Exam 6 Bottom 15% Flashcards
identify exhibits/notes/interrogatories/Schedules in the Ann. Stmt. that support an actuary’s assertion that reserve increase is NOT due to prior inadequacy
Schedule P - Part 2 (ultimate losses)
supports actuary if it shows minimal reserve development
Schedule F - Part 1 (assumed reinsurance)
supports actuary it is shows MORE assumed reinsurance
Schedule F - Part 3 (ceded reinsurance)
supports actuary it is shows LESS ceded reinsurance (since reserves are shown net of reinsurance)
5-Year Historical Data:
supports actuary if it shows a mix shift from short-tail → long-tail lines (which tends to increase reserves)
General Interrogatories:
supports actuary if there was a merger
Notes to the Financial Statements:
supports actuary if there was a commutation of reserves
supports actuary if there was an increase in pooling percentage for company
why do we bother with financial strength ratings at all
for policyholders:
financial strength ratings help buyers assess an insurer’s ability to pay claims
some buyers MUST place business with highly rated insurers or reinsurers
if the potential policyholder is an insurer seeking reinsurance, the insurer may require the reinsurer have a high rating
for P&C insurers:
a high rating can help insurers get business
a financial strength rating by a rating agency can uncover potential solvency issues without involving a regulator
identify the importance of financial strength ratings to reinsurers
same as for insurers:
a high rating can help reinsurers get business
a financial strength rating by a rating agency can uncover potential solvency issues without involving a regulator
plus:
some insurers must place business with highly rated reinsurers
if downgraded to below investment grade, a reinsurer may not be able to renew its treaties and thus lose business
who does financial strength ratings
A.M. Best:
has the most experience with financial strength ratings of insurers
Moody’s:
focuses more on debt ratings (versus overall financial strength ratings)
S&P (Standard & Poor’s):
focuses more on debt ratings (versus overall financial strength ratings)
how are financial strength ratings done
All 3 agencies use something called interactive rating as an overall methodology but they differ in their specific rating or capital model
how do rating agencies ensure consistency across insurers
- standard information-gathering & assessment guidelines
- ratings are related to economic capital
- analysis & final rating should be issued by separate bodies.
describe shortcomings of rating agencies
conflict of interest
rating agencies are paid by the companies they rate
history of unreliability
rating agencies have given high ratings to companies that then went bankrupt.
E.g. Enron
identify the legislative response to criticism of rating agencies
law now requires extensive DISCLOSURE of rating agencies’ methods to help users understand ratings
why might rating agencies prefer stability over responsiveness in their rating methodology
-stability increases trust in ratings
-being too responsive might mean responding to statistical noise (versus signal)
what is the broad description of ‘interactive rating’
a comprehensive qualitative & quantitative evaluation of an insurer’s ability to pay claims (financial strength)
describe the 5 steps of the interactive rating process
RM-PDP
Research: by ratings analysts (insurer submits proprietary info)
Meeting: between rating analysts & insurer’s senior management for presentations
Proposal: the rating analyst leader proposes a rating (insurer may submit further info)
Decision: by ratings committee
Publication: to public & fee-paying subscribers
(these 5 steps should provide a comprehensive evaluation of the company)
What are drawbacks to the interactive rating methodology?
[Hint: it TIEs up company resources]
Time-consuming: requires extensive meetings with senior management
Intrusive: insurer must provide detailed operational info
Expensive: insurer must pay for rating agencies to do the interactive ratings
if interactive ratings are such a royal pain, why do insurers bother with them
USE
Unrated insurers: agents are wary of unrated insurers
Solvency assessment: 3rd parties such as regulators or investors may rely on a rating agency’s assessment
Efficiency: agents, underwriters, regulators don’t have the expertise to evaluate the financial strength of an insurer
if rating agency concludes that an insurer’s financial strength has changed in a material way, what reporting options are available
- downgrade or upgrade insurer’s rating
- change the outlook (do not upgrade or downgrade)
→ rating agencies hesitate to change ratings too quickly to avoid angering paying clients (if their rating is downgraded) and to maintain consistency & reputation among users of financial ratings
which responds faster to shocks: rating agencies or bond/stock market (why)
- bond/stock market is faster
responds almost immediately - rating agencies may take months
interactive ratings are time-consuming
but can properly verify info and that the shock was real, not just noise
in the ‘meeting’ phase of an interactive rating, is the focus on gathering qualitative or quantative info
Qualitative
identify (Best, Moody, S&P) rating models (capital standard models)
A.M. BEST:
- EPD (Expected Policyholder Deficit)
MOODY’S:
- use stochastic cash flows to model economic capital
STANDARD & POOR’S:
