Chapter 12: Actuarial Investigations Flashcards
6 Steps involved in rating analyses
- estimating ultimate claims
- estimating profitability of existing rates
- projection forward to a new rating period
- reviewing the suitability of the existing rating structure
- comparing rates with those of competitors
- analysing the profitability of old years on new rates
Rating analyses:
Estimating ultimate claims
The new premium rate for a policy will be based on the expected cost of claims for that policy.
We estimate this cost using recent claims experience from the existing portfolio.
Rating analyses:
Estimating profitability of existing rates
Estimate the profitability of the existing premium rates by reference to the recent claims experience, adjusted if necessary for any abnormal features.
We will look at the claims corresponding to the premium and compare actual and expected experience.
Rating analyses:
Projection forward to a new rating period
Project forward to the period over which the new rates will be charged and the corresponding claims will be settled.
In doing this, we make assumptions about future claims trends and inflation.
rating structure
The relative levels of premium charged to different policyholders, depending on their particular risk profile.
Rating analyses:
Comparing rates with those of competitors
In making the final pricing decision, we will be strongly influenced by what the market is doing.
Our premium rates must make allowance for our competitors’ rates.
What should be done when entering a new market with no suitable data from its own experience? (4)
- We may be able to use some relevant external data or internal data from related accounts.
Alternatively, we could:
- as reinsurers
- partner with another insurer on a quota-share basis and use their data
- use market data such as Lloyd’s
4 Sources of “relevant external data”
- reinsurers’ data
- industry data
- other insurers’ data
- relevant organisations or government bodies
Define “deferred acquisition costs”
Acquisition costs relating to contracts in force at the balance sheet date.
They are carried forward as an asset from one accounting period to subsequent accounting period in the expectation that they will be recoverable out of future margins within insurance contracts, after providing for future liabilities.
4 parts of expenses analysis
We:
- split between DIRECT VS INDIRECT expenses
- split between TYPES OF EXPENSE (initial, admin, renewal, claims, investment)
- allocate by CLASS AND RATING GROUP
- express the expenses as a proportion of numbers of policies or claims, or of amounts of premium, sum insured or claim
Direct expenses
Those expenses that can be directly allocated to a class of business
Indirect expenses
(overheads)
Relate to support functions, and therefore cannot be directly attributed to any one class of business or policy.
Non-commission expenses can be split into (5)
- initial expenses
- administration expenses
- renewal expenses
- claims expenses
- investment expenses
Initial expenses
Arise when business is being acquired and written into the books of the insurer
Renewal expenses
Incurred in the recosting, renewing or lapsing of a policy at the end of the policy period.
Claims expenses
Incurred in the assessment and payment of policyholder compensation.
Initial, administration and renewal expenses
can be loaded according to whether the expenses is proportional to: (3)
- the number of contracts being acquired or on the books
- the amount of sum insured or EML
- the amount of premiums being acquired or on the books
Most expenses are proportional to the contracts in force, with 2 exceptions:
- underwriting expenses (mainly related to the amounts of new business premium)
- claims expenses (related to the level of claims payout, with higher expenses for larger claims)
Fixed expenses
The expenses that remain relatively fixed (in the short term),
regardless of how many policies we sell
Variable expenses
Expenses that vary according to the amount of insurance business being handled.
They may be linked to the number of policies, claims or the amount of premiums.
Main items of a general insurers expense are:
- salaries and salary-related expenses
- property costs (rent, property taxes, heating, lighting and cleaning)
- computer costs
- investment costs (investment dept, stamp duty, commission, etc.)
- one-off capital costs
- claims handling costs
The process of allocating expenses
Expenses are split down and analysed into required “cells”, being:
- whole business of the insurer
- whole business of a particular accounting fund
- each main product line of the insurer
Why might an insurer want to allocate expenses to different product lines?
To accurately as possible ensured that
- the premium charged to each class is correct, and
- the profitability of each class is assessed correctly.
