Study 7 - Pricing the Risk Flashcards
Define pure premium
Portion of the total premium that is needed to pay expected losses. It does not take into account money needed for company expenses
Define premium
The price of insurance protection for a specified risk for a specified period of time
Define acquisition cost
The cost of putting a business on the books and acquiring the premium. The items involved are not standard with all insurers, but generally may include items such as commissions, field representative costs, premium tax, and perhaps some of the relevant head office acquisition costs of operation
Define commission
Compensation based on the amount of production; for example, independent insurance agents are compensated on the basis of a percentage of the premium. The percentage varies with different lines of insurance
What are development factors?
Adjustments to current reserves for claims that have yet to be settled
What are trend factors?
Adjustments applied to all losses to reflect what they would probably cost if they were to occur next year rather than having occurred at some time in the past
What are administrative expenses?
General expenses incurred to operate the
ie. Buying/leasing equipment, purchasing office supplies, paying salaries and benefits for staff, and covering interest costs on debt
What are six common items go into allocating premium?
Pure premium, development factors, trend factors, acquisition costs, administration expenses, profit
What are ULAEs?
Unallocated loss adjustment expenses
Cannot be attached or attributed to a single claim
Define underwriting profit
The amount of money an insurance company gains as a result of its insurance operations. Excess of earned premiums collected over loss payments and expenses
Define underwriting loss
The amount of money that an insurance company loses as a result of its insurance operations, it excludes investment transactions and income taxes
What is often used to offset underwriting losses?
Investment income
Define actuary
One who specializes in the mathematics of insurance, mortality rates and the like
Define ratemaking
The process of compiling and analyzing data to establish rates that accurately reflect the level of risk. Usually performed by actuaries
Define rate
Amount charged to an insured that reflects the expectation of loss for a covered risk, insurance company expenses, and profit. In other words, it is the basis of premium calculation for the insurance provided for the exposure
What are the three major components of any rate?
- Anticipated cost of settling claims
- Acquisition costs of the business, such as commissions
- Cost of administering the process, including taxes levied on the premiums
What two conditions ensure rate adequacy?
- Actuarial forecast of future losses based on past losses is accurate for the population
- Sample represented by the book of business written by a particular underwriter or insurer is representative of the population
What is the 8-step process is establishing rate adequacy?
1) Classify risks based on the types of objects of insurance, hazards of exposure, or both
2) Determine the number and nature of 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 total premium
8) Calculate the premium rate or unit cost
What is the exposure base?
The denomination in which the unit of exposure is express
What is the exposure unit?
A specified amount of the exposure base
What is ASP?
Automobile Statistical Plan
A collection of statistical information that all automobile insurers who write business in Canada must record and file as prescribed by the Superintendent of Insurance. Commonly known as the Green Book.
What is GISA?
General Insurance Statistical Agency
What three plans are administered by GISA?
Automobile Statistical Plan
Ontario Statutory Accident Benefits Statistical Plan
Ontario Commercial Liability Statistical Plan
Define law of large numbers
The mathematical premise that states that the degree of uncertainty is reduced as the number of events increases
What two things are used to predict future losses?
The law of large numbers
Theory of probability
What three major aspects of statistics are also considered?
Size of the sample
Time period over which the sample was taken
Past and future conditions
What are the two basic approaches to rating?
Class rating
Schedule rating
When is class rating used?
When statistics can be gathered on a large number of risks that share common characteristics
What three categories can losses be subdivided into under class rating?
Territory
Type of unit insured
Value of the unit insured
How can class rating be summarized?
Virtually eliminates the element of judgment in rating and streamlines the policy-issuing process, also reducing production costs
Define schedule rating
A method of rating risks 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
When is schedule rating used?
When the body of statistical data is too fragmented to permit class rating
Such as commercial insurance
What are the factors that allow for an underwriter to have some degree of flexibility when it comes to rating a risk?
The type of insurance and the size of the risk
What are the general processes described for all ratemaking?
- Classifying risk
- Determining rating classes
- Selecting proper measures of exposure
- Gathering statistics
- Predicting future losses
- Calculating pure premium, total premium, and finally the premium rate
When is class rating used?
• When statistics can be gathered on a large number of risks that share common characteristics (for example, the same basic risk factors are either present or absent for most automobile insurance risks) • Same is true for homeowners and small business insurance • This makes it possible to statistically measure the claims experience for each risk factor, something that is not possible for more complex risks • The record of losses for the period under review can be subdivided into categories such as territory, type of unit insured, and value of the unit insured • When the total losses in dollars are calculated and divided by the number of units to be insured, the result will be an average class cost per unit insured
Why is schedule rating used in some instances by underwriters?
• Some classes of business are individually rated because of their complexity and the need for underwriting judgment—schedule rating is used when the body of statistical data is too fragmented to permit class rating
• Rates are based on a schedule or manual that lists a multitude of characteristics identified by underwriters over a period of many decades as important factors in
measuring the degree of risk
• The process of schedule rating involves the fixing of a base rate or key rate
• Base rate is used as the initial charge to apply to the particular community in which the object of the insurance is located and takes into consideration the degree of public fire protection
• After these rates are determined, debits and credits are applied based on factors that make the risk either better or worse than the average risk of its type
How are future losses predicted?
- Apply the law of large numbers
- Statistics are only useful in predicting future loss depending on how much loss information is collected, when it is collected, and under what conditions it is collected
- Examine the size of the sample
- Examine the time period over which the sample was taken
- Look at past and future conditions
Explain the concept of proper measure of exposure
- Proper measure of exposure for a given class of risks is the exposure base
- Exposure base is the denomination in which the unit of exposure is expressed
- An example of an exposure base is gross sales, which is used for some classes of liability insurance; the exposure unit is expressed as a specified amount of the exposure base
- For example, gross sales are often expressed in units of $1,000 so that rating for the liability exposure of a certain risk might be expressed as so much per $1,000 of gross sales
- The right exposure base for a given risk depends on the nature of the risk and the kinds of loss it might incur
- Ideally, the exposure base will reflect the frequency and severity of loss that the risk experiences
- Exposure bases vary between lines of insurance
- In property insurance, for example, the exposure is the value of the property and the exposure unit is each $100 of property
- Selecting the right exposure base to measure the susceptibility or vulnerability of the insured to loss is probably one of the most important steps in the initial determination of a rate for a new coverage
