Paul Budde, Ph. D., ACAS, MAAAPaul Budde, Ph. D., ACAS, MAAASenior Vice PresidentSenior Vice President

Using Catastrophe Models for Pricing: Using Catastrophe Models for Pricing: The Florida Hurricane Catastrophe FundThe Florida Hurricane Catastrophe Fund

CAS Special Interest Seminar on CAS Special Interest Seminar on Catastrophe Risk ManagementCatastrophe Risk ManagementOctober 8, 2002October 8, 2002

Florida Hurricane Catastrophe FundFlorida Hurricane Catastrophe Fund

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Florida Hurricane Catastrophe FundFlorida Hurricane Catastrophe FundFHCF RatemakingFHCF Ratemaking

FHCF is a tax-exempt state trust fund administered by the Florida FHCF is a tax-exempt state trust fund administered by the Florida State Board of AdministrationState Board of Administration

Mandatory reinsurer of all residential property in Florida (excl. Mandatory reinsurer of all residential property in Florida (excl. surplus lines insurers and reinsurers)surplus lines insurers and reinsurers)

Limit availableLimit available

2002/03 Contract Year2002/03 Contract Year $11.00 billion$11.00 billion

Subsequent season capacitySubsequent season capacity $9.62 billion$9.62 billion

2002 annual premiums = $468 million2002 annual premiums = $468 million

Projected assets at 12/31/02 = $4.92 billionProjected assets at 12/31/02 = $4.92 billion

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Florida Hurricane Catastrophe FundFlorida Hurricane Catastrophe FundFHCF RatemakingFHCF Ratemaking

$4.9 billion in net assets

$461 million

2002 Hurricane Season2002 Hurricane Season Subsequent Season*Subsequent Season*(Assuming $11B loss in 2002)(Assuming $11B loss in 2002)

$11.00 B$11.00 B

$6.1 billion from bonding2.21% assessment

$9.15 billion from bonding3.79% assessment

$9.62 B$9.62 B

* Bonding Aamounts and assessment levels as reported in May 14, 2002 Bonding Capacity Analysis* Bonding Aamounts and assessment levels as reported in May 14, 2002 Bonding Capacity Analysis

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CoverageCoverageFHCF RatemakingFHCF Ratemaking

Covered events are all hurricanes causing property damage in Covered events are all hurricanes causing property damage in FloridaFlorida

Coverage includes additional living expenses beginning in 2002Coverage includes additional living expenses beginning in 2002 5% of reimbursable loss added (within limit) for LAE5% of reimbursable loss added (within limit) for LAE Companies select 45%, 75% or 90% coverageCompanies select 45%, 75% or 90% coverage Companies have individual retentions and limitsCompanies have individual retentions and limits

Retention = 8.03106 x FHCF premium (2002/03)Retention = 8.03106 x FHCF premium (2002/03)

Max. reimbursement = 23.5254 x FHCF premium (2002/03, projected)Max. reimbursement = 23.5254 x FHCF premium (2002/03, projected)

No reinstatementNo reinstatement

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2002/03 Industry Coverage2002/03 Industry CoverageFHCF RatemakingFHCF Ratemaking

FHCF Layer88.08% of

$12.49 billion excess of $3.84 billion

$3.84 B$3.84 B

$16.33 B$16.33 B

1-in-9.5 yrs1-in-9.5 yrs

1-in-45 yrs1-in-45 yrs

From Modeling to PricingFrom Modeling to Pricing

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How is/are catastrophe models selected?How is/are catastrophe models selected?FHCF RatemakingFHCF Ratemaking

Florida Commission on Hurricane Loss Projection MethodologyFlorida Commission on Hurricane Loss Projection Methodology Established in 1995Established in 1995

Role, as defined in Section 627.0628(3)(a), Florida Statutes:Role, as defined in Section 627.0628(3)(a), Florida Statutes: ““The commission shall consider any actuarial methods, principles, The commission shall consider any actuarial methods, principles,

standards, models, or output ranges that have the potential for standards, models, or output ranges that have the potential for improving improving the accuracy of or reliability of the hurricane loss projectionsthe accuracy of or reliability of the hurricane loss projections used in used in residential property insurance rate filings. The commission shall, from residential property insurance rate filings. The commission shall, from time to time, adopt findings as to the accuracy or reliability of particular time to time, adopt findings as to the accuracy or reliability of particular methods, principles, standards, models, or output ranges.” (emphasis methods, principles, standards, models, or output ranges.” (emphasis added)added)

FHCF uses all models deemed “acceptable” by Methodology FHCF uses all models deemed “acceptable” by Methodology CommissionCommission ““to the extent feasible,” the FSBA must “employ actuarial methods, to the extent feasible,” the FSBA must “employ actuarial methods,

principles, standards, models, or output ranges found by the principles, standards, models, or output ranges found by the Commission to be accurate or reliable” in producing rates for the Commission to be accurate or reliable” in producing rates for the FHCF reimbursment premium. (Section 627.0628(3)(b), F.S.)FHCF reimbursment premium. (Section 627.0628(3)(b), F.S.)

Models used for 2002/2003: AIR, ARA, Catalyst, EQE, RMSModels used for 2002/2003: AIR, ARA, Catalyst, EQE, RMS

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What Data to be Modeled?What Data to be Modeled?FHCF RatemakingFHCF Ratemaking

Start with data from prior year data callStart with data from prior year data call

CleansedCleansed

Adjusted, as necessaryAdjusted, as necessary

Trended forward one yearTrended forward one year

AggregatedAggregated

FHCF Goal: Provide all modelers with same data in a FHCF Goal: Provide all modelers with same data in a format that minimizes assumptions neededformat that minimizes assumptions needed

1010

How well does the data being modeled represent How well does the data being modeled represent actual loss potential?actual loss potential?

