B.6 LAE, UW Expenses, and Profit Load

Question 1

2 ways to incorporate ALAE in indications

Answer 1

1. Included with loss: Add loss and ALAE and treat as 1
   amount.
2. Analyzed separately: This is done if ALAE is large as
   in some commercial lines. ALAE is then developed and
   trended separately from loss.

Question 2

Pure Premium Method Formula

Answer 2

Indicated Prem = (Pure Prem incl. LAE + Fixed Expense per Exposure)/(1-

Question 3

Loss Ratio Method Formula

Answer 3

Indicated Change = ((Loss and LAE Ratio + Fixed Expense Ratio)/(1-

Question 4

3 methods to incorporate UW expenses in pricing

Answer 4

1. All Variable Expense Method: Treat all UW expenses as
   variable to premium. This assumes future expense ratios
   will be consistent with historical expense ratios.
2. Premium-Based Projection Method: This assumes future expense ratios will be consistent with historical expense ratios, but separately calculates fixed and variable expense ratios.
3. Exposure/Policy-based Projection Method: In this method you divide fixed expenses by exposures (or policy counts), and divide variable expenses by premium (as in the other methods).

Question 5

Which expense categories relate to written vs earned

premium

Answer 5

Other Acquisition: Written Premium
Commissions & Brokerage: Written Premium
Taxes, Licenses, & Fees: Written Premium

General Expenses: Earned Premium

Question 6

Which expense categories generally use state vs

countrywide data

Answer 6

Other Acquisition: Countrywide
General Expenses: Countrywide

Commissions & Brokerage: State
Taxes, Licenses, & Fees: State

Question 7

Shortcoming of All Variable Expense Method

Answer 7

Since the All Variable Expense Method treats all expenses as variable, this method can result in inaccurate cost estimates if some expenses are truly fixed. If some expenses are fixed, then this method will undercharge risks with lower than average premium, since it assumes that all expenses are variable and are fully reduced with the lower average premium. Similarly, it will overcharge risks with higher than average premium, as it bases the expenses fully on the higher average premium.

Question 8

One way to address shortcoming of All Variable

Expense Method

Answer 8

Use a premium discount or expense constant in the rating algorithm.

Question 9

3 shortcomings of Premium-Based Projection Method,

and how they can be addressed

Answer 9

1. Rate changes can impact historical expense ratios, causing them to be different than the expected future ratios. One way to solve for this is to on-level premiums before calculating the expense ratios, though it can be difficult to on-level countrywide premiums.
2. Premium trends can also impact expense ratios. A solution to solving this is to trend all premiums to the projected future level before calculating expense ratios.
3. This method can create inequitable rates across states for multi-state insurers when countrywide fixed expenses are allocated to the state level. The issue is that states with higher average premium will get a higher allocation of fixed expenses, which may not be fair. One way to solve this would be to calculate fixed expense ratios by state.

Question 10

4 possible enhancements to the Exposure/Policy

Based Projection Method

Answer 10

1. Finding a more scientific way to split expenses into fixed and variable components.
2. Finding a more equitable way to allocate countrywide
   expenses to states.
3. Some expenses that are considered fixed actually do vary by characteristics such as whether a policy is new business or a renewal. To the extent that the distribution of these characteristics varies by state or is changing over time, this method could result in inequitable allocations of fixed expenses.
4. The existence of economies of scale in a changing book of business will lead to increasing or decreasing future average expenses per exposure. These impacts could be identified more directly and quantified.

Question 11

2 ways to incorporate non-proportional reinsurance

costs into ratemaking

Answer 11

1. Restate all premium and loss data to be net of reinsurance.
2. Calculate the net cost of reinsurance and treat it as a fixed expense.

Question 12

Formulas for Variable PLR and Total PLR

Answer 12

Variable PLR = 1 - Variable Expense % -
Target UW Profit %
Total PLR = 1 - Total Expense % - Target UW Profit %