Staff salaries can be split into 3 groups:
- staff whose work falls entirely within a single cell of the analyses
- staff whose work falls within more than one cell
- other staff
10 types of reinsurance investigations
Analyses of:
- the REQUIRED RISK RETENTION allowing for the solvency position
- the extent of exposure to ACCUMULATIONS OF RISK
- the need for CATASTROPHE reinsurance
- the need for REINSTATEMENTS
- the VALUE FOR MONEY of existing reinsurance
- the APPROPRIATENESS of existing cover
- the PROFITABILITY of layers
- the effects on CAPITAL
- the cost of COMMUTATION
- to check on the REINSURERS’ SOLVENCY LEVELS and assess the need for a bad debt provision.
Commuting a reinsurance contract
Means that the insurer accepts a fixed premium now and the reinsurer does not make any future payments to the insurer.
ie the insurer swaps future recoveries for a fixed sum.
Why are commutations used?
An insurer may wish to commute a reinsurance arrangement:
- if it helps with the insurer’s cashflow, or
- if it is concerned about the solvency of the reinsurer.
Describe the consequences for an insurer of taking out TOO LITTLE REINSURANCE.
If too little reinsurance is used, and experience is worse than assumed, there is a risk of
- sharply reduced profit and
- lower published solvency, or even
- insolvency
for the insurer.
Describe the consequences for an insurer of taking out TOO MUCH REINSURANCE.
If too much reinsurance is used then the reinsurer will be profiting at the insurer’s expense in the long term.
7 Main reasons for monitoring business written
- assess performance against goals
- manage risk
- gain market intelligence
- satisfy the regulators
- influence the market
- assist with reserving
- validate assumptions as part of the actuarial control cycle
4 key factors monitored (in business monitoring)
- premium rate changes
- portfolio movements
- volumes of quotations
- persistency and profitability by source
6 aspects of portfolio movements that are monitored
- lapses at renewal / renewal rates
- new business volumes
- quotes that result in written business
- mid-term cancellations
- policy endorsements
- mix of business
4 Main methods of calculating premium rate changes
- direct calculation for each risk separately
- direct calculation using a standard risk
- measuring rate changes on individual renewals
- using underwriters’ views
5 Features of a good business monitoring system
- tailored output
- accurate and validated data / results
- easy to use and well documented
- consistent over time and with other data sources and analyses
- minimal delay between data cut-off and production of results
6 uses for actuarial investigations
- carry out profit testing
- estimate price elasticity
- create lifetime pricing models
- redesign rating tariffs
- help with other pricing and reinsurance decisions
- feed into other processes
Reasons for monitoring business written:
Assessing performance against the organisation’s goals
The ultimate goal for most general insurance companies is to exceed a minimum level of profit or return on equity for a given level of risk.
However, companies will break this objective into more specific targets.
… this will enable different parts of the business to be monitored more effectively.
… If one target is not met, it could be investigated and rectified.
Reasons for monitoring business written:
Managing risk
Monitoring business written allows the company to assess how much risk is inherent to the portfolio.
This will be a factor in determining
… how much CAPITAL the company should hold and
… what its REINSURANCE purchasing strategy should be.
Reasons for monitoring business written:
Gaining market intelligence
Monitoring written business can provide useful information about competitors’ strategies.
It can also allow the company to compare itself with the market and assess the UNDERWRITING CYCLE.
Reasons for monitoring business written:
Satisfying regulators
Market regulators may require periodic monitoring and reporting of written business.
Reasons for monitoring business written:
Influencing the market
A company may be able to influence the market by publishing the results of its monitoring exercises.
An example of how an insurer’s results might have an impact on market behaviour.
A company might choose to publish its persistency rates.
If the company has been retaining its business, this may attract prospective policyholders in the belief that they must be getting “a good deal” since the company is popular with existing policyholders.
