq porches,

reinspected. garaqes, materials which saunas,

specifically, hot water

solar

more expensive examples of

roofinq items

and finished a

basements

increase

policyholder's

property

2.

broad

advertising renewals dwellinq which

or

direct encourage

mail

campaign,

or to

notices consider

accompanying increasinq

policy their

pclicyholders

coveraqe.

3.

Revisions of dwelling

to company procedures replacement costs.

or tools

which

aid

in

the determination

4.

Changes existing

in legal statutes.

reguirements (For

or chanqes example, stricter

in the degree building in the industry owl,

of enforcement codes or stronger

of

enforcement and Iniki protection dwellinq

of existing era. Restrictions

codes are emerqing

on

post-Hurricane

Andrew

the

lumber

due to the increased have an impact or

of wildlife, costs.)

like

the spotted

may also

540

5.

Changes housing

in

economic

trends. with

(An economic considerably

downturn less

may result

in

ncw

beinq

constructed

features.

6.

A rapid

change

in

construction

design

or efficiency.

7.

Regional actuary replacement

"hot should cost

spots"
be

of certain

quickly that just

changing such

home values; are

however, adjustments

thc in

occurrences value.

and not

market

In

addition close

to

keeping

an eye

out

for

the with

above

situations,

one

shou Id

maintain Underwriting often

and continua1 reports source

communication helpful

the underwriting actuary. data is just

department.. dra

can be very of knowledge,

to the

Underwriters not available.

the best

when credible

The

actuary to

should interna1

arrange meetings

to

receive involving procedures. magazine

minutes

and

other

correspondence and other should

related meetinqs

underwriting In addition, to stay current

proqrams

regarding

new or revised one trade

the actuary about

have access construction. impact

to at least However, projection

residential

be wary of temporary period.

conditions

which

may not have an

in the

Obtain

Data

The actuary be expanded, enlist meet the

should

research

what company will

reports

already

exist, The

which actuary

should should to

and what help

new reports peers

be required. experts needs. and

of company a with expected

and other

to design Besides the people

new reports underwriters, is highly

short-term

long-term claims

consultation recommended.

marketing,

research

541

Examples in levels

of reports of

that

can be useful To Value and

for

a fast-track coverage

monitoring changes

of changes include the

Insurance

other

following:

1.

The number dwelling and

(or

percentage) amounts preferably

of

policies

with

mid-term

changes coverage (The district

in their increases marketing which

coverage

and the amount of dwellinq for the last two years.

decreases,

department can help

may have reports pinpoint the locales

available where

by agent changes

or agency

are most siqnificant.)

2.

A current Insurance always otherwise

and prior to Value.

year

comparison data

of

an insurer's run for early newer

distribution business that

of should could

(A separate because it

be considered be disguised

reveals of total

movements

in a report

writinqs.)

3.

A listing period

of existing and the results

policies of those report

which

have been reinspected Exhibit

in a recent the and

activities.

#l illustrates to changes

framework
reasons

of a simple for the updates a samplinq

which

can keep one attuned basis. policies

on a frequent of reinspected

To keep the amount of data may be best.

manageable,

4.

The percentaqe reasons period other

of policies than for

cancelled non-payment

and non-renewed of premium by the for

by the a current

insurer

for

and prior

and other

than

those

initiated

policyholder.

542

5.

The distribution dwelling monitor study features. changes as needed.

of basic Exhibit in these

types

of dwellings a sample items

and the frequency report which

of use of

#2 is types of

can be used to further

and which

can trigger

6.

Policyholder for items not

questionnaires statistically (For

or research identifiable example, to county

studies or not

to verify available for

policy

data

or any ot ot

throuqh a sample the accuracy

efficient policies square

method.

insurer tax records

records

can be compared footage.)

to check

The actuary actuary If

must exercise be committed are

care to

in maintaining a continua1 one must

and analyzinq re-evaluation of

such data. these

The

should

reports. of

severa1

reports

used,

ensure

that

no double-counting

effects

occurs.