- PB (principles-based) models & ERM practices (Enterprise Risk Management)
fully describe A.M. Bests’ rating model
Method:
- EPD = $P / $V
- $P = pure premium of treaty
- $V = market value of reserves
SELECTION:
- choose required capital so that EPD = 1%
fully describe Moody’s rating model
Method:
- model is based on repeated simulations of loss distributions of separate risks
Time Horizon:
- project cash flows until liabilities are settled
fully describe Standard & Poor’s rating model
Method:
- evaluate insurer’s ERM (Enterprise Risk Management) & internal capital model
Rating:
- weighted average of S&P & insurer capital assessment
identify incentives for rating agencies to create more accurate capital models
- increase public confidence in rating agencies
- increase competitive advantage against other rating agencies
identify an incentive for a rating agency to have high (or low) capital standards
high standards:
- ensures highly rated insurers are truly able to withstand stress events
low standards:
- rating agency may gain market share because weak insurers may still receive a good rating
compare the capital models used by rating agencies vs RBC
Method:
- rating agencies may use stochastic model & qualitative considerations
- RBC uses a fixed formula, quantitative only
regulatory action:
- rating agencies have no regulatory authority
- RBC results can initiate regulatory action
Data:
- rating agencies use confidential company data
- RBC uses public data
All risks:
- rating agencies can include any relevant risks
- RBC is constrained by the given formulas
identify an advantage of the capital model used by A.M. Best
- models individual risks then combines risks using a covariance adjustment (similar to RBC)
- sets capital level so that EPD (Expected Policyholder Deficit) = 1%
- GOOD because tail risks are modeled better than RBC’s ‘worst-case’ approach
identify an advantage of the capital model used by Moody’s
- uses a stochastic cash flow model
- GOOD for complex multivariate risks
identify an advantage of the capital model used by Standard & Poor’s
- uses a weighted average of its own model & a company model
- GOOD because it incorporates company knowledge of risks to the final rating
describe how state regulators & A.M. Best differ in their evaluation of capital adequacy
Note: Current RBC model DOES consider catastrophe risk and interest rate risk
quantitative vs qualitative data:
- state regulators mainly use RBC, which uses quantitative data only
- A.M. Best incorporates qualitative data
capital requirements:
- state regulator (RBC) uses RBC formula
- A.M. Best uses a 1% EPD (Expected Policyholder Deficit)
identify A.M. Best’s broad categories of financial strength ratings for insurers
- Secure: likely to meet their obligations (divided further into 3 sub-levels)
- Vulnerable: may not meet their obligations in adverse scenarios (divided further into 7 sub-levels)
identify A.M. Best’s 2 broad categories of credit quality ratings for bonds
- investment grade: 4 levels (+ sublevels)
- non-investment grade: 4 levels (+ sublevels)
identify differences between RBC requirements and rating agency capital requirements
quantitative / qualitative
- RBC is a quantitative formula
- rating agencies include qualitative information (interactive ratings)
types of risk
- RBC is constrained by the given formulas
- rating agencies can include all relevant risks
Intervention
- RBC can trigger regulatory intervention
- rating agencies don’t trigger regulatory intervention
Data
- RBC uses public annual statements
- rating agencies have access to proprietary data (interactive ratings)
identify a reason for a company to disclose damaging information to a rating agency
- non-disclosure may have worse consequences if the rating agency discovers the data later anyway
- integrity is important in a rating agency’s qualitative assessment
argue for & against: ‘A.M. Best is effectively a regulator of the insurance industry’
For:
- reputation is critical for an insurer to attract business
- a good rating from A.M. Best improves an insurer’s reputation
- therefore A.M. Best can pressure insurers to take corrective action (even without the force of law)
- ALSO, regulators often reference ratings from rating agencies
Against:
- if A.M. Best gives a low rating, insurer can just seek out another rating agency
- insurers don’t NEED a financial rating from a rating agency
- A.M. Best cannot accept/reject filings or take control of a potentially insolvent insurer
identify similarities & differences between ‘interactive ratings’ & ‘public ratings’
Similarities:
- both use public financial statement info
- both disclose rating to public
Differences:
- interactive ratings are more costly & time-consuming than public ratings
- interactive ratings use confidential company information (public ratings using publicly available info)
identify a reason for a company NOT to disclose damaging information to a rating agency
- insurer doesn’t want a lowered rating
- adverse development may be less than expected
describe procedures for monitoring solvency recommended by the NAIC
RBC formula:
- calculate capital requirements with possible regulatory action
IRIS ratios:
- allocate state regulatory resources based on IRIS results
Financial Statements:
- use annual/quarterly statements for consistent comparisons across companies & time
what is the purpose of NRRA? And how does the NRRA accomplish its purpose?
