flashcards
Criteria for evaluating rating variables
Statistical, Operational, Social, Legal
Statistical Criteria
Statistical Significance, Homogeneity, Credibility
Operational Criteria
Objective, Inexpensive to administer, Verifiable
Social Criteria
Affordability, Causality, Controllability, Privacy concerns
Legal Criteria
Insurance rates should be not excessive, not inadequate, and not unfairly discriminatory. Additionally, some states’ statutes may require certain rates to be actuarially sound.
Policy Year Advantage
Matches premiums and losses from policies
Policy Year Disadvantage
Less mature than other methods
Calendar Year - Advantage
Fully mature at end of the year
Calendar Year Disadvantage
Premiums and losses are not matched
Cal/Acc Year Advantage
Does a better job of matching premium and loss
Cal/Acc Year Disadvantage
Requires adjustment for audits & rates
Define exposure.
Basic unit of risk underlying the premium
Define loss adjustment expense.
Expense to settle claims incurred by the insurer
Describe the goal of ratemaking.
Goal of ratemaking is to have a balanced fundamental insurance equation
Describe why an actuary should consider the fundamental insurance equation at the individual risk level.
Third CAS Ratemaking Principle: A Rate provides for the costs associated with an individual risk transfer, Policy with more risk should cost more; Failure to recognize risk differences leads to rates that are not equitable
It is desirable that the exposure unit is
- practical; 2. verifiable; 3. varies with the hazard
Statement of Principles Regarding Property and Casualty Insurance Ratemaking,
- A rate is an estimate of the expected value of future costs; 2. A rate provides for all costs associated with the transfer of risk; 3. A rate provides for the costs associated with an individual risk transfer
If a rate is actuarially sound, it complies with four criteria commonly used by actuaries. Name these four criteria.
It is reasonable; Not excessive; Not inadequate; Not unfairly discriminatory
According to the Statement of Principles Regarding Property and Casualty Insurance Ratemaking, which of the following statements is true?
Taxes, licenses, and fees exclude federal income taxes.
State the four ratemaking principles of the Casualty Actuarial Society.
- A rate is an estimate of the expected value of future costs; 2. A rate provides for all costs associated with the transfer of risk; 3. A rate provides for the costs associated with an individual risk transfer; 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
Written premium
Dollar amounts charged by an insurer for policies written during a specific time period.
Earned premium
Amount of the policy premiums that have been exposed to risk during a specified time period. Earned Premium is directly proportional to the portion of the policy period covered by the insurer during the specified time period.
Unearned premium
Portion of written for which coverage has not been provided
In-force premium
Full-term premium of all policies in effect at a specific point in time.
Calendar year 2011 written premium will be fixed (i.e. not change) at December 31,2011.
True - CY is transactional data with no future development. Thus, CY 2011 written includes all transactions in 2011 (new written, mid-term adj) and is fixed at the end of the year.
Calendar year 2011 earned premium will be fully earned (i.e. not change) at December 31, 2011.
True - CY earned premium is premium associated with coverage provided during CY 2011.
Policy year 2011 written premium will be fixed (i.e. not change) at December 31, 2011.
False - Policy year 2011 written premium will not be fixed as of 12/31/2011, because; any midterm changes associated with policies effective during 2011, even if change; happens in 2012 or later, should be included. Eg policy effective 7/1/2011, add a; new vehicle on 4/1/2012, this contributes to PY 2011 written.
Policy year 2011 earned premium will be fully earned (i.e. not change) at December 31, 2011.
False - PY 2011 earned prem will not be fixed as of 12/31/11. This is the earned premium; associate with all policies with effective dates in 2011. If they are annual policies,; all coverage has not been provided as of 12/31/11. Premium could be earned until; one policy term after the last effective date in the policy year, or 12/31/12 for; annual policies.
How are experience rate changes and law amendment rate changes different in their purpose and their effect?
The purpose of experience rate changes is to adjust rates for changes in projected experience levels from the expected loss level. The purpose of law amendment changes is to adjust rates for statutory modifications to benefits. Experience rate changes affect premiums only at the policy effective date. Law amendment changes affect premiums of all in-force policies at the date of the law amendment rate change.
Discuss whether or not it is appropriate to perform a classification ratemaking analysis using premiums adjusted with aggregate on-level factors.
No. If a rate change disproportionately effects a certain class more than others, the on-level factors will vary by class. Therefore aggregate OLF should not be used.
State one advantage and one disadvantage of the parallelogram method relative to the extension of exposures method.
Advantages - Easy to calculate; Does not require individual policies, only need aggregate data; Disadvantages - Assumes policies written uniformly throughout the year; Applied at aggregate level using overall average changes so may not work for classifcation analysis
Give one argument for using average earned premiums in the premium trend analysis and one argument for using average written premiums.
- The premiums being trended are earned premiums, thus it is better to use average earned premiums in the premium trend analysis. 2. Average written premiums are more responsive to recent changes.
Explain why using average premium is better than total premiums when analyzing premium trend.
Total premiums are affected by exposure changes, while average premiums have averaged exposure effects out. Thus changes in average premium are more related to the premium trend.
Explain the effect of each of the following on the average premium level. a. (0.5 pt) Past rate changes.
Past rate changes directly affect the premium level, usually in a one-time and measurable way.
Explain the effect of each of the following on the average premium level. b. (0.5 pt) Model year and symbol rating plans.
Model year and symbol rating plans affect the premium gradually and continuously. As people trade in older cars for newer cars, the premium level will tend to increase.
Provide an example of a situation that can cause a one-time abrupt change in the average premium level and explain how the historical premiums should be adjusted to account for this abrupt change.
Past rate changes. Recalculate the total historical premium to what it would be under current conditions
Explain why an actuary should use premium adjusted to current rate level to analyze premium trend.
If premiums are not adjusted to current rate levels, the trend calculated would reflect both the rate level changes and actual premium trend. Rate level changes are one time changes; however, the trend calculated would suggest that those rate levels changes in the data would continue in the future, which is an inappropriate assumption. In addition, the abrupt changes in the data may make it difficult to select a trend.
Explain why an actuary should use written premium, rather than earned premium, to analyze premium trend.
The written premium should be used to analyze premium trend because it allows for the use of more recent data, which could reflect trends that have yet to show up in EP.
An automobile insurer implements a new 5% discount for female drivers without offsetting base rates. Explain the effect on average premium level AND briefly describe how to adjust the historical premium for use in ratemaking.
i. Average premium level will decrease since the new discount was not offset; ii. Treat as a one time, measurable rate change using on level factors
A homeowners insurer includes an Inflation guard endorsement on all policies, which automatically increases Coverage A in line with an external inflation index. Explain the effect on average premium level AND briefly describe how to adjust the historical premium for use in ratemaking.
i. Average premium level will increase since the Cov. A limit will increase with the inflation index and result in increased premiums; ii. Treat as a gradual/continuous change and adjust historical premiums with a premium trend (similar to an automobile model year/symbol factor)
Briefly discuss when it is appropriate to use two-step trending.
Single annual premium trend is not appropriate for each year in experience period; Trend in historical period is significantly different that what is expected in future
Provide one advantage and one disadvantage associated with using calendar year incurred losses rather than accident year incurred losses for ratemaking.