While

not

addressed

in this other

paper, than those

the

actuary

must also to Insurance

remain

wary

of thr ma)

many considerations also need monitorinq. for

related

to Value the use of

which

A distributional while unrelated be quantified.

change to Insurance

in

various both

deductibles, premium

example,

to Value,

affects

and losses,

and should

STUDYING CHANGES IN INSURANCE TO VALUE What are the Impacts? must have play a key role in identifying, and then measuring, al1

The actuary elements that

a bearing

on ratemaking

determinations.

543

The potential to Value are:

impacts

of changing,

presumably

increasing,

levels

of Insuranc

1.

The additional actions these

premium

generated

by larger

coverage

amounts

from more of

such as inspections activities during

and reinspections. an unprofitable

One would

expect

underwriting

cycle.

2.

The additional larger coverage

total,

and near

total,

losses by

which

accompany

the and

amounts

generated

additional

inspections

reinspections.

3.

The reduced renewals.

premium

from

increased

numbers

of

cancellations

and non-

4.

The reduced non-renewals.

claim

payouts

from

increased

numbers

of cancellations

and

5.

The reduced quggentions (Improved new front

claim to

payouts the

if risk

broader of

reinspection loss which are

programs then

result

in out.

reduce

carried roof

conditions steps, are

of homes,

such as repairs

of prior

damage or

two examples.)

6.

Changes inspection increased result

in

expenses

such

as

(1)

the

greater

cost

of cost

additional generated by

and reinspection premium-related from additional expenses

activity, expenses, premiums),

(2) the greater such as commissions and (3) the eventual claims, to loss for

and taxes savings brought

(which in about loss by

adjustment reinspections

from

fewer reduced

(or

reduced) exposure

instigating

some policies.

How Can We Ouantifv It was noted the that

the Exhibit

Effects? #l coverage presents a simplified generated can extrapolate a longer worksheet by more, this period approach or broader, information of time. to

estimate inspections to quantify

additional

and premium The actuary

and reinspections. the effect for al1

policies

and for

If

such

a report can
be

is

not

available,

or

not

feasible, like close is Exhibit

some data

and

some at an other

judgement
estimate.

used to complete where data

a document is lacking, offices

#3 to arrive with at should ratio in

As always, departments A fairly to produce #3.

communication crucial or to arrive

home Office estimates. developed IV of

and regional simple computer

good be
item

program

spreadsheet

a qood estimate

of the premium

to coveraqe

Exhibit

On the

claim

side,

one can use the

additional with additional coverage

coverage

estimates

obtainable loss one method large had

from Exhibit distribution will to pay for making

#l or Exhibit curve, the this to

#3, combined evaluate dwelling would for been the

the use of a representative dwelling

amounts.

claim

dollars

increased estimate as a basis amounts

An alternative data for dollar actual

be to computinq

use

credible the additional

dwelling additional

claims

payouts

coverage

in effect.

Reduced cancellations easily

premium

and

reduced

claim should

payouts also

resulting

from

additional fairly

and non-renewals projected and and

be quantified. by tracking the number that

One can the of

determine

reductions

in premium
by

additional

cancellations inspections

non-renewals

generated and simply 545

supplemental figure by the

reinspections

multiplying

average multiplying loss

premium the

per

policy.