4 Definitions of premium rate used in the general insurance market
- premium income per unit of expected loss
- premium per unit of limit
- premium per unit of exposure
- premium per unit of risk-adjusted exposure
Define a “movement” in a policy
Refers to a policy going on risk, off risk or moving between risk groups.
6 Movements usually monitored
- lapses or renewals
- new business
- quotes not taken up
- mid-term cancellations
- endorsements
- mix of business in the portfolio
Endorsement
A “mid-term adjustment”, where a policy is amended during the policy year.
Studying the movements of the business, and their trends, we can (3):
- measure the extent to which different parts of the portfolio are growing or contracting
- get an early indication of undue losses or gains in business that might indicate that rates are out of line with the market (possibly leading to anti-selection).
- assess the effects of a new set of rates or marketing campaign on the business, and hence the sensitivity of the portfolio to market influences.
Strike rate
(conversion rate)
The number of written policies divided by the number of quoted policies in a given period.
Declinature
Where the insurer refuses to provide cover.
Key features of a good system for monitoring business:
Tailored output
Output should generally be concise, and tailored to the strategic goals of the organisation.
Output should aid decision making.
3 Processes included in systems for monitoring business
- data capture process
- calculations and/or manipulations on the data
- process for reporting the results
Key features of a good system for monitoring business:
Accuracy
(3)
- Data should be reliable and validated
- Calculations should take into account all the key drivers
- Results should be validated.
Key features of a good system for monitoring business:
Ease of use
(3)
- Data should be easy to collect
- Calculations should not be overly complex
- System should be documented, extendable and low maintenance.
Key features of a good system for monitoring business:
Consistent
(3)
- Output should be consistent over time. If methods for calculating rates change, then indices should be restated.
- Inputs should be consistent with other data sources. If two quantities are the same, then it should be the same regardless of data source. Otherwise the reader (user) will lose confidence.
- Outputs should be consistent with other analyses.
Reasons for estimating reserves (9)
- to determine liabilities in PUBLISHED, solvency and management accounts
- to VALUE an insurer for purchase or sale
- to assess the ACCURACY of previous reserve estimates
- to provide MANAGEMENT information on performance and profitability
- to estimate the COST of recent claims incurred
- to understand the extent of MARGINS held in the reserves
- calculating RANGES of results to understand the potential for reserves to be insufficient
- transforming an underwriting year into an accounting year
- calculating MOVEMENTS in reserves from one period to the next and analysing reasons for these
Reasons for analysing investments and capital (4)
- to evaluate the existing portfolio
- to assess capital requirements, risk and investment policy
- to allocate capital between classes
- to determine return on capital
Reasons for analysing investments and capital:
evaluation of the existing portfolio
Review the current portfolio to see the return made, how it compares with expected return and what the market as a whole has one.
Also compare the value of assets to the value of liabilities to assess the solvency position of the company and compare this to regulatory capital requirements and those set by the board.
Reasons for analysing investments and capital:
To assess capital requirements, risk and investment policy
The insurer will consider how much to invest in LIQUID ASSETS to make sure cashflow remains positive at all times.
Analyses of experience may cover (7)
- pricing and sales of policies
- claims reserves estimation and changes to claims experience or environment
- exposure and aggregation of risk
- expense analysis and allocation
- policyholder behaviour
- estimation of claim trends
- anything else the management require.
Analyses of claims experience may be done at 3 levels:
- overall company level
- class of business level
- more granular level, eg by risk or rating factor
3 key points to consider when deciding on the extent to which the analyses should be split by rating factor
- What is the PURPOSE of the investigation?
- Have we ENOUGH RELIABLE DATA to support a detailed analyses by risk group?
- Do we NEED to split into different risk groups? (eg in some cases, different rating factors have little impact on results)
Analysis of claims experience:
Changing frequency and severity
In analysing the cause of changes, it might be useful to split the effect of:
- frequency
- severity
The analysis might provide more information on the underlying experience of an account that seems to be stable, eg, if claim amounts are masked by an increase in one element and a decrease in the other.