CY incurred losses are more responsive than AY since loss info is known once CY is complete. AY incurred provides a better match to premium and loss then CY basis, although not as well as PY matches premium and loss.
Describe basic limits losses and explain why they are often used in ratemaking analyses.
Basic limits losses are losses capped at the basic limit/level. They are often used in ratemaking to minimize the impact of extraordinary losses
Briefly describe one advantage and one disadvantage associated with using policy year losses for ratemaking.
Advantage - True match between premiums and losses; Disadvantage - It takes longer to develop
Briefly explain both the direct and indirect effects of a legislative change that increases the statutory Workers Compensation indemnity benefit by 15%.
The direct effect is that more indemnity payments will be paid. This is even if reported claims and average duration do not change. The effect may not change exactly by 15% due to minimum and maximum benefit levels or % of wage. The strength of the indirect effect is a function of the economic environment and the nature of the insured population. The law change may encourage workers to claim benefits.
Workers compensation law changes can produce both direct and indirect effects. a. Explain what is meant by direct effect. b. Explain what is meant by indirect effect. c. Will implementation of cost of living adjustments have a direct effect, indirect effect, or both? d. Will changes in administrative procedures have a direct effect, indirect effect, or both?
a. A direct effect is the direct impact on premium or losses solely due to law change not taking into account the human response to a change. For example, if the max benefit is increased, losses will automatically go up because those already at the max will get an increase in benefits. b. An indirect effect is the impact a change has on premium and losses because of the change in human behavior. For example, if the duration of benefits is lengthened, more people that are ready to go back may malinger to get benefits longer. c. Both. Direct ? Increase in indemnity payments because they will be adjusted upwards with inflation. Indirect ? More people may stay out of work longer because their benefits are keeping up with inflation. Previously, they may have returned to work because their benefits were not a sufficient amount. d. Indirect effect only ? Administrative procedures that make it easier to file claims may cause some to file claims they wouldn?t have in the past.
Regarding workers’ compensation, identify and briefly describe an indirect effect that may result from increasing the maximum benefit.
Because increasing the maximum benefit increased the effective compensation rate, we might expect to see longer duration injuries, since injured workers are receiving more benefit, they have less incentive to return to work. We would also expect an increase in claims, since workers will be paid more for injuries, they will report more injuries.
Briefly describe a method that can be used to estimate development beyond 75 months.
? May fit curves to historical development factors to extrapolate the development beyond the patterns in the historical data ? Alternatively, may perform special studies that include more years of data
Fully discuss why it may be inappropriate to apply a basic limits loss trend to total limits losses.
If loss costs are increasing, basic limit losses will trend at a lower rate than total losses, and thus a basic limit trend will understate the actual underlying loss trend. Basic limit losses trend at a lower rate than total losses because for losses near or at basic limits before trending, the full trend will not be realized by limiting losses. A loss that is already at or above basic limits, in fact, will observe no basic limit trends if losses are increasing.
Identify a situation in which the excess limit trend will be less than the basic limit trend.
When loss trends are negative.
Briefly describe three causes of loss development.
- New claims reported; 2. Development on known claims; 3. Reopened claims
Briefly explain why it is appropriate to both trend and develop losses (i.e., why there is no overlap).
Trend develops losses from the midpoint of the experience period to the midpoint of the exposure period. Development takes the losses from the midpoint of the exposure period to ultimate. to the midpoint of the exposure period. Development takes the losses from the midpoint of the exposure period to ultimate.
Fully discuss the “overlap fallacy” between trend and loss development.
It was believed that loss development and loss trend capture the same change in loss patterns. Therefore, using both would be ?double counting?. This belief was referred to as ?overlap fallacy.” It is incorrect, because loss trend projects losses from the midpoint of experience period to the midpoint of exposure period, while loss development projects losses from midpoint of the exposure period to ultimates.
Identify four adjustments made to historical losses in projecting losses for a future policy period for ratemaking. Briefly describe the purpose of each.
- Development ? taking losses from an early state (e.g. 24 months) to their total ultimate state when all losses are paid and the claims are closed. 2. Trend ? taking the historical losses from the midpoint of the experience period and projecting to the midpoint of the future period (takes things such as inflation into account) 3. Benefit Level Changes ? take into account anything that would change the benefits being changed to get losses to a ?current benefit level? (e.g. workers comp. change in the law affecting benefits paid) 4. Catastrophes/Shock Losses/Extraordinary Events ? adjust historical losses to take out any cats and load back in an amount to account for them. If cats were always just included, rates would increase years after cats and decrease after years without them to volatile.
Fully explain the overlap fallacy between loss development and loss trend.
? Trend factor reflects trend between midpoint of experience period and midpoint of exposure period ? The LDF reflects trend between occurrence and settlement The loss trend gets the experience period historical losses to the cost level of the average loss in the prospective experience period. The loss development factor accounts for the development of the average prospective loss to its ultimate settlement value.
The “Actuarial Standard of Practice No. 13, Trending Procedures in Property/Casualty Insurance Ratemaking,” has a recommended practice regarding selection of trending procedures. The Standard suggests that “the actuary should select trending procedures after appropriate consideration of available data.” List the four specific items the actuary may consider relevant when selecting.
? Procedures established by precedent or common usage in actuarial profession ? Procedures used in previous analysis ? Procedures that predict insurance trends based on insurance, econometric & other non-insurance data ? Context in which the trend estimate is used in overall analysis
?Actuarial Standard of Practice No. 13, Trending Procedures in Property/Casualty Insurance Ratemaking? discusses the concept of social inflation. Define social inflation and give two examples of phenomena that contribute to social inflation.
Societal changes that impact insurance costs. Examples include claims consciousness, court practices, and judicial attitudes
According to “Actuarial Standard of Practice No. 13, Trending Procedures in Property/Casualty Insurance Ratemaking,” social inflation is a noneconomic factor and thus is reflected outside of the trending procedure. True/False?
FALSE
Assume the fixed expense provision in a statewide rate level indication is based on a countrywide historical multi-year average of the ratios of actual expenses to actual earned premium. a. State two items that can cause this methodology to create inaccurate and inequitable indicated rate changes. b. For each of the two items stated above, give a potential solution to correct for the inaccuracy.
- Rate changes can impact the historical expense ratios and lead to an excessive or inadequate overall rate indication. 2. Significant premium trend between the historical experience period and the projected period can lead to an excessive or inadequate overall rate indication. 3. Can create inequitable rates for regional or nationwide carriers because it uses countrywide expense ratios and applies them to state projected premiums to determine the expected fixed expenses. 1. Restate the historical written or earned premiums at current rates. 2. Trend the historical premiums to prospective levels. 3. Track fixed expenses by state and calculate fixed expense ratios for each state.
Explain any inequity in the allocation of expenses to State X that may occur if the State X average premium is significantly higher than the countrywide average premium.
Since fixed expenses should be a fixed dollar amount per policy, a state with a large average premium should have a lower fixed expense ratio or expense fee ratio. Using a flat countrywide expense fee ratio in that state would allocate too much expense to that state.
Briefly define fixed expense and variable expense.
Fixed - assumed to be the same for each exposure, regardless of premium (e.g., overhead) Variable - vary directly with premium (e.g., commissions)
Identify a situation that could impact the appropriateness of the historical fixed expense ratio for projection purposes and briefly explain the impact on the estimated fixed expenses.