For

reduced leaving

claim

estimates, books

one can begin recent the help

by

number Then,

of policies with

the

by the with

average of the the

per policy.

some judgement, one should on these cancelled

preferably estimate

underwriters loss per

and claim policy expect risks. loss the per would the

personnel, have policies been

how much higher policies

departing

as one would to be poorer to determine incorporate the

certainly than the result

being

and non-renewed this policies estimate and

average reduced into

The actuary policy

can then

utilize

on the process.

remaining

ratemaking

To illustrate policies failure that will to

this

scenario,

suppose out of 1,000 and other

it

is total

known policies

that

approximately in a given state

100 for

be non-renewed repair prior year's roof

damages. total

Company data loss

may indicate is

the previous

statewide claim payouts

average resulting

per Homeowner policy unrepaired

$150 with With that the

30% of total help of claim

from these

damages.

and underwriting the claims would

personnel's be 40% higher policies

judgment, ir

you estimate were the

on these

100 homes,

the policies reduce

to be renewed. overa11 loss per

The non-renewal policy for the

of these remainrng

would

obviously

Homeowners

policies.

First,

calculate = ($150 Ir 1

the loss

per policy

of the 100 homes with + + ($150 x 70%)

unrepaired

damage:

x 30% x 1.40) $63 $168

$105

Then,

calculate

the

loss

per

policy,

shown

as variable

X below,

for

the

remaining

900 policies.

546

We know the

following

is

true

for

the

loss

per

policy

of the

entire

current

book of business: $150 = (0.9 X = $148 Thus, by in this

case

x $X)

(0.1

x $168)

the loss

per policy and

will

be reduced projections

from the previous should include

ye;lrthib;

1.3%

t(14f3/150)-1)1,

ratemaking

information.

TO determine induced claims approach actuary changes in the with should

the

judgmental

component of risk, author as the business

of

claim

savings

from

inspectionof 40% highecand conquer" the

in the conditions above the first Using example, actuary this acting the

such as the estimate recommends coordinator. into statistically the "divide

When possible, identifiable

segment a Delphi they're in claim these

characteristics. of experts of projected will (in this

approach" likely frequency actions.

the actuary company experts) and severity, The variance of

independently for by in their

cause

inquires estimates of loss,

case,

changes result from

which opinions

the

independent or bad the

may provide may

be

the this

actuary task.

an understanding

how good

estimates

for

Exhibit for each such

#4 provides an approach. of loss

a worksheet Estimates can, estimates to

which of

summarizes changes in

the

necessary

calculations for In

frequency

and severity data. claim The portion

cause

some extent, by company activity with the

be based experts are for

on historical specific

addition, from III)

though,

impacts (Item of

inspection of Exhibit
6

and reinspection #4 which deals

essential.

distribution

of claims

by cause

Spyros Makridakis and Steven C. Wheelwright, Methods For Manaoement, Fifth Edition, pages 547

Forecastinq 324-326.

loss aware

can be derived that certain

directly trends are

from

historical that is

data. usually

Unless the trends

the best tend

actuar-y reflection

is

changing, Crime usually

of what short-term normally historical

is expected in nature, deserve

to continue. since the most they

and liability relate for closely

to be more and from are then by and

to the

economy,

consideration These of total individual loss

possible peri1

deviation

distributions. into an appraisal

estimates per policy

transformed summing the 111 to arrive

savings

in forte, II

products

of each pair

of components

A through

E in items

at an estimate.

Additional judgments. reinspections, severity with crime policies poor data

statistical If there are

reports particular consider

should areas

be of

considered focus or for

to the

aid

in

these and and

inspections frequency

one should for them.

reviewing, if with then

obtaining,

For example, dwellings agents,

reinspections woodburning data

are directed stoves, for areas these

at homes of high

fire

protection, or hiqh loss

losses, would

historical estimation

particular

be most valuable

to the

process.

