Why P&C is starting to use geospatial-based hazard ratings

The P&C insurance industry’s combined ratio rose from 99.5% in 2021 to an estimated 105.6% in 2022, according to the Insurance Information Institute. Many insurers have struggled to maintain profitability, and as such, they must seek improved methods to evaluate, underwrite, and price risk. 

The increasing losses can be attributed, in part, to the frequency and intensity of significant natural disasters, as well as the population’s migration to regions that are more prone to catastrophes. The decline is also due to the insufficient availability of precise and detailed information concerning potential risks and the exposure to loss at each insured location.

Pricing by territory is insufficient

Underlying the challenge – and the need for change – is the fact that typical territory definitions and ratemaking methods are insufficient and inefficient. Insurers have the arduous 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. 

While traditional territory ratemaking has been utilized by actuaries for several decades, it presents significant difficulties for product managers, underwriters, actuaries, and IT teams. The primary issue is that most all risks are not correlated with zip codes or municipal boundaries. Historical territory definitions are simply not sufficiently correlated with the propensity for loss. 

The new era of geospatial hazard rating

With the significant advancements in Geographic Information Systems (GIS) and Geospatial Artificial Intelligence (GeoAI), along with increased accessibility to location-specific data and risk scores, the restrictions imposed by territorial rating can soon be retired.

Geospatial Hazard Rating utilizes satellite technology and sophisticated GIS systems to offer location-specific data and hazard scores. These scores are determined by intricate calculations, which are rapidly performed with the help of GeoAI and delivered in real-time through Application Program Interfaces (APIs). Rather than relying on large, arbitrary, and less accurate territorial boundaries, Geospatial Hazard Ratings are produced for each individual address by collecting historical data and events for a specific peril within a defined geographical radius.

Geospatial Hazard Rating offers a wide range of advantages over traditional territorial rate-making methods, such as:

Improving the accuracy of risk assessments – By utilizing Geospatial Hazard Rating, it becomes possible to identify the precise distribution of risk at the level of individual residential or commercial properties, rather than relying on broader territorial methods that use larger area boundaries such as municipal, zip code, or census block boundaries. This allows insurers to gain a detailed understanding of the risks associated with a particular property and to underwrite and price accordingly.
Adjusting premiums without rate changes – Employing Geospatial Hazard Rating as opposed to territorial rating also permits adjusting to fluctuations in risk levels without rate changes. When damaging events become more frequent in a particular region, the hazard scores assigned to the corresponding addresses will gradually rise, leading to a corresponding rise in premiums at renewal time. Consequently, adjusting rates for an entire territory may not be necessary.
Supporting data for rate changes – And while 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.
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.
Speed and efficiency of risk assessments – Geospatial applications and Geospatial Hazard Rating offer insurers the ability to greatly improve the speed in conducting property assessments and generating policy quotes by providing precise hazard ratings for each peril at each customer’s or prospective customer’s address.New risk insights – Because geospatial data is highly structured, highly objective, and collected at a high scale, 

insurers also gain enhanced capabilities to analyze data and uncover novel risk insights that would not be feasible with traditional territorial rating.
Together, these benefits present a new frontier for the P&C insurance industry. 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.

By moving beyond legacy territorial ratings, every property can be rated fairly according to its actual exposure to loss, without subsidy and without bias.