Rate changes can impact the historical expense ratios ? If there are rate increases that impact only a portion of historical premium or happen after historical time period, current procedure will tend to overstate the expected fixed expenses
The premium based projection method could produce distorted results if:
- Premium is not placed at the current rate level. If rates have increased (decreased) since or throughout the historical experience period, premium used in the expense ratios would be understated (overstated), resulting in an overstated (understated) expense ratio. 2. Premium is not trended to reflect shifts in average premium. If average premium is trending upward (downward) after or throughout the historical experience period, premium used in the expense ratios would be understated (overstated), resulting in an overstated (understated) expense ratio. 3. If we are using a nationwide expense ratio and apply it to a state that has significantly different average premium but the same fixed expense, there will be a distortion. For states with higher (lower) average premium, fixed expense will be overestimated (underestimated).
Briefly describe the potential distortions of using the All Variable Expense Method.
Assumes all expenses vary directly with premium. However, a portion may be fixed. Problems ? Understates premium need for small premium risks ? Overstates premium for large premium risks
Briefly describe three shortcomings of the Exposure-Based Expense Projection Method.
- Requires the actuary to split expenses into fixed and variable 2. Proposed procedure allocates countrywide fixed expenses to each state based on exposures ? Average fixed expense levels may vary by location (e.g., advertising costs) 3. Some expenses considered fixed vary by other characteristics ? E.g., New vs. renewal business - only affects if distribution changing significantly and/or varies significantly by state 4. Existence of economies of scale in a changing book will lead to increasing or decreasing projected average expense per exposure figures
Briefly describe whether it is necessary to trend fixed expenses using the Premium-Based and Exposure/Policy-Based Expense Projection Methods.
Premium-based Projection Method ? If average expenses and average premium changing at same rate ? No trending necessary ? If assume average fixed expenses changing at different rate than average premium ? Trend fixed expense ratio Exposure-based Projection Method ? If inflation sensitive exposure base used ? No trending necessary if assume expenses and exposure base changing at same rate ? If non-inflation sensitive base or policy counts ? Trending necessary because average fixed expense is expected to change over time
Briefly describe two ways to consider non-proportional reinsurance in your ratemaking analysis.
? Reduce projected losses for reinsurance recoveries and premiums for cost of reinsurance ? Net cost of non-proportional reinsurance may be included as an expense item i.e., cost of reinsurance minus expected recoveries
List two practical differences between the pure premium method and the loss ratio method.
- Loss ratio method uses on-level earned premium. Pure premium method uses exposures. 2. Loss ratio method develops an indicated rate change. Pure premium method develops an indicated rate.
Describe a situation where the pure premium method cannot be used.
The pure premium method cannot be used if exposure information is not available
Describe a situation where the loss ratio method cannot be used.
The loss ratio method cannot be used for a new line of business because the method requires existing rate.
Expenses can be related to written premium or earned premium. Briefly explain why other acquisition expenses are related to written, while general expenses are related to earned.
Other acquisition expenses are assumed to be incurred mainly at the beginning of the policy, in the effort of “acquiring” the policy, so compare to written premium. General expenses, like salary, would continue to incur even if policies were no longer written, so compare to earned premium.
Describe one situation in which it is preferable to use the loss ratio method, and one situation in which it is preferable to use the pure premium method.
Loss ratio method is preferred with exposure unit is not available or reasonably consistent between risks. Pure premium method is preferred for a new line of business or where the on-level premium is difficult to calculate.
Which approach is more appropriate when pricing a new line of business? Explain.
Pure premium method produces an indicated rate, so no existing rate is required. Loss ratio method produces an indicated rate change, so an existing rate is required. Pure premium method is more appropriate for new line of business.
Which approach is more appropriate when pricing a line of business for which the historical rate change history is not available? Explain.
Pure premium method does not require premium at current level. Loss ratio method requires premium at current level to calculate the indicated change. Pure premium method is more appropriate when no historical rate changes are available.
For each of the following identify whether the loss ratio or pure premium ratemaking method is preferable. Briefly explain your answer. a. Setting prices for a new line of business. b. Setting prices for a product that is not written uniformly throughout the year; current systems do not support re-rating policies. c. Setting prices for a commercial lines product that has multiple complex exposures underlying each risk.
a. Pure premium because it produces an indicated rate, which does not require historical rates; b. Pure premium. Loss ratio method requires on level premiums which would be challenging or not possible here; c. Loss ratio. In this situation it would be easier to use premiums and not have to deal with difficult exposures in the pure premium method.
Identify whether the loss ratio or pure premium ratemaking method is preferable in each of the following scenarios. Briefly explain each answer. a. A company introduced two new rating variables within the past year. b. A company is entering a new line of business. c. A company writes a commercial product with multiple exposure bases.
a. Pure premium because bringing historical premium to current rate level with the new variables may be difficult; b. Pure premium because there is no existing rate to which an indicated change can by applied; c. Loss ratio because an accurate and consistent exposure measure will be difficult to calculate
Identify and explain three statistical criteria that should be considered when selecting rating variables for a classification plan.
Statistical significance - expected cost estimates should vary for different levels of the rating variable Homogeneity - members of a group receiving same rate should have similar expected costs Credibility - rating group should be large enough to measure costs with sufficient accuracy.
Finger, “Risk Classification,” chapter 6 of Foundations of Casualty Actuarial Science, lists a number of social criteria that any rating plan should satisfy.
a. (1 pt) List and briefly describe four of these social criteria. Causality - should be an intuitive relationship between the rating variable and the cost of insurance Controllability - should be under the control of the insured, so if insured behaves in a certain way, premium will be reduced Affordability - high rates often seen as causing affordability problems, especially when there is a negative correlation between incomes and ins rates Privacy - people may be reluctant to discuss personal information
You are the Homeowners ratemaking actuary for your company. You have just concluded a study that indicates a very strong correlation between the expected liability losses for one household, and the number of children residing there. You wish to propose a modification to your rating structure that will incrementally surcharge for each additional child living in the household. Discuss how this proposal would or would not satisfy any two of the social criteria that you listed above.
Causality - seems to fit because of the increased chance each child has to cause damage to someone else, and also increased number of other kids (friends) that would be on the property Controllability - does not satisfy because children already are born by the time the rating factor would be introduced Affordability - may fail due to the fact the families with more children may have less additional money to spend Privacy - shouldn’t cause any privacy issues
Some companies use information from credit reports as a rating variable. State four criteria for rating variables and explain whether or not they are fulfilled by information from credit reports.
Many to choose from 1. Privacy: not fulfilled, people consider credit reports private. 2. Causality: not fulfilled, a bad credit report does not cause more claims (or more severe claims). 3. Controllable: is fulfilled, by managing finances, paying off debts, credit reports are controllable. 4. Verifiability: fulfilled, companies can run credit reports quite easily.
As the actuary for an insurance company, you are developing an auto class plan in which one of the proposed rating variables is estimated miles driven during the coverage period.
a. (1.5 pts) Identify and briefly describe two statistical criteria, and explain whether mileage defined this way satisfies these criteria. Statistical significance - expected cost estimates should vary for different levels of the rating variable. Mileage satisfies this criteria because the more miles driven, the more exposure to loss, and hence more losses Homogeneity - members of a group receiving same rate should have similar expected costs. Mileage satisfies criteria because grouping by mileage is grouping by similar exposure and expected losses. Credibility - rating group should be large enough to measure costs with sufficient accuracy. Can satisfy criteria if mileage broken into large enough segments.