The

various

changes be

in

expenses of

noted the Historical

cx-lier

chnlild. of data

also

be quantified. the additional of premium-

Records inspections related

should

maintained

cost

performing for the

and reinspections. expenses to premium should

ratio

be readily expenses

available which of loss would

to use for result

estimating

any change in premium.

in these

premium-related

from a change expenses of any tc los:

The historical a basis savings. for

relationship determining

adjustment estimate

claims

provides

a reasonable

adjustment

expense

548

Besides that

the

effects

the

actuary but

attempts intangible to

to measure, results risk

it

should

also

be noteci

there

are many positive emphasis Stressing on the

from an insurer's quality and company and 11 protectiorj back U:I

additional operations. more watchful

programs importance risk

improve of

inspections, provides

reinspections, greater the insurer

eye on improvinq for as well the

conditions

and more satisfaction track operationally

policyholder it

and can put financially.

as benefit

The Costs The costs reports, these

and Benefits to the actuary as the

of Ouantification and others time of the involved experts in developing providing against the and maintaining to make al1 derived.

as well estimates,

assistance benefits

must be weighed

carefully

It

may become clear minimal,

part

way through cruder hand,

an analysis

that

certain detail

impacts are

will the

be best

quite

and that On the other

estimates if the

and much less impact could

alternative. analytical raises those one's efforts.

be significant, This paper

greater hopefully into

detail

and effort

may be well about this

worthwhile. and provides

consciousness

subject

some insights

GUARANTEED REPLACMENT COST (GRC) COVEXAGE mat is it? Replacement Cost is a coverage George that Head's is at that surfaced in the 1980's Pire its began rates that is on

Guaranteed beginning policies Born existing out

to make obsolete insured of at a leve1

comment that least this 80% of coverage

are based

replacement as a benefit

cost. to

a competitive

environment,

qualifying

policyholders

and a way to attract

new customers.

549

Previously, the primary

a typical dwelling that

Homeowner to exceed the

policy the

never

permitted coverage

the amount.

loss

payment

on

dwelling

GRC coverage, even if the

h,>wever, ost -ti11 rating. addition replacement its value

provides

dwelling coverage

may be replaced limit of liability. at least

or repaired An amount to serve to value. dwelling

exceeds eclared

the dwelling in the is

is usually for in its

policy rwuired

declarations, to be fully initially

as a basis Generally, to 100% of

The policy to the cost, by

insured the

policyholder

insuring to report the effect policy for

he or she promises more during in

any alterations term. Many

which

increase have this

5% or

companies to direct

additional coverage

eligibility to a preferred

rules class

GRC coverage

of Homeowner

business.

GRC coverage provides. any doubt a total its

quickly

became a hot seller benefits from

because this might

of the guarantee because

the company it removes event of in and fully

The consumer that loss. the For amount this

new coverage be insufficient is putting

of coverage guarantee, personnel cost

in the

a company

much more trust determine remains premium.

own methods, adequate and the

and in its replacement insurer

and agents so that the

to accurately policyholder

maintain insured

continues

to collect

an adequate

Severa1 Because rating, entire

-llenaes the

Exist

to Pricinq to Value replacement

GRC requirement cost is critica1 are for appropriate to the

100% Insurance initial

accurate GRC pricing cost quantify

estimates in that from square

essential

structure. is evidenced it.

The difficulty by the fact vary

determining companies straight footage

a dwelling's employ square combined various footage with adjusted a

replacement methods costing judgmental to to

The approaches hybrid involving

a more involved assessment

of the degree

of home customization, 550

and then

for

any of a long primarily

list

of special base

characteristics cost on the

which

apply. of

Still rooms in

other the

companies dwelling.

replacement

number

Sometimes to be

even the

best

possible

estimates

of replacement a efficient if riskier for renovations for inflation

Cost venture an

can tUrn than to

out

inadequate, coverage. frequent the of

making It

GRC coverage may not to be

normal make have

Homeowners reinspections occurred the

insurer or is to

enough

ascertain

add-ons

or if

insurer's protection the

adjustment from area

clause to area

maintaining policy. The

same leve1

and policy

company must choose

appropriate

balance

point.

