Paul Budde, Ph. D., ACAS, MAAA Senior Vice President Using Catastrophe Models for Pricing: The Florida Hurricane Catastrophe Fund CAS Special Interest Seminar on Catastrophe Risk Management October 8, 2002

Florida Hurricane Catastrophe Fund

3 FHCF Ratemaking FHCF is a tax-exempt state trust fund administered by the Florida State Board of Administration FHCF is a tax-exempt state trust fund administered by the Florida State Board of Administration Mandatory reinsurer of all residential property in Florida (excl. surplus lines insurers and reinsurers) Mandatory reinsurer of all residential property in Florida (excl. surplus lines insurers and reinsurers) Limit available Limit available  2002/03 Contract Year$11.00 billion  Subsequent season capacity$9.62 billion 2002 annual premiums = $468 million 2002 annual premiums = $468 million Projected assets at 12/31/02 = $4.92 billion Projected assets at 12/31/02 = $4.92 billion

4 Florida Hurricane Catastrophe Fund FHCF Ratemaking $4.9 billion in net assets $461 million 2002 Hurricane Season Subsequent Season* (Assuming $11B loss in 2002) Subsequent Season* (Assuming $11B loss in 2002) $11.00 B $6.1 billion from bonding 2.21% assessment $6.1 billion from bonding 2.21% assessment $9.15 billion from bonding 3.79% assessment $9.15 billion from bonding 3.79% assessment $9.62 B * Bonding Aamounts and assessment levels as reported in May 14, 2002 Bonding Capacity Analysis

5 Coverage FHCF Ratemaking Covered events are all hurricanes causing property damage in Florida Covered events are all hurricanes causing property damage in Florida Coverage includes additional living expenses beginning in 2002 Coverage includes additional living expenses beginning in % of reimbursable loss added (within limit) for LAE 5% of reimbursable loss added (within limit) for LAE Companies select 45%, 75% or 90% coverage Companies select 45%, 75% or 90% coverage Companies have individual retentions and limits Companies have individual retentions and limits  Retention = x FHCF premium (2002/03)  Max. reimbursement = x FHCF premium (2002/03, projected) No reinstatement No reinstatement

6 2002/03 Industry Coverage FHCF Ratemaking FHCF Layer 88.08% of $12.49 billion excess of $3.84 billion FHCF Layer 88.08% of $12.49 billion excess of $3.84 billion $3.84 B $16.33 B 1-in-9.5 yrs 1-in-45 yrs

From Modeling to Pricing

8 How is/are catastrophe models selected? FHCF Ratemaking Florida Commission on Hurricane Loss Projection Methodology Florida Commission on Hurricane Loss Projection Methodology  Established in 1995  Role, as defined in Section (3)(a), Florida Statutes:  “The commission shall consider any actuarial methods, principles, standards, models, or output ranges that have the potential for improving the accuracy of or reliability of the hurricane loss projections used in residential property insurance rate filings. The commission shall, from time to time, adopt findings as to the accuracy or reliability of particular methods, principles, standards, models, or output ranges.” (emphasis added) FHCF uses all models deemed “acceptable” by Methodology Commission FHCF uses all models deemed “acceptable” by Methodology Commission  “to the extent feasible,” the FSBA must “employ actuarial methods, principles, standards, models, or output ranges found by the Commission to be accurate or reliable” in producing rates for the FHCF reimbursment premium. (Section (3)(b), F.S.)  Models used for 2002/2003: AIR, ARA, Catalyst, EQE, RMS

9 What Data to be Modeled? FHCF Ratemaking Start with data from prior year data call Start with data from prior year data call Cleansed Cleansed Adjusted, as necessary Adjusted, as necessary Trended forward one year Trended forward one year Aggregated Aggregated FHCF Goal: Provide all modelers with same data in a format that minimizes assumptions needed

10 How well does the data being modeled represent actual loss potential? FHCF Ratemaking Invalid ZIP Codes Invalid ZIP Codes Law and Ordinance Law and Ordinance Losses to FHCF layer Losses to FHCF layer  Pure premium to the layer  No reinstatements  Internal FFT aggregation model used to limit losses to one limit  ReMetrica – simulation to verify  2.1% reduction

11 How can we combine modeled results? FHCF Ratemaking Simple average Simple average  Equal weight to each result Median value Median value  Drop high and low “Mode” “Mode”  Some answers are closer to others. Ought those get more weight? Weighted average Weighted average  5 / 20 / 50 / 20 / 5 weighting scheme  If a model is revised, or if the mix of models changes, will overall changes be significant? (stability vs. accuracy)

12 Credibility theory? FHCF Ratemaking What credibility weight to What credibility weight to  Prior year modeling?  Prior versions of a model? FHCF has given full credibility to most recent modeling work FHCF has given full credibility to most recent modeling work  Best expression of actual exposure  With stochastic simulations of 50,000+ years, modeling results represent a complete “historical” picture  Assumes models are always improving, never regressing

13 How much total premium do we need to charge? FHCF Ratemaking Excess losses to layer Excess losses to layer Retention and limit adjustment Retention and limit adjustment Post-model adjustment factors Post-model adjustment factors Investment income credit Investment income credit Fixed expense loadings Fixed expense loadings Premium credits Premium credits 2002/03 FHCF premium $467.6 million 2002/03 FHCF premium $467.6 million

14 How is the premium allocated to risks? FHCF Ratemaking Primary Rating Factors Location, location, location! Location, location, location! Type of business Type of business Deductibles Deductibles Construction Construction Premium credits Premium credits

15 How are loss costs combined? FHCF Ratemaking Detailed ZIP Code level loss costs from 3 modelers Detailed ZIP Code level loss costs from 3 modelers Combined through straight average Combined through straight average Used to define territories and allocate premium across the different risk classifications Used to define territories and allocate premium across the different risk classifications

16 Assigning ZIP Codes to Territories FHCF Ratemaking Residential base (2%) deductible Residential base (2%) deductible Loss costs for blended construction Loss costs for blended construction Ranked Ranked

17 Territories FHCF Ratemaking 25 Regions 25 Regions ZIP Code definitions ZIP Code definitions Based on losses to layer Based on losses to layer Revised annually Revised annually Changes tempered Changes tempered

18 References FHCF Ratemaking Florida Hurricane Catastrophe Fund 2002 Ratemaking Formula Report to the Florida State Board of Administration March 28, 2002 Available through the FHCF website: (Look for meeting materials from the 28 March 2002 Advisory Council meeting, amended to final mitigation levels)

19 Speaker Notes FHCF Ratemaking Paul E. Budde, Ph.D., ACAS, MAAA Senior Vice President Benfield Blanch 3600 W 80 th St Minneapolis, MN