Identify and briefly describe two operational criteria, and explain whether mileage defined this way satisfies these criteria.
Objective Definition - little ambiguity and should be mutually exclusive. Mileage satisfies because it is an objective measure Administrative Expense - cost of obtaining and verifying information. Mileage does not satisfy this criteria because it can be expensive to obtain. Verifiability - easily available for rating purposes. Mileage does not satisfy this criteria because the insured could lie about mileage to save money, so insurer must audit
An insurance company wants to use color of car as a rating variable within its risk classification system.
a. (1 pt) Identify two operational risk classification criteria and evaluate the variable ?color of car? with respect to each criterion. 1. Verifiable - color would be easy to verify 2. Objective Definition - color would also satisfy this criteria b. (1 pt) Identify two social risk classification criteria and evaluate the variable ?color of car? with respect to each criterion. 1. Privacy - color would satisfy this criteria since color is not a very private issue 2. Controllability -the insured can choose the color of their car, so it is controllable
Fully discuss how an insurance company can “skim the cream” to gain a competitive advantage.
If an insurer notices a positive characteristic that is not used in their rating structures (or competitors), the insurer can market to those with the positive characteristic and try to write more of them (skimming the cream). The insurer will then benefit from lower loss ratios and better profitability.
An insurance company is considering using a rating factor based on a detailed psychological profile. a. Identify and briefly explain two of the criteria for desirable classification rating factors. b. Evaluate if the rating factor based on the new psychological profile meets each of the criteria identified in part a. above.
Sample Answer 1 ? Cost effective - the cost of obtaining the information should not exceed the benefit of additional accuracy. ? Privacy ? insured may rather pay more to avoid disclosing certain information Sample Answer 2 ? Social criteria: privacy, affordability, causality and controllability ? Operational: Low administrative expense, objective definition, verification intuitively related, underlying losses Sample Answer 1 ? For cost effectiveness, detailed psychological profile may cost a lot to obtain. This is most likely not cost effective. ? For privacy, many people will not want to take the psychological test for the profile or may not wish to disclose their profile to insurance company. Sample Answer 2 ? Social: privacy not met, insured may not want to disclose that information and it?s not something that?s easily controllable, although it may be good from causality standpoint. ? Operational: increased administrative expense, but it is objectively defined, verifiable, and likely intuitively related.
Briefly describe a reason multivariate classification techniques are preferred over univariate classification techniques when performing territorial relativity analyses.
Territories are generally heavily correlated with other variables. Multivariate techniques take into account the effects of other variables, whereas univariate techniques do not.
Describe the distortion of the Pure Premium approach to calculating territory factors and the effect on the indicated territory relativities.
Assumes uniform distribution of exposures across all other rating variables. If territories have a disproportionate number of various classes, this assumption is violated. For example, if one territory has a high proportion of one class and a different territory has a high proportion of a different class. By ignoring correlation between territory and class, loss experience of various classes can distort the indicated territory relativities. This results in a double-counting effect.
Describe the situation when the Adjusted Pure Premium approach will produce the correct relativities.
If true class rels used to determine exposure-wtd avg rels, then method would produce correct territory relativities
List and describe four operational considerations in designing a risk classification plan.
1) Measurability ? the variables should be easy to defined & measure. 2) Manipulation ? the plan should not allow for insureds to manipulate their classifications. 3) Expense ? the expenses of the classification plan should possible while maximizing company value. be as low as 4) Absence of ambiguity ? the classifications should be all encompassing and mutually exclusive; each insured should fit into one and only one class.
According to ?Risk Classification Statement of Principles? the process of risk classification should serve three
primary purposes. Briefly describe how each of these purposes helps to establish and maintain a viable insurance system.
- Risk classification minimizes adverse selection which will exist when buyers are free to select who they purchase insurance from 2. Rate should be in line with their expected loss costs and there shouldn?t be any subsidy between risk classes 3. Each risk class should be priced to their expected losses so that insurers have same profit potential on all risks and are willing to write high risks and low risks, rather than just going after low risks. This increases availability.
With respect to a private, voluntary insurance program, discuss the extent to which each of the following assumptions is or is not important for defining a risk classification system.
a. (0.5 pt) The system should contemplate the level of competition in the market place. Important ? in a competitive market risk classification is important to avoid adverse selection. b. (0.5 pt) The characteristics of the system should be based on causality. Not important ? may help with public acceptance, but difficult to prove; can use plausibility instead. c. (0.5 pt) The system should provide incentives for risks to reduce their expected losses. Not important ? thought hazard reduction incentives are beneficial to society, the utility is limited. d. (0.5 pt) The system should balance between providing a reasonable continuum of expected claim costs and maintaining significant differences in prices between classes. Important ? system should avoid extreme discontinuities, but should have significant enough differences to justify different class.
Based on the American Academy of Actuaries, “Risk Classification Statement of Principles:”
a. (1.5 pts) Identify and briefly describe three statistical considerations when developing a risk classification system. 1. Credibility - the larger the volume of data in a class, the more reliable or believable are the indications for that class 2. Homogeneity - risks in a class should be reasonably similar in the expected loss potential 3. Predictive Stability - a risk characteristic should be responsive in reflecting the changing nature of insurance losses but should avoid unwarranted abrupt changes in indication b. (1.5 pts) Identify three elements of program design and briefly describe the impact of each on risk classification. 1. Degree of Buyer Choice - in a compulsory insurance system and where there is little choice among competing insurance providers less refined risk classification systems may be used without the issue of adverse selection 2. Degree of Experience based pricing - to the extent that the premium is modified based on the insured?s own experience, less refined classification systems may be used 3. Premium payer - Is someone other than the insured is the premium payer, then the premium and hence the system is of less concern to the insured, so broader risk classification definitions may be used
Briefly describe the shortcoming of univariate approaches.
They do not accurately take into account the effect of other rating variables
Identify the circumstances that led to the adoption of multivariate techniques.
? Computing power ? Data warehouse initiatives ? Competitive Pressure
Identify the benefits of multivariate methods.
? Adjust for exposure correlations ? Allow for nature of random process ? Provide diagnostics ? Allow interaction variables ? Considered transparent
Briefly describe three reasons an actuary may prefer to model frequency and severity separately.
? Modeling loss ratios requires premium @CRL which can be difficult at granular level ? Experienced actuaries have an a priori expectation of frequency and severity patterns ? In contrast, loss ratio patterns dependent on current rates ? Actuary can better distinguish signal from noise ? Loss ratio models become obsolete when rates and rating structures are changed ? No commonly accepted distribution for modeling loss ratios
You are modeling driver age for personal automobile bodily injury. The results of a univariate analysis and a multivariate analysis are significantly different. Explain.
Disparity suggests age is strongly correlated with another variable in model ? E.g., prior accident experience, use of auto ? Univariate results are distorted
Briefly describe the benefits of statistical diagnostics with GLMs.
Aid modeler in understanding certainty of results and appropriateness of model. Some can help determine if predictive variable has a systematic effect on insurance losses and others assess modeler’s assumptions around the link function and error term
Briefly describe two statistical diagnostics used with GLMs.
