Robin: UW Profit Provision Flashcards
methods to calculate the UW profit
- CY investment income offset: adjusts traditional profit provision for investment income
2. Present value offset: adjusts traditional profit provision by comparing investment income of a particular line to income of a reference line
- CY ROE method: not covered
- PVI/PVE method: not covered
5. PV cash flow return: selects provision necessary to produce a PV of cash flow equal to PV change in equity
- risk adjusted discounted cash flow: derives the provision from fair premium
- internal rate of return: not covered
methods require number of steps
- calculate the premium using the unique assumptions and methodologies of the method
- the combined ratio is then calculated
- provision is determined from the combined ratio
there is question of how much UW profit is adequate
one school of thought & problems
-one school of thought is that provision is adequate if it results in adequate total profit after investment income and taxes have been considered
- approach presents some problems:
1. not obvious how to apply in ratemaking
2. there is question of what is an adequate total return
3. ratemaking is conducted on prospective PY basis but total return is measured on CY basis
5 Types of UW Profit
in general there are different types of UW profit provision that may be referred to:
- provision included in manual rates/filings to change manual rates
- corporate target UW profit provision
- breakeven UW profit provision
- charged UW profit provision
- actual UW profit
corporate target UW profit provision
this should be sufficient to generate an expected return similar to that provided by investments with similar risk
breakeven UW profit provision
these provide a rate of return to stockholders equal to rate of return on risk free investments; stockholder receives no compensation for risk borne
charged UW profit provision
rate achieved after applying experience and schedule rating modifications as well as other adjustments ie WC premium discount to manual rate
actual UW profit
these will differ from charged provisions as provision for losses and expenses more likely won’t be accurate; also because the actual CAT loss in a year most likely won’t match the provision
paper examines methods used to determine
profit provisions in rate filings or profit targets/breakeven profit provisions
CY investment income offset procedure
**method adjusts the traditional UW profit provision to account for investment income
-this method is based on CY data
final UW profit provision = traditional UW profit provision – investment income offset
CY investment income offset procedure advantages and disadvantages
Advantages:
- data is easily obtained and verified using the annual statement
- since figures are reported in filed documents, it is less likely that insurer is making pessimistic projections in order to increase profit provision
- CY investment portfolio yields are relatively stable compared to investments initiated in certain year
Disadvantage:
- since CY results are retrospective, they may not be totally applicable to prospective ratemaking ie if there are changes in growth and loss experience
- lack of economic theory supporting calc & results distorted if large change in volume or reserve adequacy
*This is a problem as the provision is therefore hard to justify
CY offset: analysis should be performed over
several iterations since the permissible LR is used as determinant of profit provision but this provision impacts the permissible LR
Present Value Offset Method
**similar to method 1, method adjusts the traditional UW profit provision for investment income; assumption is made that traditional provision reflects the investment income from a reference line
- it applies an offset that is based on difference between:
1. present value of losses for short tail reference line (assumes traditional provision is appropriate for this line)
2. present value of losses for line under review
3. offset = difference in PV loss patterns * projected LR
final UW profit provisions = traditional UW profit provision – offset
there are a few options of rates at which to discount losses to calculate the PV
Portfolio yield from a recent year
Estimated portfolio yield for year in which rates will be in effect
New money yield
new money yields are more suited
to prospective nature of ratemaking but historical prospective yield are more stable and verifiable (but not necessarily representative of the future)