A,policyholder's insurers insurer. insurer. the country, for It the

expectations name of the

of the word "guarantee", coverage, also creates which

which

is used by many for the

challenges intended cases out

can produce

additional

exposure

was not individual been paid

by the across

In some catastrophe many more dollars interpreted the

situations than coverage

and other intended broadly. the have

as courts language, tT>

have sometimes sales the below materials public actual

Insurers' coverage may turn

policy

and advertisements the actuaries'

must convey loss

appropria'cely out

or else payouts.

projections

to be weli

Pricina Currently, the

GRC most insurers use at most a small no direct dollar is or percentage made for charge for

GRC coverage. additional

Sometimes premium For the author

charge

GRC coverage

becauss cost should

is automatically actuary

generated what severa1

by the 100% replacement the cost of this product

requirement. be, this

to measure utilizing 551

recommends

statistical

reports.

As previously policyholders requirements similar reports would truly rules. but it to are

noted, to create other

eligibility for

rules

are

usually These of

different differing

for

Homeowner

qualify the

GRC coverage. for a group In

qualification which may not statistical Most helpful if a be

potential

policies case

Homeowners

policies. the

that

separate

essential of

to review loss

non-homogeneous data by cause of

segments. loss

be a review different This may are

frequency class may not exists only in

to determine GRC eligibility information,

Homeowner information also aid

due to the be insightful determining

insurer's ratemaking if

management

GRC eligibility

rule

revisions

in order.

Next,

while

data claims

may in

be which

sparse, payments #5 is the

report exceed

which the of

provides

details coverage which

for amount

individual should

dwelling a report

be created. assistance are

Exhibit for

an example

provides with related to include the to

ratemaking GRC coverage premiums

or

GRC coverage.

The losses The losses

associated are then up"

itemized per

and summarized. policy. e.g. (The latter $2.87/.80

to loss

can be "grossed

premium-related point curve for

expenses,

= $3.59.)

These provide A loss also

a starting distribution

determininq extends

the pricing above

of the GRC component. cost could

which

100% of replacement

be developed.

Before inquire data. higher follow-up

utilizing with the

this claims the

particular departments fourth claim

set

of

information, any losses

the which

actuary
may

should the 46%

about listed amount. or

distort a loss

For example, than the

on Exhibit Cases excluded such

#5 involved as this the

dwelling being

coverage blindly

one deserve

before

included

from

analysis.

552

The actuary would expect

should that

compare the

data for

for

different GRC coverage

states in dollar This is

for states

reasonability. with than of above states the

One average with qreater

charge should

catastrophe below potential shortages average for

provisions catastrophe total are

be a greater

amount because

provisions. and for increased

losses

rebuilding major

coStS

due t0 supply

which

more common following

catastrophes.

Finally, information

if

possible, on total

the claims losses

department on non-GRC record the

may also policy

be able claims.

to help If that

develop claims wOUO

representatives have data been for paid review.

have recorded if GRC coverage Of course, risks

or would applied,

the amount of claims actuary would that this have

additional

the actuary homogeneous

must verify enough

non-GRC policy review.

information

reflects

to be used in the

Other This

Challenaes coverage

Caused bv GRC Coveraae can bring insurer. about a number of negative outcomes be the for winner undervalues extra both in the al1 the

consumer situations, dwelling coverage other can

and the

The consumer in every guarantee (without

may seem to case. still If

but that replacement to the

is not true cost, the

a company the

provides the

dwelling
but

policyholder

charging

appropriate

price), This provided

coverages, occur

such as personal personal dwelling Therefore, property

property,

may be inadequate. coverage amount, is often

result as a

because

property coverage the

percentage may not coverage

of the stated extend to it.

and the coverage would not have

guarantee adequate

policyholder

on personal

in such a case.

For example, cost at

consider with

a dwelling

that

is

insured with

for

100% of its property

replacement coverage

$120,000

GRC coverage

and 553

personal

provided $90,000 cost receive personal of

at the in this

insurer's case. $160,000.