- Standard errors ? Narrow standard errors suggest variable is statistically significant ? Wide standard errors, often around 1.0, suggest factor detecting mostly noise, and should eliminate from model 2. Deviance tests ? Measure how much fitted values differ from observations ? Deviance of models compared to assess whether the additional variables in a broader model are worth keeping 3. Consistency with time ? Compare results from individual years ? Gauge consistency of results from one year to the next 4. Validation ? One option to compare expected outcome of the model with historical results on a hold-out sample of data ? Considerable differences between actual and expected may indicate model is over or under-fitting
Briefly describe over-fitting a model.
Over-fitting results when variables in model reflect noise or over-specify model with high order polynomials ? Replicates historical data well but doesn’t project future reliably ? future experience unlikely to have same noise
Briefly describe under-fitting a model.
Under-fitting if model is omitting statistically significant variables ? Model doesn’t have enough explanatory power
Briefly describe four important areas that the actuary needs to consider when using GLMs.
- Ensuring data is adequate for level of detail of the classification ratemaking analysis ? Avoiding GIGO principle - garbage in, garbage out 2. Identifying when anomalous results dictate additional exploratory analysis 3. Reviewing model results in consideration of both statistical theory and business application 4. Developing appropriate methods to communicate model results ? Considering company’s ratemaking objectives 5. Retrieval of data requires careful consideration ? Volume of data ? Definition of homogeneous claim types ? Method of organization (e.g., policy vs. accident year) ? Treatment of midterm policy changes ? Large losses ? Underwriting changes during experience period ? Effect of inflation and loss development 6. Always must balance stability and responsiveness ? Choice of experience period and geographies 7. Commercial considerations ? IT constraints ? Marketing objectives ? Regulatory requirements
Briefly describe four actions the actuary should take to successfully use GLMs in the ratemaking analysis.
- Have solid background in company’s data warehouses 2. Develop some understanding of statistical methods and diagnostics 3. Work collaboratively with other professionals who know portfolio of business 4. Communicate effectively with stakeholders of company to ensure the technical results are expressed in relation to company’s business objectives
Briefly describe four ways data mining techniques can be used to enhance a ratemaking analysis.
- Shorten long list of potential explanatory variables to use in GLM 2. Provide guidance in how to categorize discrete variables 3. Reduce dimension of multi-level discrete variables 4. Identifying candidates for interaction variables within GLMs by detecting patterns of interdependency between variables
Identify and give an example of each of four types of external data sources used to supplement company data to be used with GLMs.
- Geo-demographics ? E.g., population density of an area, average length of home ownership in an area 2. Weather ? E.g., average rainfall, number of days below freezing in an area 3. Property characteristics ? E.g., square footage of home or business, quality of fire department in area 4. Information about insured individuals or business ? E.g., credit info, occupation
Identify three data mining techniques and briefly describe their use to enhance the underlying classification analysis.
- Factor Analysis ? Reduce number of parameter estimates in classification analysis ? May reduce number of variables or levels within a variable 2. Cluster Analysis ? Seeks to combine small groups of similar risks into larger homogeneous categories ? Targets minimizing differences within a category and maximizing difference between categories 3. CART (Classification and Regression Trees) ? Develop tree-building algorithms to determine a set of if-then logical conditions ? Help improve classification and detect interactions between variables ? Helps identify strongest list of initial variables and how to categorize each 4. MARS (Multivariate Adaptive Regression Spline) ? Multiple piecewise linear regression where each breakpoint defines region for a particular linear regression equation ? Use to select breakpoints for categorizing continuous variables 5. Neural Networks ? User gathers test data and invokes training algorithms designed to automatically learn structure of the data ? Results of neural networks can be fed into GLM
Identify and briefly explain two issues that arise when using empirical data to construct increased limit factor tables.
- Policy limit censorship ? Would create a downward bias 2. Some reported data may be from policies written with a deductible, or excess/umbrella policies ? Missing information on layers of loss below ded / attachment pt 3. Must adjust for trends in claims costs ? Inflation, change in jury awards, legislative actions ? When developing loss trends, important to consider cred of experience 4. Recent claims may not be settled at the time of evaluation ? Must adjust for the effect of loss development ? Concerned with the growth of a distribution of losses ? Need to address avg growth and changes in the shape of the loss dist 5. Data subj to random fluctuations, especially in higher layers where data is sparse ? Presence or absence of larger losses can result in ILF estimates that are too high or low
Briefly describe four reasons deductibles are used.
- Premium reduction ? Insured willing to cover deductible in exchange for lower premium 2. Eliminates small nuisance claims ? Often LAE on small claims exceeds indemnity payment ? Deductibles minimize occurrence of small nuisance claims 3. Provides incentive for loss control ? Insured has a financial incentive to avoid losses 4. Controls catastrophic exposure ? Insurer may be susceptible to very large aggregate loss when catastrophe hits an area where the insurer has a high concentration of policies ? Large catastrophe deductibles reduce overall exposure and reduce overall risk of insolvency
It has been observed that loss experience for large risks tends to be better than for small risks. Give two explanations that support this observation.
- Small companies have less sophisticated safety programs due to cost to implement & maintain 2. Small companies often lack programs to help injured workers return to work 3. Experience rating plan provides an incentive for safety procedures ? Small insureds either unaffected or only slightly impacted by ERP, thus less incentive to control losses
Give two reasons why small risks generally show higher loss ratios than larger risks.
- Small companies have less sophisticated safety programs due to cost to implement & maintain 2. Small companies often lack programs to help injured workers return to work 3. Experience rating plan provides an incentive for safety procedures ? Small insureds either unaffected or only slightly impacted by ERP, thus less incentive to control losses
What is the purpose of an Expense Constant?
Account for expenses that do not vary by policy size, but are constant for each policy
Why is an Expense Constant important for small policies?
The premium for small policies may be so small that it may not cover the expenses of writing the policy. Without the expense constant, insurers may not want to write small pols.
What is the purpose of a Loss Constant?
It is added to either small policies or all policies to account for the fact that small policies have worse expected loss experience than large policies.
There are several ratemaking techniques that can be used to recognize the differences between large risks and small risks for Workers’ Compensation insurance. Select two of these techniques and explain how they account for these differences.
Expense Constants Some expenses do not vary much by policy size, apply expense constant to all policies Loss Constants, Premium Discounts, or Experience Rating Plans Small risks tend to have higher loss ratios. Techniques above attempt to equalize loss ratios among large and small risks
(T/F) If less than 100% coinsurance is available, a person buying full coverage may be overcharged. Explain.
True - The pure premium rate calculation assumes that all properties are insured to the exact coinsurance requirement, and the pure premium rate decreases as the policy face increases.
Identify two considerations from the “Statement of Principles Regarding Property & Casualty Ratemaking” that could apply to the concept of insurance to value. Briefly explain the relevance of each to insurance to value.
Mix of business ? changing mix of ITV in the book will influence premium and loss trends. Economic/Social Social trends ? if there is a movement towards lower insurance to value because people are purchasing lower amounts of coverage to save money on premium due to hard economic times the actuary may want to evaluate the insurance to value contemplated on the current rates.