NRRA = Nonadmitted & Reinsurance Reform Act of 2010
Purpose:
- create a better surplus lines tax payment and regulatory system
How:
- limits regulatory authority of surplus lines to the customer’s home state
- establishes federal standards for surplus lines regarding:
premium taxes
insurer eligibility
commercial purchaser exemptions
describe a surplus lines transaction
a specially licensed surplus lines broker places insurance with an unauthorized/non-admitted insurer
identify 2 types of regulatory exemptions for surplus lines and the benefits to policyholders
exemption ==> from filing rates
- Benefit
– insurer can always charge adequate premium
exemption ==> from guaranty funds
- Benefit:
– costs of fund not passed on to policyholder
identify the key provisions of NRRA discussed in the Emmanuel reading
1-state compliance (only an insured’s home state can regulate the placement of surplus lines)
- 1-state compliance refers to licensing of surplus lines brokers whereas uniform eligibility standards applies to surplus lines insurers
uniform eligibility standards (for an insurer to sell surplus lines coverage)
ECPs or Exempt Commercial Purchasers (a diligent search is not required for sophisticated commercial purchasers)
national producer database (producers must be in a database to collect licensing fees from a surplus lines insurer)
describe the key provision of NRRA: 1-state compliance
insured’s home state has exclusive authority to regulate the placement of nonadmitted insurance (which includes surplus lines)
- only home state can require a broker’s license to sell nonadmitted insurance
– (but note that WC is an exception)
- only home state can collect premium taxes
describe the key provision of NRRA: uniform eligibility standards
states are empowered to create uniform eligibility standards for surplus lines insurers but all are currently using the NRRA default standards
- U.S. domiciled insurers (also called foreign insurers because they are foreign to all but the home state)
– ==> must have ≥ 15m in capital & surplus (or the state minimum if it’s higher)
– ==> must be authorized to write in its domiciliary jurisdiction
- non-U.S. domiciled insurers (AKA alien insurers, not foreign insurers!!!)
– ==> if insurer is listed in the Quarterly Listing of Alien Insurers, states may not prohibit placing insurance with them
–(this list is also called the “IID” list because it’s maintained by the NAIC’s International Insurer’s Department)
describe the key provision of NRRA: Exempt Commercial Purchaser (ECP)
definition of ECP: any person purchasing commercial insurance that:
- employs a NRRA-qualified risk manager
- has paid aggregate commercial premiums ≥ $100,000 (in past 12 months)
- the person’s company is “large” (high net worth ≥ ~20m or high revenues or lots of employees,…)
the related NRRA provision is:
- states cannot force a broker to do a diligent search if the purchaser is an ECP and:
– ==> the broker has disclosed to the purchaser that coverage may be available in the admitted market (which is better regulated)
– ==> the purchaser has then instructed the broker to purchase insurance in the non admitted market
describe the key provision of NRRA: national producer database
this database (or another national equivalent) is for the licensure & renewal of surplus lines brokers
- Has to be national, not regional
the specific NRRA requirement is that:
- ==> if a state doesn’t participate in such a database then they cannot collect licensing fees
Surplus Lines Laws
there is very little regulation regarding forms & rates (compare that with auto insurance which is very highly regulated)
surplus lines regulation is focused mainly on brokers (not the surplus lines insurers)
brokers must perform a diligent search before exporting business from the admitted market to the nonadmitted surplus lines market
- ==> or the broker can instead use an “export list” which is a list of coverages deemed to be unavailable through the admitted market
brokers submit tax and other filings
identify 2 methods of accessing the nonadmitted market
- surplus lines (use a local licensed broker to buy coverage from a nonadmitted insurer in your home state)
- independent procurement (also called direct placement)
what is independent procurement / direct placement
- when a U.S. citizen leaves their home state (goes to an insurer outside their home state) to insure a risk located in their home state
- and the purchase is either directly from an unauthorized insurer or a broker not licensed by the home state
describe a legal precedent related to home state regulation of independent procurement
Case: State Board of Insurance v. Todd Shipyards Corporation
Facts:
the buyer purchased property coverage from an out-of-state unauthorized insurer
the only connection between the buyer and the home state was the location of the covered property in the home state
Issue:
can the home state tax or otherwise regulate the transaction
Ruling:
under McCarran-Ferguson, the home state could not tax or regulate the transaction
because federal laws applying exclusively to insurance supersede state laws
what is a wholesale broker
- an intermediary broker between a “regular” retail broker and an insurer
- (they place business brought to them by retail brokers and have no contact with the insured)
how is licensing of a wholesale broker different from that of a “regular” retail broker
- the wholesale broker must have a license in the home state of each insured they place with an insurer
- Which means the wholesale broker may have to have many separate licenses
how are the licensing requirements of wholesale brokers being addressed
- 2015 legislation established the National Association of Registered Agents and Brokers or NARAB
- it’s a 1-stop national licensing system for brokers operating outside of their home state
- requires submission of an application and adherence to strict standards
identify criteria a surplus lines insurer must generally satisfy to become a DSLI
- DSLIs = Domestic Surplus Lines Insurance Companies
- PHS ≥ 15 million (Policyholder Surplus)
- insurer is an eligible surplus lines insurer in a jurisdiction other than its state of domicile
- the insurer’s board of directors passes a resolution seeking to be a domestic surplus lines insurer in the state of domicile
- insurance commissioner approval and issuance of certificate of authority
A start-up company has proposed entering a state as a surplus lines carrier to compete with admitted carriers by offering similar coverage on a direct-to-consumer basis. Identify 4 surplus lines regulatory requirements and briefly describe why this start-up may or may not meet those requirements.