At

standard claim

amount of 75% of the dwelling time, it turns out the the is home's

coverage, replacement

or

is actually the

The GRC coverage dwellinq, the payment of the but on it needed

means that if there is limited contents

policyholder

will on the amount had the

$160,000

on the

no guarantee by its coverage, cost policy

property This

coveraqe,

$90,000.

may be short for

because

the home been insured insurer Thus, personal if would this property

the true

dwelling

replacement of personal

of $160,000,

have provided policyholder and would

75%, or $120,000 was typical, find themselves

property

coverage. of

he or

she really

had $120,000 by $30,000.

underinsured

.4 disadvantage inspections, that the

to inflation

the

company coverage,

is

that

it

is

depending review

heavily to at

on

its

and interna1 insured and

procedures insured

ensure ful1 ful1 be

dwellinq cost. cost

is If. overshoots than

initially for

remains

replacement replacement less risk Another

example, the correct similarly

its

initial

determination amount,

of

coverage priced

the company will for

competitive if the

other rate it

insurers

competing lower

the same cost. utilized

others

at

the if it

appropriate the inflation with the

replacement index that

company shortfall moves slower obtained for

may result than

coverage result

hy an insurer premium is

should

not

enough

the

coverage

provided.

There insure

is the

obviously dwelling ful1 improve

less at

incentive an appropriate of the

for

the leve1

consumer

with

GRC coveraqe company's and its contract agents

to

when the The insurer the

guarantees perhaps protection policyholder.

replacement this situation

building.

can

by emphasizing coverage,

importance it's

of appropriate to the

on personal

property

and that

not guaranteed

554

Although which they

total will

losses

are

not

that

frequent, the dwelling

companies coverage

will

have claims

for

pay out more than will

amount due to the GRC replacement which did cost not of

coverage. valuation. remain

Some instances Some will accurate cost for might

be due to incorrect automatic policy. inflation Even

initial indexes though at other

be due to a particular

the

estimates

replacement necessary it could

be as accurate the home at claim

as possible, time will

times

the amount. thought Anrlr~w and have exceedel of these upon the

to rebuild be. Recent

he more than fire

anyone

catastrophes greater

like

the Oakland of total

and Hurricanes losses have aspect with methods,

and Iniki brought dwelling possible which actuary to

have about

involved additional amounts

numbers

dwelling which

occurrences

of claim

payments

coverage catastrophes validate to review

due to GRC coverage. they often provide cost

One positive insurers

is that their additional

more data and for

replacement GRC loss

valuation

information.

Controllins Due to insurance the

GRC

ExDosures

current closely.

loss

cycle,

most

companies this includes answer there is

are

analyzing getting

Homeowners handle produce too.

quite

Undoubtedly, Part of cost,

a better ways to avenues,

on GRC coverage better estimates

exposures. of replacement

the but

to

find

are other

Companies Additionally, to-estimate cost assess of

may consider agents building homes with

narrowing and underwriters replacement

their

eligibility could

rules

for

GRC coveraqe. out hard-

more effectively For example, features for are

screen the

cost

values.

replacement difficult to

one-of-a-kind

building ineligible

often

and could

be considered

GRC coverage.

555

Although another the

the savings possible payout for

may not be significant, that an could reduce loss claim

nor the handling settlements by have the been

very

practical,

action on multiple

would be to reduce aggregate collected premiums for the at too

some

claim

individual years) that if

(potentially

should

amount of a dwelling's the late, time of loss. and may

underinsurance, Although this an

underinsurance could process,

is found to exist too little

approach

be considered it might

not to

be

efficient at

provide to

discouragement underinsuring

policyholders homes.

policy

inception

knowingly

their

Another has better company vast

option tools should

is

not than

to

make an unlimited policyholders close to

guarantee. estimate

Because replacement

the

company the

most

cost,

be able of cases.