An insurance company increases the insurance to value of its book of business. Briefly describe the impact on each of the following: ? Premium ? Losses ? Expenses
Premium ? could see higher prem. as a result of larger exposure amounts written ? Could see lower premium if there are higher cancel/non? renews Losses ? expect to see larger total and near total claim amts from larger exposures ? Losses may decrease from higher cancel/non?renew ? Losses may decrease if reinspection also leads to loss control measures implemented by homeowners. Expenses ? increased inspection/reinspection may create additional expenses, however increase relative to premium change is unclear.
Identify the problem with underinsurance from the insurer’s perspective.
If policyholders are underinsured this is a problem from insurer?s perspective because if rates are calculated assuming all properties are insured to value, the premium charged will not be adequate to cover expected losses arising from those policies not insured to value.
Identify the problem with underinsurance from the insured’s perspective.
The insured may pay a lower premium if home is underinsured but in the case of a total loss, insured won?t get payment for full value of home. If there is a coins penalty partial losses will be subject to that penalty, so insured is still not compensated for full value of loss.
State two basic assumptions are made when calculating ILFs that allow the actuary to ignore frequency and to only consider size of loss data?
- Underlying frequency is assumed to be independent of severity 2. Frequency is independent of the policy limit
Describe two insurer initiatives that would reduce the inequity from underinsuring including an explanation of how the inequity would be reduced.
- A coinsurance clause would reduce the indemnity payments by the proportion of selected coverage out of the required coverage. This would reduce the loss ratios for underinsured homes to the same loss ratio as fully insured homes. 2. Could begin initiatives to increase ITV through home inspections, etc, forcing underinsured homes to purchase the right amount. This would increase premiums for underinsured homes and equalize loss ratios.
List and briefly describe three issues with using empirical data to calculate ILFs.
- Policy limit censorship ? Missing information above policy limit 2. Some reported data may be from pols written with a deductible, or excess/umbrella pols ? Missing information on layers of loss below deductible / attachment point 3. Must adjust for trends in claims costs ? Inflation, change in jury awards, legislative actions ? When developing loss trends, important to consider credibility of experience 4. Recent claims may not be settled at the time of evaluation ? Must adjust for the effect of loss development ? Concerned with the growth of a distribution of losses ? Need to address average growth and changes in the shape of the loss distribution 5. Data subject to random fluctuations, especially in higher layers where data is sparse ? Presence or absence of larger losses can result in ILF estimates that are too high or low
Pure premium rates fall as the assumed policy face increases. Describe the distribution of losses for the following:
a. Pure premium rate decreases at a decreasing rate. small losses outnumber large losses b. Pure premium rate decreases at an increasing rate. large losses outnumber small losses c. Pure premium rate decreases at a constant rate. losses of all sizes are equally numerous
Briefly describe how the LER approach does not recognize behavior differences of insureds and the effect on the calculated deductible credits.
- Method assumes insureds at different deductible levels have same claiming behavior. In reality insured with $250 deductible is more likely to make a claim for $1,100 than an insured with a $1,000 deductible 2. Lower-risk insureds tend to choose higher-deductibles because they realize they’re less likely to have a claim. LER approach does not recognize these behavior differences, so higher deductible policies may end up being more profitable.
Describe the difference between using GLMs and using LASs to calculate ILFs.
GLM does not assume frequency is same for all risks. The GLM results are influenced by both the limiting of losses and behavioral differences among insureds at different limits, and therefore may produce counterintuitive results such as expected losses decreasing as limit increases.
Briefly describe two challenges in territorial ratemaking.
- Tends to be heavily correlated with other rating variables ? E.g., high value homes often located together ? Makes traditional univariate analysis very susceptible to distortions 2. Often analyze territory as collection of small units ? Data in each individual territory is sparse
Describe the two basic types of spatial smoothing used in territorial ratemaking and state when each tends to be most appropriate.
- Distance-based approach ? Give weight to nearby geographic units based on distance from primary unit ? Less weight as distance increases ? Advantage - easy to understand and implement ? Disadvantages ? Doesn’t distinguish between an urban and a rural mile ? Presence of natural or artificial boundary not taken into consideration ? Assumption tends to be most appropriate for weather-related perils 2. Adjacency-based ? Weight given to rings of adjacent units ? Immediately adjacent units get most weight ? Handles urban/rural differences more appropriately ? Accounts for natural or artificial boundaries better ? Tends to be most appropriate for perils driven by socio-demographic characteristics
For territorial ratemaking, briefly describe the phase of establishing territorial boundaries.
Determining Geographic Unit Calculating the Geographic Estimator Spatial smoothing techniques used to improve estimate of unit by using info from nearby units Once geographic estimators calculated for each unit, can be grouped into territories
Briefly discuss three methods for calculating complements of credibility in first dollar ratemaking and comment on the effectiveness of each method as a complement of credibility.
Loss Costs of a Larger Group Including the Class Contains intrinsic bias and inaccuracy because actuary should believe that true expected class losses will be different from group expected losses. It has some independence as long as base class doesn’t dominate group. Performs well on availability and ease of computation, and has explainable relationship to base class Loss Costs of a Larger Related Class Biased and inaccurate, but can adjust related class loss data to reduce bias. Data not as readily available as group mean and computations may be more difficult due to loss adjustments. Explaining the complement may be easier due to it being related. Harwayne’s Method Very high statistical quality, is very unbiased, and is reasonably accurate. Data is usually available, but computations take time and are complicated. May be difficult to explain due to complexity. Trended Present Rates Not as desirable as first three complements, but may be only alternative. It is less accurate for loss costs with high process variance. It is unbiased in the sense that pure trended loss costs are unbiased. However, data is available and it is easy to calculate, and it is also very logically related to loss costs being analyzed. Rate Change from the Larger Group Applied to Present Rates Largely unbiased and very accurate, is fairly independent. Since group rate change must be calculated anyway, it is available and easy to compute. Since includes present rate, has logical relationship. Using Competitors’ Rates Has significant inaccuracies and may be difficult to obtain. Prediction errors are independent of subject class loss costs and my be more reliable than company’s own loss costs.
Answer the following questions about using the trended present rates as the complement of credibility when using ratemaking data that is not fully credible. State and briefly describe one advantage and one disadvantage of using this complement of credibility.
Disadvantage - less accurate for loss costs with high process variance. Advantage - data is available and it is easy to calculate
Identify one advantage and one disadvantage to using the trended present rate as the complement of credibility.
Several Advantages Availability - Good unless need more detail in current chg then use in previous Unbiasedness - Unbiased in the sense that pure trended loss costs are unbiased Ease of computation - Very good Explainable relationship - Very logical relationship Disadvantage Accuracy - Less accurate for loss costs with high PV
Werner and Modlin state that “It is important to consider the [fundamental insurance] equation at the individual or segment level” in addition to the aggregate level. Discuss two reasons it would be acceptable to maintain an imbalance in the fundamental insurance equation at the individual or segment level.
? Maintain competitive position. If changing rates would hurt your competitive position then is may be acceptable to take less of a change and have an unbalanced Fund. Ins Equation -> In other words hurting retention enough to offset increase. ? If the relative cost of the change outweighs the benefit. If the operational cost of changing rating algorithms or data collection processes out weigh the change in prems associated with the change then it could be appropriate to have an unbalanced Fund Ins Equation ? It might due to the regulation constraint The regulator may restrict the rate change (e.g. capped at +/- 25%) ? Marketing Constraint If the company?s marketing objective is to increase the market share on age group 50-55 drivers, it may reduce rate to attract this group of insureds. Company may look at the long term profitability of the book using asset share pricing technique.