Analysis of claims experience:
Impact of large claims
This may be useful to determine drivers of large claims, and specific areas of the account that are more prone to certain types of large claim.
It will help us decide which reinsurance coverages are appropriate and will be a key driver of the capital which the business requires.
Attritional claims
normal, non-large claims.
Analysis of claims experience:
Concentrations of claims and aggregation of risk
It is important that we can identify concentrations of claims so that we can deal with them separately from the main body of the data.
This will assist with any reinsurance recovery.
Analysis of claims experience:
Indemnity and expense split
It is useful to break claim costs down between:
- indemnity payments
- expenses
The insurer may need to review claim settlement procedures to reduce costs.
Analysis of claims experience:
Types of claim reported
We may analyse the types of claims reported to identify:
- new types of claim emerging, or
- the effectiveness of exclusions or changes to policy excesses in removing certain types of claim from the experience
Salvage
Amounts recovered by insurers from the sale of insured items that had become property of the insurer by virtue of settling a claim.
3 Main types of recovery on an insurer’s gross claims experience
- outward REINSURANCE protections
- recoveries from SALVAGE
- a 3rd party involved in the claim incident
When presenting the results of an investigation, we must communicate: (5)
- the source of the data, its preparation and verification
- our reliance on assumptions and the uncertainty of the results
- methodologies and definitions used
- key features of the results, and why they have happened
- how actual compares with expected.
9 Main claim analyses
- changing frequency and severity of claims
- impact and incidence of large claims
- assessing concentration of claims and risk
- splitting indemnity cost from expenses
- new types of claim
- recoveries on gross claims
- nil claims
- partial payments
- re-opened claims
8 Uses of actuarial investigations
- PROFIT TESTING
- estimating PRICE ELASTICITY
- create LIFETIME PRICING MODELS
- redesign RATING TARIFFS
- PRICING AND REINSURANCE decisions
- RESERVE ESTIMATION
- CAPITAL MODELLING
- FINANCIAL PROJECTIONS, for budgeting, strategy and solvency purposes
- VALUE AN INSURER for sale, purchase or merger
Profit testing
Involves projecting future income (from premiums and investments)
… and future outgo (expenses and claims)
… to give the expected profitability of a set of premium rates.
It can also be used when setting premium rates to assess the premium rates required to reach a certain profit criterion.
The projection may allow for any statutory solvency margin that might be required and for the strength of the statutory reserving basis.
Uses of price elasticity curves
Used to estimate the changes in business volumes as a result of changes to our premium rates.
Customer lifetime value
The inherent added worth of an existing customer to whom a policy has already been sold.
It will take account of:
- the policyholder’s likelihood to RENEW,
- the policyholder’s ACCEPTANCE of future RATE INCREASES, and
- the potential for CROSS-SELLING other products
How should we deal with large one-off capital costs? (in order to allocate them to premiums)
We should AMORTISE a large one-off capital cost
… over its expected useful lifetime
… and then treat the amortised cost as PART OF OVERHEADS
lapse rate
number of lapses for the period
divided by
number of renewals INVITED for the period
new business rate
number of new policies for the period
divided by
number of renewals INVITED for the period
4 Issues to consider when analysing lapse rates
- The analysis may be done at a TOTAL LEVEL and on specific subgroups
- Careful to allow for the time lag between the RENEWAL DATE and the point at which it becomes apparent that a policy has lapsed.
- There might be PROCESSING DELAYS.
- We can obtain lapse rates by projecting the number of lapses processed to date for each month’s renewal cohort to their ultimate value, using normal CHAIN LADDER TECHNIQUES.
Solvency accounts
Those accounts required to demonstrate to the supervisory authorities that the company can be expected to meet its obligations due to policyholders.