to come quite Because replacement guarantee it

to determining however,

such costs for

in the to one 10%

majority

is difficult, cost estimates, be provided amount. This It

an insurer every say

he accurate at

on al1

its the

and to maintain up to some limit, would

100% to value, the rather the

could

or 20%, above of coverage

dwelling than upper

coverage a guarantee. limit

become an extra the company

layer some should

would

provide

rnmfnrt still

due to be

on its in

exposure. every as they

The policyholder case, often could even do still if after

adequately cause

protected

virtually costs the

SUPPlY large a

shortages catastrophes purchasable of coverage

increased If (or

material desired, for

occur. option above

company

provide layers

options) 20%.

a policyholder

to buy additional

10% or

Yet another share

coverage

alternative building

is

for losses

the

company beyond

and the

policyholder For example,

to

in claims might

involving

some limit. the dwelling

the insurer

pay 80% of dwelling

losses

exceeding

amount up

to 125% of the dwelling be for those loss provide the from data the insurers 110% to to

coverage. pay al1

Another dwelling like

possibility losses Exhibit and of al1 up to #5,

along

this

line

would 50% of

110% and then supplemented

130%.

A report if

by total would agairl

on non-GRC framework

policies for a pricing

possible study

appropriate, these limited

guarantees.

CLOSING

The actuary which paper. get the the ever can This

must take impact the

the

time

to

understand, process for such

monitor as those

and quantify described

matter-in thib:

ratemaking a challenge only assorted

is quite

the data-hungry bits of data

actuary

who may have tr; judgments with tools in

job done with changing with

and a number of communication the basic

business

of insurance. statistical

Constant reports provide

peers from

combined which studies the

efficient can

actuary

complete involving

his

or

her

ratemaking

analysis,

includinq like GRC.

such as those

Insurance

to Value

and coverages

SS7

EXHIBIT #l HOMEOWNERS ADDITIONAL INSPECTION AND REINSPECTION !mTH OF -.___~~

ACTIVITY

I)~ji-v Number ~=xxxxxxxxxxxx

Dwellinq Pre-Inspection $

Coveraqe Post-lnsoection s

Change in Premium from Coverage Chanqe

Comments*

_____
Totals 5 s

--.___
5

*Comments + + + t

might include: Inaccurate square footage Recent room addition Wood shake roof installed Sauna added

on previous

records

558

EXHIBIT #2 REPORT TO MONITOR CHANGES IN THE DISTRIBUTION OF TYPES OF DWELLING AND IN THE FREQUENCY OF USE OF SELECTED DWELLING FEATURES DISTRIBLJTION OF POLJCB.-____ PERCENTAGE CHANGE. PRIOR PERIOD CURRENT PERIOD _---.___..__

1.

TYPES OF DWELLING _-c--_ 1. 2. 3. 4. 5. Economy Standard Above Averaye Deluxe Ultradeluxe

100%

100%

DWELLING FEATLJRE 1. 2. 3.

PERCENTAGE OF POLICIES WITH FEATURE-_ PERCENTAGE CHANGE PRIOR PERUD CURRENT PERIOD

4. 5. 6. 7. 8. 9. 10. ll. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24.

Finished Basement Family Room Addition Kitchen Package (e-g. Microwave, Dishwasher, Garbage Disposal, etc.) Central Air Covered Patio Solar Hot Water System Hot Tub/Spa Sauna Wet Bar Deck Wood Burning Stove Wood Shingle Roof Wood Shake Roof Concrete Tile Roof Clay Tile Roof Finished Attic/Room Over Garaye One Fireplace Hearth Two Fireplace Hearths More than Two Fireplace Hearths Attached Garage - 1 Car Attached Garage - 2 Cars Attached Garage - 3 Cars Attached Garaqe - > 3 Cars Carport

559

EXHIBIT 113 PROJECTEOCHANGE IN PRENIUNS GENERATEDBY A CHANGE IN THE AMOUNT OF DYELLING REINSPECTIONS ---A Simplified Yorksheet---

1.

Additional Dwellings (As a percentage of

Reinspected al1 dwellings)

II.