Reconcile an imbalance in the fundamental insurance equation with the following quote from the Statement of Principles Regarding Property & Casualty Insurance Ratemaking: A rate provides for the costs associated with an individual risk transfer.
An actuarially sound indication may not always be implemented since the insurance company needs to balance other objectives, such as marketing, then actuarially balancing premium and loss. The actuary is allowed to deviate from this principle under influence of management, with the proper disclosure. Additionally asset sharing pricing techniques have demonstrated that under certain circumstances, it is ultimately profitable to write business that currently produce a net loss.
Briefly describe five reasons U.S. Regulatory Constraints may cause implementation of rates different from what was indicated by ratemaking analysis.
- Limit on amount of an insurer’s rate change ? Overall average rate change for the jurisdiction or change for individual customer or group 2. Regulatory requirements depending on magnitude of requested change ? May require company to provide written notice to insureds or hold public hearing ? Company may choose lesser change to avoid 3. Prohibit use of particular characteristics for rating ? Even if demonstrated to be statistically strong predictors of risk ? E.g., credit score because perceived to be correlated with certain socio-demographic variables 4. Prescribe use of certain ratemaking techniques ? WA currently requires multivariate classification analysis be used to develop rate relativities if insurance credit score is used to differentiate premium in personal automobile 5. Company actuary and regulator may disagree on ratemaking assumptions ? E.g., loss trend
Briefly describe four actions a company can take with respect to regulatory restrictions.
- Take legal action to challenge regulation 2. Revise underwriting guidelines to limit amount of business it considers underpriced 3. Change marketing directives to try and minimize new applicants it considers underpriced 4. Use a different allowed rating variable for a restricted variable if believes the different variable can explain some of effect associated with restricted variable
Briefly describe two operational constraints that may make it difficult or undesirable for a company to implement the actuarial indicated change.
- Changing rating algorithm can require significant systems changes ? Complexity of change depends largely on ? Extent of structural changes (e.g., num of rating variables, num levels within each) ? Number of systems impacted (e.g., quotation, claims) 2. New rating variable may require data that has not been previously captured ? May need to collect through questionnaire or visual inspection
Briefly describe the use of a cost-benefit analysis when an operational constraint arises.
Performed to help determine the appropriate course of action when selecting a rate change. Can estimate the change in business, costs and profit associated with a change. Standard ratemaking analysis generally doesn’t account for implementation costs or staffing changes.
Briefly describe five factors that commonly affect the insured’s desire to renew or purchase a new policy.
- Price of competing products 2. Overall cost of product - if relatively cheap, less likely to shop around 3. Rate changes - significant rate increase can cause existing insured to shop 4. Characteristic of the insured - younger policyholder may shop more frequently 5. Customer satisfaction and brand loyalty - poor claims handling or poor customer service
Identify four techniques used for incorporating marketing considerations.
- Competitive comparisons 2. Close, retention, and growth ratios 3. Distributional analysis 4. Dislocation analysis
Describe the use of competitive comparisons.
? Compare premium to the premium charged by one or more competitors to determine competitive position. ? % Win is the percentage of risks an insurer beats the price of a competitor ? Rank = Rank of Company Premium when compared to several competitors ? All information needed to accurately determine premium charged by competitor may may be difficult to obtain. ? Companies generally interested in two levels of competitiveness ? How competitive rates are on average - i.e., all risks combined ? How competitive rates are for individual risks or groups - e.g., new homes, young drivers
Describe the use of close ratios.
? Close ratio measures the rate at which prospective insureds accept a new business quote Num of Accepted Quotes Total Number of Quotes ? Primary signal of competitiveness of rates ? Changes in the close ratio often used to gauge changes in competitiveness ? Important to view when rate changes are implemented
Describe the use of retention ratios.
? Retention ratio measures the rate at which existing insureds renew their policies on expiration Num of Policies Renewed/Tot Num of Potential Pols ? All else being equal, renewal customers tend to be less expensive to service and generate fewer losses on average than new business ? Primary signal of competitiveness of rates ? Changes in the retention ratio often used to gauge changes in competitiveness ? Important to view when rate changes are implemented
Describe the use of growth ratios.
? Growth is a function of attracting new business and retaining existing customers (New Pols Writ - Lost Pols) Policies at End of Period Policies at Onset of Period Policies at Onset of Period ? Low or negative growth can indicated uncompetitive rates and vice versa ? Changes in growth can also be significantly impacted by items other than price ? E.g., Company loosens/tightens underwriting standards
Describe the use of distributional analysis.
? Companies may look at distributions of new and renewal business by customer segment ? Normally includes both the distribution by segment at given point and changes over time ? Distributional information should be considered in context of general population of insureds and the target distribution of the company ? Can look at target markets to determine if rates are competitive in these areas ? Comparison over time can help determine if competitive position is a recent development ? Could indicate a major competitor is targeting the market
Describe the use of policyholder dislocation analysis.
? Purpose to quantify the number of existing customers that will receive specific amounts of rate change ? Use information to extrapolate how the rate change may affect retention ? Dislocation analysis highlights effects outside of threshold they believe will produce an unacceptable effect on retention. ? Company may then choose to revise proposed rate change ? Expected dislocation can be shared with sales and customer service to help them prepare for the change
Briefly describe two systematic techniques for incorporating both marketing information and actuarial indications when proposing rates.
- Lifetime Customer Value Analysis ? Exam profitability of an insured over a longer period of time ? Takes retention into consideration 2. Optimized Pricing ? Multivariate statistical modeling techniques applied to develop renewal and conversion models ? Customer Demand Models ? Use loss cost and customer demand models together to estimate expected premium volume, losses, and total profits for a given rate proposal ? Test several rate change scenarios ? Objective to identify the rate change that best achieves the company’s profit and volume goals
Explain why the off-balance factor is necessary.
The off-balance factor is necessary because the average relativity under indicated rates is different from the average relativity underlying the current rates.
What is the purpose of the off-balance adjustment when calculating new territorial rate relativities?
A. The off-balance adjustment is made to retain the same overall rate level.
Explain any inequity in the allocation of expenses to State X that may occur if the State X average premium is significantly higher than the countrywide average premium.
Since fixed expenses should be a fixed dollar amount per policy, a state with a large average premium should have a lower fixed expense ratio or expense fee ratio. Using a flat countrywide expense fee ratio in that state would allocate too much expense to that state.
Explain the purpose of a minimum premium.
Minimum premium ensures that the company collects an amount of premium that is enough to cover fixed expenses and a minimum risk provision for small-premium policies.
Describe two non-pricing solutions to bring an unbalanced fundamental insurance equation into balance.
- Expense Reductions Marketing budget, reduce staff, commissions; 2. Reducing Average Expected Loss ? Change in mix of business Tighten underwriting criteria Non-renew policies that are significantly underpriced ? Reduce coverage provided by policy ? Institute better loss control procedures
Identify the necessary steps to calculating new rates for an existing product.
