ASOP 12: Risk Classification

Question 1

Section 1 - Purpose, Scope

Answer 1

1. Purpose – provide guidance to actuaries with respect to designing, reviewing or changing risk classification systems
2. Scope – applies to actuaries when designing, reviewing or changing risk classification systems intended to reflect the relative likelihood of expected outcomes
   - Includes expert testimony, regulatory activities, legislative activities, or statements concerning public policy
   - Risk classification can affect rate setting, contributions, reserves, benefits, dividends, experience refunds, analysis of results, underwriting and assumptions

Question 2

Section 3 - Analysis of Issues and Recommended Practices

Answer 2

1. Considerations in Selection of Risk Characteristics
a. Relationship of Risk Characteristics and Expected Outcomes
▪ Variation in the actual or expected experience correlates to the risk characteristic
▪ Rates considered equitable if difference in rates reflects material differences in expected cost
▪ Should consider interdependence of risk characteristics

b. Causality
▪ Do not need to demonstrate cause and effect relationship in order to use a specific risk characteristic

c. Objectivity
▪ Based on readily verifiable observable facts

d. Practicality
▪ Practical considerations such as cost, time and effort needed to evaluate

e. Applicable Law
▪ Whether law creates limitations on choice of risk characteristics o IndustryPractices
▪ Consider usual and customary risk classification in the industry

f. BusinessPractices
▪ Limitations related to business practices

2. Considerations in Establishing Risk Classes
a. Intended Use

b. Actuarial Considerations
▪ Adverse selection
▪ Credibility
▪ Practicality

c. Other Considerations
▪ Legal compliance, industry practice, business practice limitations

d. Reasonableness of Results

3. Testing the Risk Classification System
a. Test long-term viability of the system and determine any need for change

b. Effect of Adverse Selection
▪ When material, estimate the potential impact and appropriate mitigation measures o Risk Classes Used for Testing
▪ Consider using different set of risk classes for testing long-term viability if it improves the meaningfulness of the tests

c. Effect of Changes
▪ Test effects of changes in risk classification system, business or industry practices

d. Quantitative Analysis
▪ Analyze impact of compliance limitations, departures from industry practice, limitations of business practices, changes made by actuary, and effects of adverse selection

4. Reliance on Data Supplied by Others
a. Refer to ASOP #23 (this reliance should be disclosed)

5.Documentation
a. Refer to ASOP #41

Question 3

Section 4 - Communications and Disclosures

Answer 3

1. Communications and Disclosures
   a. Refer to ASOP #23 and #41 (Data and Actuarial Communications)
   b. Disclose impact of compliance limitations, departures from industry practice, limitations of business practices, changes made by actuary, and effects of adverse selection
2. Prescribed Statement of Actuarial Opinion
   a. Not required, unless law, regulation or accounting requirements apply
3. Deviation from Standard
   o Explain and justify any procedures that depart materially from these standards