surplus/capital requirements
- there is a minimum capital requirement (can vary by state)
- → a start-up may have troubling raising enough capital
authorization/licensing requirement
- insurer must be authorized in domiciliary jurisdiction
- → we are not told if the start-up has been authorized
coverage must be declined by admitted market
- unless insured is an ECP (Exempt Commercial Purchaser) they must first perform a diligent search for an admitted insurer
- → start-up would only be able to write business with exempt commercial purchasers (market may be small)
must meet managerial requirements
- ensures surplus lines carrier can meet customer’s needs
- → start-up management may be inexperienced (may not satisfy this requirement)
Identify the 2 categories and 10 Notes to the Financial Statements that are covered in Odomirok
Category 1: notes requiring direct involvement by actuaries [Hint: noteCARD +PDR]
- Change (incurred loss & LAE)
- Asbestos & environmental reserves
- Reinsurance
- Discounting (unpaid loss & LAE)
- PDR (Premium Deficiency Reserves)
Category 2: notes that are relevant to actuaries: [Hint: SHIES]
- Summary of significant accounting principles (This is Note #1 in the reading)
- High deductibles
- Intercompany pooling
- Events subsequent (aka ‘subsequent events’.)
- Structured settlements
describe the Financial Statement NOTE: Change in incurred loss & LAE
shows prior AY changes
- affects current CY U/W income
- disclose change & reasons for change (segment, LOB,…)
describe the Financial Statement NOTE: Asbestos & environmental exposure
- significant adverse development over several decades
- must disclose detailed quantitative & qualitative information regarding reserves
- these reserves relate to exposures other than for policies specifically covering A&E
describe the Financial Statement NOTE: Reinsurance
reserves are net of reinsurance on the B/S & I/S
- reinsurance can significantly lower the B/S reserves and affect the surplus
- must understand credit risk associated with reinsurance (use Sections A,B,D of reinsurance notes)
- A: unsecured recoverables, B: disputed recoverables D: uncollectible recoverables
questions the actuary might ask about each section
- A: why wasn’t security provided? did a cat increase recoverables unexpectedly? are the unsecured amounts concentrated with 1 reinsurer?
- B: what is the nature of the dispute? is the disputed amount material? is there a legal opinion on the dispute?
- D: what was the reason for the uncollectible insurance? could other unpaid amounts become uncollectible for similar reasons?
other comments
- A: a note is required if (unsecured amounts) / surplus > 3%
- B: recoverable is considered to be in dispute once a formal written refusal to pay is received from the reinsurer
- D: uncollectible amount is treated as an expense
describe the Financial Statement NOTE: Discounting
- disclose whether discounting is used for reserves
- if so, then disclose type of discounting: tabular (for WC) or non-tabular
describe the Financial Statement NOTE: PDR (Premium Deficiency Reserve)
- inclusion of investment income to offset PDR is optional
- disclose amount and effective date of PDR
- if PDR is recorded as part of UEP then this Note is the only way to know if PDR exists
describe the Financial Statement NOTE: Summary of significant accounting principles
- (this is note #1 in the reading)
- disclose source of rules (usually NAIC APPM and the SSAPS)
- disclose exceptions to rules
describe the Financial Statement NOTE: High deductible policies
insurer pays the full claim and then seeks reimbursement from the insured for the deductible
- creates credit risk that isn’t shown on the B/S
- disclose amount recorded & billed but not collected
describe the Financial Statement NOTE: Intercompany pooling
this is when companies in a group cede all business to lead company
- each member of group then assumes back a specified percentage
- note must disclose pooling arrangements
pooling affects: U&IE, Schedule F Parts 1 & 3
- Schedule P shows only pool member’s share of pooled results
describe the Financial Statement NOTE: Events subsequent
must disclose Type 1 (recognized) & Type 2 (non-recognized) subsequent events
describe the Financial Statement NOTE: Structured Settlements
usually WC - insurer buys annuity from life insurer for structured settlement payments
- disclose total amount of structured settlement payments for which insurer might be liable
- if payments from single life insurer >1% of surplus ==> disclose life insurer & amount
pertains to credit risk and is not shown on the B/S
where in the Annual Statement should commutation agreements be disclosed and identify specific items
location: notes to the financial statements
items to disclose:
- list of reinsurers
- amount of reserves commuted (taken back by primary insurer)
- price of commutation
why is a ceding insurer required to disclose commutation agreements in the Annual Statement
distortions in Schedule P triangles (net paid, net incurred, claims counts) must be considered in a reserve analysis
- impact on income & surplus - commutations generally decrease pre-tax income for primary insurer (because net losses liabilities increase)
how is uncollectible reinsurance addressed in the ‘Notes to the Financial Statements’ vs. in the ‘Statement of Actuarial Opinion’
‘Notes to the Financial Statements’:
- uncollectible reinsurance over the past year is written off as an expense
‘Statement of Actuarial Opinion’:
- uncollectibility is assessed by considering reinsurance arrangements and opinion of management
describe required items from Note to Financial Statements 30 (Premium Deficiency Reserves)
amount & evaluation date of premium deficiency reserves
identify B/S or I/S line items that could help a regulator assess credit risk and assess their effectiveness
PUB
Provision for reinsurance
- identifies and penalizes unauthorized and slow-paying reinsurers
- such reinsurers increase credit risk
- somewhat effective since the provision is formulaic (omits qualitative info)
Uncollected premiums and agents’ balances in the course of collection
- identifies and penalizes balances past 90 days due
- somewhat effective but 90 days is arbitrary
Bonds (capital allocation based on equities in the balance sheet)
- bonds should be a high proportion of investments (versus stocks, which are riskier)
- somewhat effective since bond RATINGS are also important (not given on B/S)
describe reasons supporting a decision to remain in a market despite missing target profits
The insurer should give Homeowners a chance and RUN with it!