- Select an overall average premium target for the future policy; 2. Finalize the structure of the rating algorithm; 3. Select the final rate differentials for each of the rating variables; 4. Calculate proposed fixed expense fees, if applicable; 5. Derive the base rate necessary to achieve the overall average premium target
Describe an advantage and disadvantage of using the extension of exposures technique
Advantage - Most accurate estimate; Disadvantage - May not have exposure distribution for each unique combination of rating variables
Identify an advantage of using the approximated change in average rate differential method over the approximated average rate differential method.
Disadvantage of the approximated average rate differential method is that you must do calculations for each rating variable and the rating algorithm can be quite complex. To use the change in average rate differential method, you only need to do calculations on rating variables that are changing.
Describe a way an insurer can mitigate the premium impact of a selected rate change for any single insured.
Use a premium transition rule that can dictate the max/min amount of change in premium that an insured can receive at a single renewal. The company can extend time period get the full rate change to multiple renewals.
Compare schedule rating and retrospective rating with respect to the following:
a. (0.75 pt) Providing incentive to insureds to control losses. Compared with schedule rating, retrospective rating provides more incentive for insureds to control losses. Because the retrospective premiums depend on the insured?s loss experience, they will have more incentive to control their losses. Schedule rating does not depend on the insured?s loss experience. It assigns credits/debits to the insured?s premium based on risk characteristics at the onset of the policy term. Thus it provides fewer incentives for loss control. b. (0.75 pt) Providing stability in the premiums charged to the insured. Schedule rating provides more stability in the premiums charged to the insureds. The premium is determined at the onset of the policy period and do not change. Alternatively, retrospective premium depends on the insured?s experience and may not be known until well after the completion of the policy term.
Briefly describe the following: ? Schedule Rating ? Experience Rating ? Composite Rating
- Schedule Rating ? Does not directly reflect claim experience ? Recognizes characteristics expected to have material effect on experience that are not actually reflected in experience ? May be based on objective criteria or subjective underwriting judgment 2. Experience Rating ? Used when past is predictive of the future ? Weight actual and expected experience ? Credibility assigned to actual experience reflects the degree of belief that the entity’s experience is a valid predictor of future costs 3. Composite Rating ? Large, complex risks use a single, composite, exposure base instead of several for many different coverages ? Composite rate determined at the beg of policy period using historical exposures ? May be determined using manual rates with exp and/or sched mods or based solely on own experience ? After expiration, audited to determine composite exposures
Contrast experience rating and retrospective rating with respect to the following concepts:
a. (0.75 pt) Providing incentive to the insured to control losses during the policy period. In retrospective rating, insurer will try to control losses in coming period because their loss experience will be used to calculate their rate. In experience rating, they have less motivation to control losses, because rate is based on past experience. b. (0.75 pt) Providing stability in the premium charged to the insured. Experience rating is more stable because it uses experience over several periods and retrospective rating is very likely to fluctuate because it is based on loss experience during a single policy period only.
An insurer has been tracking the claims experience of a very large construction company for the three years the construction company has been insured by this insurer. The construction company will implement a new safety program starting in the upcoming year.
a. (0.5 pt) Determine whether the insurer should use experience rating, schedule rating, or both to rate the construction company for the upcoming policy period. Briefly explain your answer. Both. Experience rating should be used to reflect the claims experience over the previous 3 years and schedule rating to reflect the new safety program and the expected reduction in losses it will create. b. (0.5 pt) Assuming no additional changes, determine whether the insurer should use experience rating, schedule rating, or both to rate the construction company five years from now. Briefly explain your answer. Just experience rating. 5 years after the safety program has been implemented, the effects of the program should be seen as experience and taken into account through experience rating.
Briefly explain why claims-made rates are both more accurate and more responsive to changing conditions than are rates for an occurrence policy.
Claims-made rating is more accurate because of a shorter forecast period. Claims-made rating is more responsive because external changes affect losses as they are reported.
Which of the following are true?
- Occurrence policies will generate more investment income than will claims-made policies 3. An occurrence policy should cost more than a claims-made policy, if claim costs are increasing at a rate greater than investment returns.
Which of the following are true?
- The confidence interval about the projected losses for a claims-made policy is generally narrower than for an occurrence policy priced at the same time.
For each of the Claims-Made Principles stated below, briefly describe why it is true.
a. (0.5 pt) A claims-made policy should always cost less than an occurrence policy, as long as claims costs are increasing. For occurrence policies, some losses will have inflation act on them for many years, while for claims-made policies, there is only one year of trend. b. (0.5 pt) Whenever there is a sudden, unpredictable change in underlying trend, claims-made policies priced on the basis of the prior trend will be closer to the correct price than occurrence policies priced in the same manner. The trending period for claims-made losses is shorter. c. (0.5 pt) Whenever there is a sudden unexpected shift in the reporting pattern, the cost of mature claims-made coverage will be affected very little, if at all, relative to occurrence coverage. The shift in reporting pattern would change the occurrence year from which claims are reported, but would have minimal effect on the cost. d. (0.5 pt) The investment income earned from claims-made policies is substantially less than under occurrence policies. The investment income is less since the claims-made policy is only concerned with losses that are reported in the next policy period. There is no need for pure IBNR and the time lapsed between the collection of premium and the payment of claims is shorter.
Which of the following statements are true regarding claims-made ratemaking?
- The investment income earned under claims-made policies is substantially less than the investment income earned under occurrence policies. 3. Claims-made policies incur no liability for IBNR claims.
A claim occurred in May 2001 and was reported in September 2003. Which of the following would cover this claims?
- Tail coverage effective January 1, 2003 for a physician retiring after 10 years of practice covered by claims-made coverage
Which of the following statements are true regarding claims-made ratemaking?
- The investment income earned under claims-made policies is substantially less than the investment income earned under occurrence policies. 2. A claims-made policy should always cost less than an occurrence policy, as long as claim costs are increasing. 3. Claims-made policies incur no liability for IBNR claims.
2010 - #22
a. (0.5 pt) Coverage Trigger Claims made coverage is triggered when claim is first reported to the insurer, (given that it occurred on or after the retroactive date and is reported in policy period) Occurrence coverage is triggered when the loss occurs during the policy period. b. (0.5 pt) Claims made policies have a much shorter tail than occurrence policies, so they are not affected as severely by inflation, trend, etc. This makes pricing the future easier. c. (0.5 pt) There is no IBNR (incurred but not reported) on a claims?made policy since all claims are reported at the end of policy period. So, it makes it easier to set reserves. d. (0.5 pt) To provide coverage for claims that may be reported after the claims?made policy expires For example, a doctor may retire, so no more new claims occur, but he/she needs coverage for claims that might be reported after he/she is done practicing medicine.
Briefly describe two advantages that claims-made coverage has over occurrence coverage for a medical malpractice insurer.
- C-M policy should always cost less than an occurrence policy, as long as claim costs are increasing 2. Whenever there is a sudden, unpredictable change in the underlying trend, C-M policies priced on the basis of the prior trend will be closer to the correct price than occurrence policies price in the same way 3. Whenever there is a sudden unexpected shift in the reporting pattern, the cost of mature C-M coverage will be affected very little if at all relative to occurrence coverage 4. C-M policies incur no liability for IBNR claims so the risk of reserve inadequacy is greatly reduced
