Study 6 - Analyzing Risk

Question 1

Define class rate

Answer 1

A rating approach that uses rates that reflect the average probability of loss for businesses within large groups of similar risks

Question 2

What are three questions a broker may use to analyze prospective clients?

Answer 2

What are the clients values and business objectives?
Does the client tolerate dangerous workplace conditions and practices?
Does the client regard insurance as a safety net that eliminates the need to take sensible precautions?

Question 3

What are the three functions of an actuary?

Answer 3

• Analyzing stats on frequency & severity of past claims
• Estimating the cost of settling outstanding claims
• Estimating the cost of future claims

Question 4

What are the two functions of the price of insurance, and by whom?

Answer 4

Ratemaking by actuaries

Rating by underwriters

Question 5

What are the three major components of any rate?

Answer 5

• Anticipated cost of settling claims
• Acquisition costs of the business, such as commissions
• Cost of administering the process, including taxes levied on the premiums

Question 6

What are the two conditions for a rate to be considered adequate?

Answer 6

1) The actuarial forecast of future losses based on past losses is accurate for the population
2) Sample represented by the book of business written by a particular underwriter or insurer is representative of the population

Question 7

What are the eight steps to establish rate adequacy?

Answer 7

1) Classify the risk
2) Determine the rating classes
3) Select the proper measure of exposure
4) Gather loss statistics
5) Predict future losses based on past losses
6) Calculate the pure premium from the predicted losses
7) Calculate the premium rate or unit cost
8) Calculate the final premium rate

Question 8

Define exposure base

Answer 8

Denomination in which the unit of exposure is expressed

Question 9

Define exposure unit

Answer 9

A specified amount of the exposure base

Question 10

What is the ASP?

Answer 10

Automobile Statistical Plan

Collection of statistical information that all automobile insurers who write business in Canada must record and file as prescribed by the Superintendent

“The Green Book”

Question 11

What resource may be used for automobile insurance statistics?

Answer 11

GISA

General Insurance Statistical Agency

Question 12

What are the two mandatory plans under GISA?

Answer 12

ASP (Automobile Statistical Plan)

OCLSP (Ontario Commercial Liability Statistical Plan)

Question 13

What two things go into predicting future losses?

Answer 13

Law of large numbers

Theory of probability

Question 14

What three things must be reviewed for predicting future losses?

Answer 14

• Size of the sample
• Time period over which sample was taken
• Past and future conditions

Question 15

Define pure premium

Answer 15

Portion of premium required to pay expected losses

Question 16

Define schedule rating

Answer 16

Rating by measuring them against fixed standards of construction and protection. Risks below standards earn a charge that increases the rate; risks above earn a credit that reduces the rate

Question 17

What is COPE?

Answer 17

Construction
Occupancy
Protection
Exposure

Question 18

When a broker requests a quote, an insurer may response with one of the following:

Answer 18

• A request for more info
• Refusal to cover the risk
• Quotation of terms

Question 19

What actions should a broker take after receiving the quote?

Answer 19

• Review the quote against submission (limits, coverage/rating, proposed wording, factors affecting binding)
• Note any differences the underwriter imposed
• Compare various quotes to eachother
• Assess terms of each quote
• Consider whether terms will be acceptable to the client
• Contact the underwriter to discuss possible amendments if necessary

Question 20

How does host liquor liability differ from bars and homeowners?

Answer 20

Bars are held to a higher standard

Question 21

What factors should you consider when reviewing host liquor liability?

Answer 21

• Previous claims
• House of operation
• Employee training and education
• Volume versus sales
• Policies and procedures
• Monitoring patrons
• Experienced management

Question 22

How could you explain rate class?

Answer 22

• When underwriters assign premiums, they must consider larger trends.
• Class rating is used for common risks, which are charged a standard rate.
• These risks tend to have similar characteristics and risk qualities to other similar risks.
• Impossible to separate an individual’s risk from the broader class rate to which that risk belongs.
• The claims experience is statistically measured for each risk factor, not the client as an individual.
• Class rating reduces the element of judgment in rating and is often automated through a computer-generated process.
• Client’s attitude toward loss control does help underwriter in the final assessment of risk.

Question 23

What is the process of ratemaking?

Answer 23

• The price of insurance is based on historical data about incurred losses.
• Statistical techniques are applied to these data to develop a forecast of the rates needed to provide sufficient premium for future losses.
• The application of these statistical techniques is done by an actuary—a professional skilled in the application of mathematics to financial problems.
• Rating is done by underwriters. A rate is the price of a unit of insurance for the policy period and includes the following:
o Anticipated cost of settling claims
o Acquisition costs of the business, such as commissions
o Cost of administering the process, including taxes levied on the premiums
• A premium is the total cost of the insurance. It is derived by multiplying the rate of insurance by
the amount of insurance.

Question 24

Explain pure premium, premium, rate and final premium

Answer 24

• The pure premium is the amount of the premium needed to pay expected losses.
• Pure premium is calculated based on information from an insurer’s book of business.
o Example using 100,000 buildings, 8,000 fires, average $15,000 damage
o 8,000 x $15,000 = $120,000,000 in damage
o $120,000,000 damage / 100,000 buildings = $1,200 per building
• Exposure units allow insurers to talk about a “unit” of exposure when setting rates—the exposure unit for a property is usually $100 worth of property value.
o A property worth $1.2 million has 12,000 exposure units.
• The premium rate of insurance is calculated by dividing the pure premium by the exposure unit.
o A pure premium of $1,200 divided by 12,000 units is $0.10 per unit premium rate.
• The final premium is calculated by adding commission (15%), administrative costs (20%), and profit (10%) to the premium rate.