7 reasons geospatial-based property ratings should replace historical territory ratings

The P&C insurance industry’s combined ratio is forecast to worsen to 105.6% from 99.5%, according to the Insurance Information Institute. Over the past several years insurers have been teetering around the edges of profitability. The industry must find better ways to assess, underwrite and price risk — and more accurately select and price policies in line with the actual risk of a property.

Growing losses, in part, can be attributed to the frequency and severity of large natural disasters — and population shifts to more catastrophe-prone areas. However, decreased profits also stem from a lack of granular, accurate information about potential hazards and exposure to loss at each insured location.

Pricing by territory is insufficient

Underlying the problem — and the need for change — is the fact that typical territory-based definitions and ratemaking methods are insufficient and inefficient. Insurers have the difficult task of balancing the need to create territories large enough to be credible from a statistical perspective — yet small enough to represent homogeneous regions where exposure to loss is relatively uniform.

Although traditional territory-based ratings have been a part of the actuarial tool kit for decades, they pose major issues and challenges to product managers, actuaries, underwriters and information technology teams. One key reason why is that most perils are not correlated with ZIP codes, state or municipal boundaries, yet territories are often underwritten and defined by these boundaries. Historical territory-based definitions are simply not sufficiently correlated with a propensity for loss. And further, perils are inconsistent within boundaries — and territory boundaries are constantly changing.

The new era of geospatial hazard rating

The limitations of territorial rating will inevitably become a thing of the past due to significant advances in geographic information systems (GIS), geospatial artificial intelligence (GeoAI), and greater access to the location-specific data and risk scores they can provide. 

Geospatial hazard rating leverages satellite technology and advanced GIS systems to provide location-specific data and hazard scores. These scores rely on complex calculations, made rapidly with the assistance of GeoAI and delivered in real time through application program interfaces. Geospatial hazard rating is produced for each individual address by aggregating historical data and events for a given peril within a specific geographical radius instead of relying on much larger, arbitrary and less accurate territorial boundaries.

There are a broad range of benefits in using geospatial hazard rating over traditional territorial methods, including:

1. Accuracy in risk assessment: Geospatial hazard rating can isolate the geographic distribution of risk at the individual residential or commercial property level, as opposed to the much larger area municipal, ZIP code and census block boundaries used in territorial methods. As such, insurers can precisely understand, underwrite, and price a specific property’s risks.

2. Increase premiums without rate changes: Another benefit to using geospatial hazard rating instead of territorial-based rating, is the ability to respond to changes in risk levels without rate changes. When a specific area starts to see more damaging events, the corresponding hazard scores for those specific addresses will increase over time and result in a corresponding increase in premium at renewal, making some rate changes for an entire territory unnecessary.

3. Fairness and accuracy in pricing: With such accuracy, comes the ability to tie higher risk probabilities to higher premiums and lower risk probabilities to lower premiums automatically when geospatial hazard ratings are updated at acquisition or renewal.

4. Supporting data for rate changes: Although geospatial hazard rating will make it less necessary to seek rate changes for geographic changes in risk, in the event a rate change is needed, insurers will have the very detailed data needed to justify the change.

5. Speed and efficiency of risk assessments and policy quotes: With specific hazard ratings for every peril for every customer and prospective customer address, geospatial applications and geospatial hazard ratings enable insurers to greatly increase the speed at which they undertake property assessments and policy quotes.

6. New risk insights: Because geospatial data is highly structured, highly objective and collected at a high scale, insurers gain increased abilities to analyze data and identify new risk insights that are not possible with traditional territorial rating.

7. Reduce losses and expense ratios: Although it is early in the adoption of geospatial data, the business use cases for such applications point to a real and significant opportunity to reduce losses and improve combined ratios by better aligning price with risk — and eliminating the burden of administering territories.

Together, these benefits present a new frontier and new opportunity for P&C insurers. By moving beyond legacy territorial ratings, every property can be rated fairly according to its actual exposure to loss, without subsidy and without bias.

Tammy Nichols Schwartz, CPCU, is the senior director of data & analytics at Guidewire, a leading provider of technology solutions to the P&C insurance industry. She has more than 20 years of experience as an actuary, underwriter, and executive at leading insurance carriers and financial institutions including Farmers Insurance and Bank of America. Prior to Guidewire, Schwartz was the Founder and CEO of Black Swan Analytics.

Opinions expressed here are the author’s own.

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