[R] there are approved RATE changes
[U] make U/W changes to limit poor risks
[N] New line of business
need more data before deciding to exit
[cats] cat losses may have distorted results
identify Notes to the Financial Statements that could help a regulator assess credit risk and assess their effectiveness
Category 1: (actuaries directly involved)
- Reinsurance
– assesses unsecured, disputed, uncollectible recoveries (good)
– not all sources of reinsurance credit risk are covered (bad)
Category 2: (relevant to actuaries)
- High deductibles
– deductible amounts are not included in reserves
– this note identifies high deductible policies (good)
– can evaluate if insured will pay the deductible (good)
-
Events subsequent (aka ‘subsequent events’)
– identifies subsequent events that may materially impact insurer (good) (Ex: large cat)
– alerts regulator that reinsurer credit risk needs attention (good)
– but does not mention amounts recoverable (bad) -
Structured settlements
– discloses structured settlements where insurer could be liable (good)
– identifies providers of structured settlements for further scrutiny (good)
describe reinsurance transactions appearing in Notes to Financial Statements dealing with cessions for prior occurrences
retroactive reinsurance:
- covers liabilities that occurred before the effective date of the reinsurance contract
runoff agreements:
- transfers risk to another entity (often to exit market)
Commutations:
- primary insurer re-assumes liabilities from reinsurer that were previously ceded
describe the accounting treatment of items from part (b) on the B/S and in Schedule P
retroactive reinsurance:
- balance sheet:
– purchase price decreases assets
– ceded reserves recorded as write-in contra liabilities
– surplus gain recorded as special surplus (until recoverables > purchase price)
- Schedule P:
– no effect (because reserves are recorded as write-in contra liabilities)
runoff agreement:
- balance sheet:
– purchase price counts as paid loss
– reserves recorded as ceded loss
- Schedule P:
– shows decrease in net incurred loss
Commutation:
- balance sheet
– purchase price increases assets
– re-assumed reserves increase direct reserves
– surplus gain recorded as unassigned surplus
- Schedule P:
– shows increase in current year reserves
define ‘insurance score’ and ‘Credit score’
- Insurance score: a numerical score assigned to an insurance risk based on a risk’s underlying characteristics
- Credit score: an insurance score using attributes found in a credit report
identify attributes correlated with credit score
- # of inquiries into opening new accounts
- # accounts 30+ days past due
- (regulators think that credit scores may be unfairly discriminatory)
what are credit scores used for
- U/W criterion
- assignment to tiers
- rating variable
what are some arguments for and against the use of credit scores
for: [Hint: SMORe]
- Statistical significance (in predicting expected loss costs – improves availability and affordability)
- Manipulation (credit scores are difficult to manipulate because they are calculated by 3rd party companies, not self-reported)
- Objective (credit scores are based on numerical data so they are objective)
- Removal (removing credit scores won’t change aggregate premium, provided an off-balance is applied)
- e (doesn’t stand for anything, I needed the “e” to spell Alice’s favorite snack)
against: [Hint: FEED]
- Frequency (credit score is correlated only with frequency, not with severity of claims)
- Errors (50% of credit reports have errors, sometimes due to identity theft)
- Economic downturns (downturns in economy may have a disparate credit impact on vulnerable populations)
- Discriminatory (credit scoring may lead to rates that are unfairly discriminatory - see below for details)
on what ‘levels’ can credit score impact occur
- AGGREGATE company premium level
- INDIVIDUAL premium level
what is the credit score impact on aggregate premium (vs individual premium)
USE/PROHIBITION of credit scores doesn’t necessarily affect aggregate premium (even if individual premium is redistributed)
what is the impact of credit score on renewal business
some insurers / jurisdictions only use credit score on renewals if it results in a LOWER RATE for the insured
provide arguments in support of using credit scores in rating
for: [Hint: SMORe]
- Statistical significance (in predicting expected loss costs – improves availability and affordability)
- Manipulation (credit scores are difficult to manipulate because they are calculated by 3rd party companies, not self-reported)
- Objective (credit scores are based on numerical data so they are objective)
- Removal (removing credit scores won’t change aggregate premium, provided an off-balance is applied)
- e (doesn’t stand for anything, I needed the “e” to spell Alice’s favorite snack)
what concerns might a regulator have regarding credit scores in an economic downturn
- ON AGGREGATE PREMIUM: an unwarranted increase in aggregate premiums if the average credit score got worse
- ON INDIVIDUAL PREMIUM: a distributional shift in individual premium that doesn’t reflect true cost differences (losing you job doesn’t mean you’ll have more car accidents)
Potential solution:
- FOR AGGREGATE PREMIUM: We can apply an off-balance factor to keep the aggregate premium unchanged.
