IF3.10 Pricing Factors Flashcards
risk premium
the expected ultimate cost in claims of the risk being accepted, including an allowance for the degree of uncertainty attaching to the claims cost.
pricing factors: Frequency
the expected number of claims should be forecast accurately and should account for anticipated changes in the environment, the portfolio of risks and the individual risks.
pricing factors: severity
The average cost of different types of claims with an allowance for catastrophies.
pricing factors: large claims
A rough prediction of how may large claims should be expected and how much they need to allow for these claims.
Periodic Payment Orders (PPOs)
can ad significant costs to claims settlements as they provide a service which makes structured payments to claimants for life (and avoid the need for the state to fund care costs once settlements have been spent by the claimants)
pricing factors: reinsurance costs
In order to protect the company from catastrophic single or combined losses insures buy reinsurance protection, which is a cost which must be factored into the premium cost.
Underwriting year, claims go in the year…
the policy incepts not the year they were made
Calendar year, claims go in the year…
the claim is made.
pricing factors: Claims Run Off
Claims data should be adjusted to allow for the provisional nature of case estimates & allow for cases to be reponed.
The company needs to ensure that appropriate reserves are in place, even if they want to deny a claim.
pricing factors: Incurred but not reported claims
precautionary reserves must ben in place in the even of a latent claims coming through
pricing factors: catastrophic claims
need to estimate frequency and severity and manage their exposures to buy optimum levels of reinsurance cover.
What is a catastrophic claim
an accumulation of a large number of claims all arising from a common even
pricing factors: Latent claims
In some instances there is a long time between the cause and the claim, e.g., with asbestos. These must be considered in the pricing process.
pricing factors: claims inflation
Claims inflation can often exceed generic inflation due to changes in legislation (some of which is retrospective). premiums must be adjusted to reflect any devaluation of the funds available to pay claims when they arise.
pricing factors: Exposure
Claims data is historical and should be adjusted to reflect todays exposure to keep predictions accurate and relevant.
pricing factors: Fraud
fraud costs insurers a lot of money and this must be taken into account when pricing premiums.
Claims fraud
fraudulently filing a claim e.g. if you caused the loss purposefully, or your incorrectly entering details of the loss.
Application Fraud
misrepresenting information in the application to obtain a lower price.
pricing factors: Legal aid, sentencing and punishment of offenders Act (LASPO) 2012
introduced changes to the way claims are notified and settled, therefore reducing claims costs in the short term.
In addition to claims costs what other costs must be reflected in the premium pricing
expenses
examples of expenses
- staff costs
- premises
- electricity and other utilities
- computers and machinery
- marketing and advertising
- commission paid to agents and brokers.
Fixed expenses
costs associated with processing a particular product, that does not increase as the size of the risk increases.
e.g. admin
Variable expenses
Costs that vary according to the size, complexity and nature of each risk.
e.g. underwriting, commission & claims handling
Commission
the amount paid to the agent, intermediary or broker who introduces the business to the insurer.
Forms of commission
- a percentage of the premium
- work transfer (paid more to take on more work)
Costs of claims handling
- cost per claim
- a cost reflecting the differences in the volume of work required for more involved cases.
Other expenses to take into account when pricing?
- risk management funds
- low claims rebates ( pay back some premium to incentivise more positive risk management)
Concept of Return on capital employed (ROCE)
Classes of insurance with a higher degree of volatility must be capable of generating higher profits if they are to justify the shareholders taking that risk.
Risk capital requirement
the proportion of total account premiums which must be kept as free reserves to ensure that an insurer can meet its claims obligations
Higher risk investments might carry…
greater return
investment income
insurers are able to earn investment income due to the substantial amounts of capital and reserves they control and hence can invest.
underwriting result
the business result without the investment income
combined operating ratio (COR)
Compares claims & expenses to premiums
What produces the cyclical nature of insurance?
the profit and the yield from the underwriting result plus investment income
Hard markets
when rates and premiums are high
soft markets
when rates and premiums are lower to attract more business on which to secure investment returns
When will markets turn from soft to hard?
returns for insurers are inadequate and capital is withdrawn.
What two types of investment do insurers take
- interest bearing investments
- investments whose value can be expected to grow at least inline with the economy equities (long term higher rate of return, but volatile short term)
What happens if the contributions of capital gains were ignored?
returns would be understated, and the insurers products may be overpriced and uncompetitive.
What happens if the returns/capital gains are relied on?
products may become very competitive, which may cause difficulties if the investment returns diminish.
What taxes must insurers take account of in their pricing?
- Financial Services compensation scheme (FSCS), surcharge based on a percentage of gross direct premium
- Motors Insurers Bureau (MIB), annual levy dependent on claims experience & type of motor insurance.
- Mesothelioma Act 2014, levy charged on all premiums for employers liability cover.
Financial Services compensation scheme (FSCS)
fund claims by policyholders whose insurer has become insolvent
Motors Insurers Bureau (MIB)
the insurer of last resort for property damage or injury caused by an uninsured driver.
Mesothelioma Act 2014
fund from levies fund the diffuse mesothelioma payment scheme which allows those suffering from mesothelioma-related illnesses, but unable to trace their employers to obtain financial support.
difference between IBNR and run off
IBNR hasn’t been reported yet whereas
run off claims have been reported and closes
Latent claims take a long time to become obvious
why is claims inflation a problem
the value of money set aside to settle claims will have reduced in real terms.
What is ROCE
return on capital employed i.e. the profit made on the capital invested
Claims run off
when a claim is re-opened
What do insurers have to account for when pricing their premiums
- risk premium
- expenses
