Rating using frequency-severity and burning cost approaches

Question 1

Outline the frequency-severity approach

Answer 1

• Estimate expected claim frequency & claim severity
  o Estimations are done separately assuming frequency & severity are uncorrelated
• The results are combined to assess the expected loss cost for a particular insurance/reinsurance structure

Question 2

Advantages of the frequency-severity approach:

Answer 2

• This approach mirrors the underlying process - gives attention to individual claims - readily understood by underwriters
• Usable for complex insurance structures (deductibles, limits can be allowed for appropriately)
• Separate assessment of loss frequency & severity gives additional insights into aggregate loss amount
• Helps identify trends more easily
  o Allows for trends in freq/severity to be analysed separately
  o Potentially missed trends when looking at overall claims per exposure
  o Because freq/severity can offset each other

Question 3

Disadvantages of frequency-severity approaches:

Answer 3

• Assessing compound freq-severity loss dbn requires more data (both quality & quantity) than assessing aggregate amounts
• Can be time-consuming and requires high levels of expertise

Question 4

What information do we receive from the broker for frequency-severity rating of commercial risks?

Answer 4

• Submission document
• Exposure information
• Individual loss information

Question 5

What does the submission document contain?

Answer 5

o Background info. about the insured
o Details of the cover sought
o Qualitative document written from U/W PoV

Question 6

What does exposure information concern?

Answer 6

• Insured’s historical exposure

- Projected exposure to prospective policy period

Question 7

What does individual loss information concern?

Answer 7

• Provides details on each historical loss

Question 8

What are the common data issues?

Answer 8

• Form of data should ideally from ground up claims for all claims but sometimes its not available
• Consistency b/w claims & exposure
  o Adjust the treatment of individual loss information consistently to exposure info. (eg. after corporate acquisitions or disposals)
  o Adjust for claims that are not fully developed
  o Adjust for timings of payments due to differences in claims handling processes of past insurers
• Choice of base period - how long should it be? depends on the reporting delays & claim frequency