Percentage dwelling

of policies in 1 in which coverage amount is revised.

the

III.

Average amount

percentage change in the for the policies in II.

dwelling

coverage

-~

IV.

Average ratio of a change in premium change in coverage amount. [i.e. (Change in Premium)/(Change in

and

Coverage)]

V.

Projected

change

in premium

= I*II*III*IV=

___-

560

EXIIIBIT #4 PROJECTING REDUCE0 CLAINS DUE TO A CHANGE IN THE AMOUNTOR DEGREE OF OWELLING REINSPECTIONS WHICH WILL LEA0 TO REDUCED RISK OF LOSS 1.
Additional Risk of Dwellings Loss. (As Reinspected a percentage Which of %jl Will Lead Dwellings) to a Reduced ..--%

II.

Projected For Those

Savings Policies

In Claim in 1.

Frequency

And/Or

Claim

Severity

Pro.iected Freauency A. B. C. 0. E. Fire Wind/Hail Crime Liability Other % % % % %

Savinos Loss Per Policv* % % ; % % % % %

Severitv

III.

Expected A. B. C. 0. t.

Distribution Fire Wind/Hail Crime Liability aher Total

of

Total

Loss

Per

Policy

Uy Cause

of

LOSS

% % % % --%

100
Claim A) Savings Per Policy B) +

IV.

Total

Projected A X III.

~(11. (II. (II.

c x III.
E X III.

+ (II. C) f (II. E) =

8 X III. 0 x III.

D) +
%

*Loss 1

Per [(I

Policy (Proj.

Savings Savings

for

each

peri1

in

II
X (1

is

canculated (Proj.

as follows: in Frequency))]

in Frequency))

Savings

561

EXHIBIT 15 SAHPLE REVIEW OF HOMEOWNERS PRIMARY DWELLING LOSSES ON POLICIES WITH GRC COVERAGE

1.

Dwelling

Losses

Which

Exceeded (3) Date of Loss

Dwelling (4) Basic Policy Premium $ 250 338 278 265 443 242 359 .

Coverage

("GRC"

Losses)

(1)
Count g&,&

(2)
Policy or Claim Number A234567 Al23456 A345678 A567890 A456789 A678901 A789012 ,

:
3 z 6

01 01 01 02
02

01/31/93 01/02/93
02/14/93 02/20/93 02/22/93 02/22/93 03/11/93

(5) Primary Dwelling Coverage Amount 76,000 B 113,500

91,200 158,500
80,400 68,000

Primary Dwelling Coverage Loss. % 80,937 125,212 95.755

(6)

Loss to Dwellino Amount 1.065

1.103 1.050
1.460 1.076 1.134

231;436
86,528 77,120 152,710

02
.

119,300

1.280

.
52

.
Al1

. .

.
Al1

Al1

%17,168

$5,72;,600

$6,466,075

1.130

II.

Summary (1)

Data

for

Al1

Other (3)

Policies

with (4)

GRC Coverage (5)

(2)
Policy 01 Claim

Date of
Loss ---

Bdsic Policy
Prenium $84,839,224

Priaary Dvellinq Coveraqe

AQOult $28,613,000,000

x
253,656

State
---

Nuaber __-

Primary Bdellinq Coveraqe Loss

$44,636,280

(6)

Ratio of Dwellinq Loss to Lwellim hount 0.002

U)=(6)/(5)

III.

A. B.

From

1 above:

GRC Coverage

Losses policies

= $6,466,075 with

$5,722,600 the

= 8743,475. following

From 1 and calculations (i)

Il

combined, for can be made:

al1

GRC coverage,

AT1 GRC Coveraae Al1 Basic Policy

Losses Premiums

= $17,168

$743.475 + f84,839,224 =

0 .9%

(ii)

Al1

GRC Coveraae Total Policies

Losses

$743.475 52 + 258,656

$2.87

562