B.6. LAE, UW Expenses, and Profit Load

Question 1

Two ways to incorporate ALAE in indications

Answer 1

1. Include with losses

2. Analyzed separately (done if ALAE is large as in some commercial lines)

Question 2

Pure Premium Method Formula

Answer 2

Indicated Premium = (Pure Premium including LAE + Fixed Expense per Exposure) / (1 - V - Q)

Question 3

Loss Ratio Method Formula

Answer 3

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

Question 4

3 methods to incorporate UW expenses in pricing

Answer 4

1. All variable expense method
2. Premium-based projection method
3. Exposure/policy- based projection method

Question 5

All variable expense method

Answer 5

Treat all UW expenses as variable to premium

Question 6

Premium-based projection method

Answer 6

Assumes future expense ratios will be consistent with historical expense ratios, but separately calculates fixed an variable expense ratios

Question 7

Exposure/policy-based projection method

Answer 7

Divide fixed expenses by exposures (or policies) and divide variable expenses by premium

Question 8

Shortcoming of all variable expense method

Answer 8

Inaccurate if some expenses are truly fixed. Will undercharge risks with lower than average premium since it assumes the expenses are reduced with lower premium

Question 9

Matching expense categories with data

Other acquisition
General expenses
Commission
Taxes

Answer 9

Other acquisition, general expenses: CW

Commission, taxes: state

Question 10

3 shortcomings of premium-based method and how they can be addressed

Answer 10

1. One time changes can cause inaccurate historical expense ratios. On-level premiums before calculating expense ratio
2. Premium and/or expense trends can impact ratios. Trend all premiums and expenses to the projected future level
3. Can create inequitable rates across states when CW fixed expenses are allocated by state. Calculate ratios by state

Question 11

One way to address shortcoming of All Variable Expense Method

Answer 11

Premium discount or expense constant in rating algorithm

Question 12

2 ways to incorporate non-proportional reinsurance costs into ratemaking

Answer 12

1. Restate premiums and losses net of reinsurance

2. Calculate net cost of reinsurance and treat as fixed expense

Question 13

4 possible enhancements to the exposure/policy based projection method

Answer 13

1. Find more scientific way to split expenses into fixed/variable
2. Find more equitable way to allocate CW expenses
3. Some expenses vary by other characteristics
4. Economies of scale in a changing book will lead to increasing/decreasing future average expenses per exposure. Can identify and quantify these impacts

Question 14

Variable PLR

Answer 14

1 - Variable Expense % - Target UW Profit %

Question 15

Total PLR

Answer 15

1 - Total Expense % - Target UW Profit %