Chapter 20: Further considerations when rating Flashcards
Primary function of rating structure
To categorise policyholders into broadly similar, homogenous risk groups, so that premium rates are appropriate to the relevant risk of each sub-group.
This reduces the likelihood of anti-selection
When creating new rating structures, what may they be based on?
- subjective views - adopt new rating factor immediately without collecting the data
- detailed analysis - collect as much information as possible on new factor before implementing
Requirements of good rating factors
- define the risk clearly
- do not correlate too closely with other rating factors
- are practical to obtain and record
- are objective
- are verifiable and preferably factual
- are acceptable to the policyholder
- are non-manipulable
- are acceptable to the market
- are allowed by the regulator
Good rating factor requirements:
Define the risk clearly
In quantitative terms, the rating factor should be correlated with the expected claims
Good rating factor requirements:
Not correlated too closely with other rating factors
This ensures they add value to the underwriting process. We should choose each additional rating factor to remove as much of the residual heterogeneity as possible
Good rating factor requirements:
Objective
This avoids disputes between the policyholder and insurer over the truth of the information provided.
Good rating factor requirements:
Verifiable and factual
This helps prevent fraudulent behaviour
Good rating factor requirements:
Acceptable to the policyholder
Otherwise, the insurer may lose potential customers or renewals. E.g. requiring genetic test results to be disclosed might be unacceptable
Selection of rating factors
An ANOVA can be undertaken to help determine the rating factors. Might be a one-way, two-way or multivariate analysis (GLM). The allowance for correlations between factors depends on the approach taken.
Too many rating factors can be expensive and unpopular with customers and brokers.
Why might the premium actually charged differ from the office premium?
- to meet business objectives
- to maintain market share in highly competitive markets or in certain market conditions (e.g. the soft phase of the insurance cycle)
- if it is difficult to establish the technical premium
- if insurers can charge certain loyal customers more (inertia pricing)
- if the market does not accept different premiums (e.g. between new business and renewal premiums)
- where no-claims discounts apply
Why might it be difficult to establish the technical price?
In some classes, experience is extremely volatile and significant judgement is needed in pricing the business. In these classes, it is more likely for the price to be market supply and demand driven rather than precisely reflecting the underlying risks.
Other influences on rating
- the availability of capital to support new business
- the impact of reinsurance capacity
- the sophistication of sales and quotes systems
- the demands of regulators in the rating area
- relationship with particular distributors or brokers
- differences between the “direct” approach and the traditional routes (methods of sale)
What factors other than the premium may influence a policyholder when deciding whether or not to renew the contract
- the level of service
- the policy conditions
- the reputation of the company
- the ability to pay out claims
- the reluctance to pay out claims
- any loyalty discounts
- any advertising campaigns
- inertia
- payment method
Experience rating system
A rating system in which the premium for each individual risk depends on the actual claims experience of that risk.
Can be applied prospectively or retrospectively, using claim numbers or claim amounts
Prospective rating
The premium at the renewal date depends on the experience of the risk prior to that renewal.
The insurer takes on all the underwriting risk in such an arrangement because the policyholder pays a premium for the upcoming risk period and the premium for that period cannot be increased if claims experience is poor.
The premium can only be increased for the next risk period.
Retrospective rating
The premium for the current policy period is adjusted, based on the experience of that period of risk. A deposit premium, paid at the inception of the policy, will usually be followed by an adjustment premium or a refund at the end of the period, depending on the claims experience during the risk period.
Uses the experience during the exposure period as a rating factor. The underwriting risk to the insurer is reduced.
Number-based system
The premium adjustments are based on the number of claims paid in respect of the policyholder, and the amounts of the claims are ignored.
Bonus-malus system
Type of NCD system in which the premium paid by the policyholder after a claim has been made may be higher than the original premium paid when the policholder first took out the policy.
Cost-based system
The premium adjustments are based on the total amount of claims incurred in respect of the policyholder over a defined period.
