Are Territorial Rating Models Outdated in Residential Property Insurance Markets? Evidence from the Florida Property Insurance Market
Risk Management & Insurance Review, Forthcoming
42 Pages Posted: 6 Feb 2010 Last revised: 27 Jan 2011
Date Written: February 5, 2010
The fundamental shift in rating methodology from historical loss costs to catastrophe modeling for windstorm coverage calls into question the accuracy of rates developed using rating territories. Using premiums and modeled average annual loss estimates from Citizens Property Insurance Corporation (Citizens) in Florida, this paper analyzes the use of distance-to-coast as a rating variable in providing coverage for the windstorm peril in homeowners insurance. Catastrophe models used to generate average annual loss costs do not rely on the same application of the law of large numbers as using historical loss costs and thus allows for more granular pricing of the windstorm peril. The results show that distance-to-coast, a rating variable that is property specific, more closely aligns premiums and average annual losses than territorial rating and allows more granular pricing of the windstorm peril. More granular risk based pricing provides better incentives for homeowners regarding location and mitigation choices and may help reduce aggregate exposure to windstorm damages in the long run.
Keywords: insurance, pricing, catastrophe models, granularity, rating variables
JEL Classification: G22
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