B5. Loss-Sensitive Rating Plan

Question 1

Pros/Cons LSRP to Insureds

Answer 1

Advantages:
* Financial incentive for loss control
* Opportunity to save money in the short term with good experience
* Possible cash flow benefits vs traditional insurance policy
* Possible savings from reduced premium-based taxes and assessments

Disadvantages
* Uncertain costs vs traditional insurance plan
* Loss of immediate tax deductibility of traditional insurance premium
* Possibility of high costs in the short term with bad experience
* Additional complexityvs a traditional insurance plan
* The need to set aside collateral against credit risks (for some plans)

Question 2

Pros/Cons LSRP to Insurers

Answer 2

Advantages
* Insured’s immediate financial incentive for loss control
* Greater willingness to write risks that wouldn’t otherwise write on a traditional policy
* Less captial required to write policies since insured retains a greater portion of risks vs traditional policy

Disadvantages
* Higher administrative costs vs traditional policy
* Existence of credit risk (for some plans)
* Possible cash flow disadvantages vs traditional policy

Question 3

What is in Basic Premium

Answer 3

• UW profit provision
• UW expenses not included in taxes (T)
• Fixed Commissions

Question 4

What is in Loss Conversion Factor (C)

Answer 4

Expenses assumed to be proportional to actual losses