FHCF RatemakingFHCF Ratemaking

Invalid ZIP CodesInvalid ZIP Codes Law and OrdinanceLaw and Ordinance Losses to FHCF layerLosses to FHCF layer

Pure premium to the layerPure premium to the layer

No reinstatementsNo reinstatements Internal FFT aggregation model used to limit losses to one limitInternal FFT aggregation model used to limit losses to one limit

ReMetrica – simulation to verifyReMetrica – simulation to verify

2.1% reduction2.1% reduction

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How can we combine modeled results?How can we combine modeled results?FHCF RatemakingFHCF Ratemaking

Simple averageSimple average

Equal weight to each resultEqual weight to each result

Median valueMedian value

Drop high and lowDrop high and low

““Mode”Mode”

Some answers are closer to others. Ought those get more weight?Some answers are closer to others. Ought those get more weight?

Weighted averageWeighted average

5 / 20 / 50 / 20 / 5 weighting scheme5 / 20 / 50 / 20 / 5 weighting scheme

If a model is revised, or if the mix of models changes, will overall If a model is revised, or if the mix of models changes, will overall changes be significant? changes be significant? (stability vs. accuracy)(stability vs. accuracy)

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Credibility theory?Credibility theory?FHCF RatemakingFHCF Ratemaking

What credibility weight to What credibility weight to

Prior year modeling?Prior year modeling?

Prior versions of a model?Prior versions of a model?

FHCF has given full credibility to most recent modeling FHCF has given full credibility to most recent modeling workwork

Best expression of actual exposureBest expression of actual exposure

With stochastic simulations of 50,000+ years, modeling results With stochastic simulations of 50,000+ years, modeling results represent a complete “historical” picturerepresent a complete “historical” picture

Assumes models are always improving, never regressingAssumes models are always improving, never regressing

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How much total premium do we need to charge?How much total premium do we need to charge?FHCF RatemakingFHCF Ratemaking

Excess losses to layerExcess losses to layer

Retention and limit adjustmentRetention and limit adjustment

Post-model adjustment factorsPost-model adjustment factors

Investment income creditInvestment income credit

Fixed expense loadingsFixed expense loadings

Premium creditsPremium credits

2002/03 FHCF premium $467.6 million2002/03 FHCF premium $467.6 million

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How is the premium allocated to risks?How is the premium allocated to risks?FHCF RatemakingFHCF Ratemaking

Primary Rating FactorsPrimary Rating Factors

Location, location, location!Location, location, location!

Type of businessType of business

DeductiblesDeductibles

ConstructionConstruction

Premium creditsPremium credits

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How are loss costs combined?How are loss costs combined?FHCF RatemakingFHCF Ratemaking

Detailed ZIP Code level loss costs from 3 Detailed ZIP Code level loss costs from 3 modelersmodelers

Combined through straight averageCombined through straight average

Used to define territories and allocate premium Used to define territories and allocate premium across the different risk classificationsacross the different risk classifications

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Assigning ZIP Codes to TerritoriesAssigning ZIP Codes to TerritoriesFHCF RatemakingFHCF Ratemaking

Residential Residential base (2%) base (2%) deductibledeductible

Loss costs Loss costs for blended for blended constructionconstruction

RankedRanked

Rating Region Loss Costs and Territory Definitions

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25Territories

Aver

age

Loss

Cos

ts

Ave LCsCentersExponentialLinear

Mix 79:21Mix 21:79Graduated

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TerritoriesTerritoriesFHCF RatemakingFHCF Ratemaking

3 1

1

7

11

11

7

6

8

10

88

5 6

6

7

6

6

7

5

5

9

10

6

534

6

3

3

3

4

4

3

4

22

2

3223

2

31

1

3

1

21

1

1

1

2

4

5

4

867

5

5 1

32

11

1

1

11

11

1421

2

1

1 2

22

11

2002 RatingRegions

Not Rated1234567891011121314151617181920212223

Florida Hurricane Catastrophe Fund

Entire State

Paragon Reinsurance RiskManagement Services, Inc.

Proposed 2002 Rating Territories by 5-Digit ZIP Code

j:\fhcf\2002\ratemaking\maps\2002prelim temp2.wor (layout1)3/02

25 Regions25 Regions

ZIP Code ZIP Code definitionsdefinitions

Based on Based on losses to losses to layerlayer

Revised Revised annuallyannually

Changes Changes temperedtempered

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ReferencesReferencesFHCF RatemakingFHCF Ratemaking

Florida Hurricane Catastrophe FundFlorida Hurricane Catastrophe Fund

2002 Ratemaking Formula Report to the 2002 Ratemaking Formula Report to the

Florida State Board of AdministrationFlorida State Board of Administration

March 28, 2002March 28, 2002

Available through the FHCF website:Available through the FHCF website:

http://www.fsba.state.fl.us/fhcf/http://www.fsba.state.fl.us/fhcf/

(Look for meeting materials from the 28 March 2002 Advisory (Look for meeting materials from the 28 March 2002 Advisory Council meeting, amended to final mitigation levels)Council meeting, amended to final mitigation levels)

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Speaker NotesSpeaker NotesFHCF RatemakingFHCF Ratemaking

Paul E. Budde, Ph.D., ACAS, MAAAPaul E. Budde, Ph.D., ACAS, MAAASenior Vice PresidentSenior Vice PresidentBenfield BlanchBenfield Blanch3600 W 803600 W 80thth St StMinneapolis, MN 55431Minneapolis, MN 55431Paul.budde@benfieldgroup.comPaul.budde@benfieldgroup.com