2007 CAS Ratemaking Seminar SPE-3 Actuarial Analysis of Catastrophes & Terrorism for Commercial Insurance Rimma Maasbach - ISO

Terrorism Loss Costs Topics (1)Overview of TRIA (2)Loss Costs – International Original (2002) Revised (2004) (3)TRIA Calculation of Federal Backstop Factors (4)Domestic Terrorism Pricing

Terrorism Pricing Terrorism Risk Insurance Act of 2002 (TRIA) Overview

Terrorism Rating Overview Line of InsuranceProductDerivation Commercial Property Loss CostAIR Model + ISO Adjustment General Liability Commercial Auto Percentage Loadings To Current Loss Costs ISO Modeling BusinessownersCombination of Property and GL Other Lines (e.g. CIM, Farm) Refer to Company

Terrorism Rating AIR Commercial Property Results City/CountyRankLoss Cost (Bldgs. & Cont.) Manhattan1$.173 Chicago4.068 Seattle8.010 Marin County36.001

Terrorism Rating Commercial Property Geographic Tiers TierCities/Counties Approx. Loss Cost High HazardNYC, Chicago, SF, DC $.100 Medium HazardLA, Boston, Houston, Phil., Seattle.010 Low HazardRemainder of USA.001

Commercial Property Adjustments to AIR Loss Costs Insurance – to – Value –Divide by.80 Nuclear/Bio-Chemical –Multiply by 2.00 Federal Backstop Factor –Insurer Retained Losses  Total Terrorism Losses Loss Adjustment Expenses –Add 5% of Adjusted Losses

Terrorism Pricing Initial Terrorism Loss cost filings Program Year 1 (2003) loss costs – Building coverage Tier 1 – NYC, Chicago, DC, San Francisco Tier 2 – Boston, Houston, LA, Philadelphia, Seattle Tier 3 – Remainder of Country TierLoss Cost

WASHINGTON, D.C. IMPLEMENTED TERRORISM LOSS COSTS

Changes to AIR Model (2004) 1.Revisions to Conventional Loss Estimates Relatively small overall effect (10%) reduction) Larger impact in certain zips/counties 2.Nuclear, Biological and Chemical (NBC) Loss Estimates Refined treatment estimates NBC losses on the same geographic basis as conventional losses. Replace the prior estimate which assumed NBC=Conventional Compresses Loss Costs within Large Metropolitan Areas, i.e., smaller loss costs in the center city, higher loss cost in outlying counties

AIR Terrorism Model Commercial Property Comparison of Annual Expected International Terrorism Losses 2002 AIR Version2004 AIR Version Conventional$1.45 Billion$1.30 Billion NBC $1.45 Billion*.95 Billion Total$2.90 Billion$2.25 Billion * Preliminary Estimate

Terrorism Loss Costs Sample Impacts of Updated Model Version Original Loss Costs New Loss Costs LocationConv.NBCCombConv.NBCComb. Downtown$.100 $.200$.090$.020$.110 Outlying Area

Terrorism Loss Costs Distribution of Conventional vs. NBC Original Loss Costs New Loss Costs LocationConv. %NBC %Conv. %NBC % Chicago50% 85%15% Lake Co., IL San Francisco Marin Co., CA Houston, TX

Revised Terrorism Loss Costs New Geographic Tier Definitions Tier (a) NatureDefinition (b)Approximate # 1By ZipLoss Cost = $.10~ 40 Zips contained in 4 cities 2By City/County (c)$.01 < Loss Cost < $. 04 ~ 80 3By County (C)Loss Cost < $.01~ 70 with loss cost = $.005 remainder = $.001 (a) “Tiers” still have relevance for the purpose of backstop factor application. (b) Loss costs are unadjusted for backstop. (c) There are around 3200 counties in the US.

TRIA Federal Backstop Mechanism Program Trigger:Minimum Threshold for Total Industrywide Loss Insurer Deductible:Each Insurer Pays 100% Under Deductible (Determined based on % of prior year’s total premium) Coinsurance:Insurer’s Share Above Deductible Recoupment Threshold: Portion of Loss (after application of Deductible & Coinsurance) below this threshold to be recouped by Feds, via Policyholder Surcharges Program Cap:Maximum Liability for [Industry + Feds]

Terrorism Risk Insurance Extension Act (TRIEA) Key Features –Two Additional years (2006 & 2007) –“Make Available” Requirement –International only (No Domestic) –Applies to Underlying Coverages only (e.g. No Mandatory CBRN) –Limited Lines of Insurance Property/Casualty Only Commercial Lines Only Some Commercial Lines Excluded –Federal Backstop Mechanism Continues Unchanged But Parameters Have Changed

TRIEA Parameters Comparison Across Years Event Trigger$5 Million$50 Million$100 Million Deductible15%17½%20% Coinsurance10% 15% Recoupment Threshold $15 Billion$25 Billion$27½ Billion Program Cap$100 Billion Lines of Insurance All Comm. Lines except Medical Malpractice (& Miscellaneous) All Commercial Lines, except Professional Liability, Commercial Auto, Farmowners, Surety (& Miscellaneous.)

Calculation of TRIA Federal Backstop Factors Calculate annual expected insured losses covered by the act – mean and the 99%ile – fit lognormal and gamma distributions. Calculate industry deductible based on earned premium for the prior year. % market share impacted increases with the size of loss. Relative impacts – losses will not be distributed exactly according to insurer’s market share. Assume each quintile incurs an uneven percentage of losses – e.g., 10%, 15%, 20%, 25%, 30%. Calculate retained insured losses as a percentage of total losses, subject to the $100B cap. Distribute average retention among tiers – greater impact for Tier 1 with greater loss potential.

Certified Terrorism Federal Backstop Factors Tier * 1 (High Hazard) –.85 2 (Medium Hazard) (Low Hazard) – 1.00 * Preliminary estimate based on latest version of AIR Model and current methodology for calculating Backstop factors.

Commercial Property Domestic Terrorism Comparison of Annual Expected Losses based on AIR’s Terrorism Model 2004 Domestic 2004 International Conventional$155M$1.30B NBC 65M.95B Total$220M$2.25B Domestic as a percentage of International = 10%

Terrorism Pricing Domestic Terrorism Loss Costs AIR domestic terrorism loss costs for events $25M – no overlap with smaller terrorism losses included in ratemaking experience Compared domestic terrorism loss costs to average commercial property loss costs Domestic terrorism loading included in Basic Group I loss costs to achieve overall desired effect. 1.0% for Boston, Chicago, DC, Los Angeles and New York City 0.5% elsewhere

Commercial Property Terrorism Pricing Rimma Maasbach