- FOR INDIVIDUAL PREMIUM:
– Regarding individual premiums, we can stop using credit score (at least temporarily)
– and redo the classification analysis after the economy has stabilized (this may incur a significant lag time however)
how might caps on renewal rates violate the CAS ratemaking principles
PRINCIPLE 1: a rate is an estimate of the expected value of future costs
- violated because capping causes rates to be LESS than future costs
PRINCIPLE 2: a rate covers all costs of risk transfer
- violated because capping SOME insureds without increases for others means risk transfers costs are not covered
identify actions state a regulators can take to limit use of credit-scores
- BAN use of credit scores
- LIMIT use of credit scores to U/W
- ALLOW for renewals if it reduces premium charged
(T/F) in an economic downturn, a shift to lower credit scores causes higher premiums for everyone; (T/F) in an economic downturn, a shift in credit scores disrupts relativities & causes incorrect individual premiums
FALSE:
- increase can be reversed by reducing base rates in proportion to the shift in credit scores
FALSE:
- relativities are reviewed regularly and are adjusted accordingly based on up-to-date loss costs
regarding credit scores, what impact would an economic downturn have on (i) insureds (ii) insurers (iii) regulators
(i) INSUREDS:
- credit scores may decrease for many (due loss of job)
- premium may increase for many (due to lower credit score)
- increase may be unfair if risk profile hasn’t changed
(ii) INSURERS:
- increase in aggregate premium (if average credit score decreased)
- changes in relativities (due to shifts in individual credit scores)
(iii) REGULATORS:
- consumer complaints
- concerns over decrease in availability & affordability if rates increase
identify arguments against the use of credit-scoring
[Hint: FEED]
- Frequency (credit score is correlated only with frequency, not with severity of claims)
- Errors (50% of credit reports have errors, sometimes due to identity theft)
- Economic downturns (downturns in economy may have a disparate credit impact on vulnerable populations)
- Discriminatory (credit scoring may lead to rates that are unfairly discriminatory - see below for details)
assuming GENDER & credit score are correlated, argue for & against banning credit scoring in rating
in FAVOR of banning credit:
- not socially acceptable to discriminate based on gender
AGAINST banning credit
- low-risk would cross subsidize high-risk insureds so rate wouldn’t be actuarially sound
explain why high credit score individuals may have higher frequency of auto claims. Argue for and against using credit in auto insurance
high credit scores
- ==> better educated & wealthier
- ==> more likely to know how to use the insurance system & can afford deductibles
argument FOR:
- if high credit score individuals make more claims then they should be charged more
argument AGAINST:
- frequency is not the same as claim cost - don’t base rates on frequency alone
identify examples where credit scoring can be unfairly discriminatory
- age: young people don’t have a long credit history, elderly people use credit less often (both may result in a lower credit score)
- poor families: may use cash versus credit (you need to use credit to get a good credit score)
- recent immigrants: may not have access to credit (you need to use credit to get a good credit score)
- moral/religious beliefs: certain belief systems may discourage use of credit (you need to use credit to get a good credit score)
describe 2 age groups disparately impacted by credit
young people:
- shorter credit history (you have to use credit to get a good credit score)
elderly people:
- tend to have lower incomes and use less credit (you have to use credit to get a good credit score)
identify a characteristic (other than age) where disparate impact of credit may be an issue
poor families: may use cash rather than credit (you have to use credit to get a good credit score)
identify metrics/characteristics underlying poor credit scores
- # of inquiries into opening new accounts
- # of accounts past 30 days due– socioeconomic status
– impulse control (may be addicted to retail therapy)
define ‘cost-based’ rates
rates that VARY BY individual risk or expected loss costs
identify necessary conditions for rates to be ‘equitable’
CONDITION 1:
- should NOT have disparate impact on protected classes (race, religion,..)
CONDITION 2:
- should be a CAUSAL LINK & under control of individual
- is frequency of texting (while driving) equitable in a risk classification system? 2. How about from the perspective of a customer? 3. if all insurers EXCEPT insurer X uses texting, why would X be at risk regarding financial stability? 4. identify 2 IRIS ratios that may be relevant in evaluating insurer X to validate the concern?
- YES: it’s proven to be correlated to risk
- NO: some people who text frequently may be doing it while NOT driving (so not predictive of loss costs for those individuals)
- adverse selection
customers who text a lot and would be charged high rates by competitors will buy insurance from X instead (underpriced) - COR, 1-year reserve development, 2-year reserve development
define ‘guaranteed cost policy’
a policy where an entity transfers all liability to an insurer for a fixed premium
define ‘retrospectively rated policy’
- a policy where an entity transfers all liability to an insurer based on actual loss experience
- the final premium depends on an audited exposure base and loss experience
define ‘large deductible policy’
- a policy where an entity transfers all liability to an insurer but retains a substantial deductible
- the final cost includes
[1] final premium
[2] losses within the deductible
[3] claims handling costs
define ‘self-insurance’
- an arrangement where an entity retains all risk or purchases coverage for large claims only
- (common for exposures where insurance is not required by regulation)
define ‘claims made coverage’
- coverage where liability for claims reported after the policy expiration remains with the entity
- (unreported claims liability may accumulate for lines of business with reporting lags)
define ‘captive’
- affiliated insurance companies that can assume some or all of an entity’s liability
- captives are subject to less stringent regulation than admitted carriers
- (and can directly insure or reinsure the entity’s insurer)
define ‘direct policy’ in relation to captive
- a policy purchased directly from an affiliated captive insurer
- (typically used for coverages that would otherwise be self-insured)
define ‘fronting arrangement’
- an arrangement where an entity, having purchased a guaranteed cost policy, can transfer risk back to its captive
- (with the commercial insurer acting as a “fronting” company for excess losses)
define ‘deductible reimbursement’
- a policy written by a captive that directly reimburses the entity for its deductible obligations
- (it covers the entity’s obligations to the insurer but not to claimants)
define ‘trust’ and briefly describe how it is use in insurance
- a financial arrangement where funds or assets are set aside to cover potential losses
- commonly used to finance professional liability exposures
- (and provide coverage to affiliated entities on a direct basis)
Identify the contexts where a ‘retained risk’ actuarial analysis is generally used
AIR
Adequacy of Accruals for Financial Reporting
Internal Financial Reporting and Cost Allocation
Regulatory Filing for a Qualified Self-Insurance Designation
How are actuarial projected financial accrual for self-insured or retained liabilities (retained risk actuarial estimates) used by company management?
record & validate
- to directly record the accrual amount
- to validate the reasonableness of management estimates
Identify items included in projected financial accrual for retained liabilities.
- provisions for: deductibles
- provisions for: self-insured exposure
- provisions for: potential retrospective premium amounts
Identify key considerations when comparing an actuarial estimate to a company’s ledger.
- net or gross of insurance recoverables
- discounting
- combined accruals that include other insurance-related balances
– In some cases, the financial statement accruals may include items like third-party administrator fees that are not accounted for in actuarial calculations. This makes it difficult to directly compare the results of the actuarial analysis with the financial statement entry.
– The key idea is the concept of timing and its impact on the comparison between actuarial estimates and financial statements. The timing differences in payments, billing cycles, and the treatment of prepaid balances or amounts due to third-party administrators and excess insurers are discussed, emphasizing the need for adjustments and documentation to address these timing issues.
What are combined accruals?
financial entries that include multiple related accruals, where only a portion is considered in the actuarial analysis
What challenges can arise when comparing actuarial analysis with financial statement accruals?
- financial statement accruals may contain items that are not accounted for in the actuarial calculation
- (making direct comparisons difficult)
- Example: Third-Party Administrator (TPA) fees
What timing-related issues arise with prepaid balances or amounts due to TPAs and/or excess insurers?
- payments made but not yet reimbursed (by company to TPA) result in higher accruals
- advance payments lead to lower accruals
How do companies address timing differences in accruals related to TPAs and excess insurers?
- adjust accruals
- carry a separate timing accrual
- treat the timing difference as immaterial ← this is the simplest option if it applies!
What timing issues can arise with claims paid by the entity but not yet reimbursed by an excess insurance carrier?
when claims are paid but not yet reimbursed by excess insurance carriers
What timing discrepancies can occur with retrospectively rated and large deductible policies?
timing gaps between claim payments and premium payments
What is the general requirement for a company applying for a Qualified Self-Insurance Designation? Who should provide the actuarial opinion for a self-insured application?
- an actuarial report and certification along with its application package
- a member in good standing of the Casualty Actuarial Society
What should the actuarial opinion include for a self-insurance application?
actuarially appropriate reserves based on reserves estimated from the program’s inception to the valuation date
Additional items to include in actuarial opinion
- identifying information about the actuary
- scope of the opinion
- description of the estimation method
- exhibit showing the methodology
- data source information
- data reconciliation
- explanation of any data checking, verification, or auditing
how does price optimization compare to traditional ratemaking techniques
price optimization is a process that uses
- big data (data mining of insurance & non-insurance personal information where permitted by law)
- advanced statistical modeling
price optimization makes granular adjustments to indicated rates (specific risk classifications, or even individual insureds)
State the 4 principles in the CAS “Statement of Principles Regarding Property and Casualty Insurance Ratemaking”
- Principle 1: A rate is an estimate of the expected value of future costs.
- Principle 2: A rate provides for all costs associated with the transfer of risk.
- Principle 3: A rate provides for the costs associated with an individual risk transfer.
- Principle 4: A rate is reasonable and not excessive, inadequate or unfairly discriminatory if it is an actuarially sound estimate of the expected value of all future costs associated with an individual risk transfer.
define price optimization as it is used in the NAIC white paper
- the process of maximizing or minimizing a business metric
- uses sophisticated tools and models to quantify business considerations
define cost-based rate
this is just the traditional actuarially derived rate based on loss costs, LAE, and other expenses
define price elasticity of demand
the change in quantity demanded versus the price
- high elasticity ==> consumers will shop around even if prices only go up a little (savvy consumers!)
- low elasticity ==> price doesn’t have much effect on demand (you can jack the prices but consumers won’t shop around)
does the NAIC price optimization white paper apply to personal lines or commercial lines
Personal lines
have actuarial judgments been traditionally applied at the individual or rate class level
rate class level
does price optimization allow deviations from indicated rates at a MORE or LESS granular level than traditional ratemaking
price optimization allows deviations on a MORE granular level
identify items that are used in the price optimization process (versus traditional cost-based ratemaking)
big data
- (data mining of insurance & non-insurance personal information where permitted by law)
advanced statistical modeling
- (often GLMS or Generalized Linear Models)
define the terms ratebook optimization, individual price optimization, hybrid optimization
ratebook optimization
- → adjust factors in a cost-based rating structure using a demand model
individual price optimization
- → build a pricing structure based on both cost and demand
hybrid optimization
- → insert a new rate factor based on demand (into an existing rate cost-based structure)
These definitions highlight the critical concepts of traditional or cost-based pricing, and the demand model of price optimization.
Price optimization can be based on metrics other than demand but the demand model is one that’s very often used
define constrained optimization
- setting minimum & maximum limits on a model’s output (Ex: min = current price, max = cost-based indication)
- note that unconstrained optimization does not impose these limits
describe the main differences and other differences between traditional ratemaking and price optimization
difference 1:
- traditional: applied at class level
- price optimized: can be applied to individual policies
difference 2:
- traditional: uses cost-based pricing
- price optimized: incorporates non-cost-based considerations like propensity to shop around
difference 3:
- traditional: deviations from indicated rates are subjective
- price optimized: deviations from indicated rates are based on quantitative models
other miscellaneous difference:
- traditional ratemaking (including a component for actuarial judgment) will assign the same price to identical risks,
– price optimization may assign different prices
- traditional ratemaking (including a component for actuarial judgment) is generally accepted by regulators
–price optimization may not be acceptable
identify benefits and drawbacks of price optimization
BENEFITS
- paragraph 35
– doesn’t unfairly discriminate (low-income customers are more likely to shop around and not be penalized by non-cost-based increases)
– provides more accurate pricing (neither inadequate nor excessive)
- paragraph 37
– if optimization is applied on a ratebook level, it is not unfairly discriminatory
– note that individual optimization may be unfairly discriminatory
DRAWBACKS
- paragraph 31
– regulators don’t have the data to independently verify rates based on price optimization
- paragraph 32
– the models (often GLMs) can produce large individual rate swings (can be controlled by using constrained optimization however)
- paragraph 34
– no evidence of improved stability from using price optimization (effect on long-term costs is inconclusive)
- paragraph 38
– concern that ratemaking ASOPs may be violated (if rates are unfairly discriminatory)
identify 3 things that a rate filing cannot be
paragraph 39
- a rate filing cannot be: inadequate, excessive, unfairly discriminatory
identify possible regulatory responses to price optimization rating plans
paragraph 42a
- determine permissibility with respect to state laws
paragraph 42b
- define regulatory constraints
– ==>min/max rate swings
– ⇒ require that methods apply only to rate classes of at least a certain size
paragraph 42f
- transparency: require full explanation of…
– ==> DAM - Data / Methods / Assumptions
– ==> rate differences between customers with identical risk profiles (if any)
identify disclosures a regulator may require when price optimization is used in a rate filing
- rate adjustments that are not cost-based (may include judgmental adjustments)
- whether price optimization was used (Ex: demand models)
- which rating factors are affected by price optimization and their quantitative impact
- whether customers with the same risk profile have different rates
- data sources and models that affected the rate charged in any way
identify recommendations of the Task Force on Price Optimization regarding pricing methodology
- rates should be cost-based
- rates should comply with state law
- customers with identical risk profiles should be charged the same rate (aside from temporary differences - due to transition rules for example)
identify rating considerations that the Task Force on Price Optimization believes are unfairly discriminatory
price elasticity of demand
- May cause identical risks to be charged different rates
propensity to shop for insurance
- May cause identical risks to be charged different rates
retention adjustment at an individual level
- a policyholder’s propensity to ask questions or file complaints
identify recommendations of the Task Force on Price Optimization regarding state regulatory practices
- issue bulletin addressing use of non-cost-based methods
- enhance disclosure requirements for rate filings
- ensure compliance with state laws and actuarial principles by analyzing insurers’ rating models
explain why price optimization MAY be permissible under ratemaking ASOPs
- deviations from indicated rate is already an established practice
- deviations are now based on quantitative data and modeling
– (versus subjective actuarial judgment) - should be acceptable provided final rates are not excessive, inadequate or unfairly discriminatory
explain why price optimization MAY NOT be permissible under ratemaking ASOPs
- may lead to rates that are unfairly discriminatory
- identical risks may be charged different prices
– (differences may be due to propensity to shop around rather than risk profile)
describe constraints a regulator could place on a price optimized rating plan
- use constrained optimization (set minimum & maximum limits on rate changes)
- require that price optimization be used on rate groups of a minimum size
- ban price optimization completely
identify examples of items that appear on the 5-Year Historical Data Exhibit
- premiums (both gross and net)
- balance sheet information (assets & liabilities)
- income statement information (U/W gain, investment gain,..)
- operating ratios
- RBC (total capital & ACL or Authorized Control Level capital)
