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Product Pricing Fundamental Equation
Price = Cost + Profit
Define "Exposure (X)"
Basic Unit of risk underlying the premium
Define "Premium (P)"
Amount insured pays for insurance policy
What are the Premium Measurement methods
- Written premium - from policies issued during time period
- Earned premium - from coverage provided during time period
- Unearned premium - portion of written for which coverage has not been provided
- In-force premium - full-term premium for policies that are in effect at certain point in time
Insured request to insurer for indemnication for financial loss from an event covered by the policy
Individual(s) making the demand for indemnication (claim) by alleging injuries or damages covered by the policy
Define "Date of Loss"
a.k.a. accident date or occurrence date - date of event causing the loss
Define "Report Date"
When claimant reports claim to insurer
Define "IBNR (Incurred but not reported)"
Claims that have occurred, but not currently known by insurer
Amount payable to claimant under the terms of the insurance policy
Define "Paid Losses"
Amounts that have been paid to claimants
Define "Case Reserve"
Estimate of unpaid loss for known claims
Define "Reported Loss (a.k.a. Case Incurred Loss)"
Sum of paid loss and ending case reserve
Reported Losses = Paid Losses + Case Reserve
Define "Ultimate Loss"
Ultimate Losses = Reported Losses + IBNR Reserve+ IBNER Reserve
- Amount required to settle all claims for a defined group of policies
- Differs from reported loss due to IBNR and case adequacy (or IBNER)
Define "Allocated Loss Adjustment Expenses (ALAE)"
- Claim related expenses that can directly be attributable to a specific claim
- E.g., legal fees for outside counsel hired to work on a specific claim
Define "Unallocated Loss Adjustment Expenses (ULAE)"
- Claim related expenses that cannot directly be attributable toa specific claim
- E.g., claims department salaries and rent
What are some characteristics of Commissions and Brokerage?
- 1. Paid to insurance agents or brokers for generating business
- 2. Usually stated as percentage of written premium
- 3. May vary between new and renewal business
- 4. May be based on quality and/or volume of business written
In relation to underwriting expenses, what are "Other Acquisitions"?
- Expenses other than commissions to acquire business
- E.g., advertising, mailings, salaries of employees who help write policies
What is a "General" expense in relation to underwriting expenses?
- Remaining expenses associated with the operations
- E.g., rent, building maintenance, salaries of employees not included in other categories
What are "Taxes, Licenses, and Fees" in relation to underwriting expenses?
- Taxes and fees for writing business
- Does not include federal income taxes
Define Underwriting Profit
- Company assumes risk that premium charged is not enough to pay losses and expenses
- Must maintain capital to support this risk
- Entitles company to reasonable expected return on capital
What are the two main sources of profit?
- Underwriting profit (or operating income): Generated from individual insurance policies
- Investment income: Generated by investing funds held by company
What is the Fundamental Insurance Equation?
Premium = Losses + LAE + UW Expenses + UW Profit
Appropriate balance of the Fundamental Insurance Equation must consider facts that:
- Ratemaking is prospective
- Should be achieved on overall and individual level
What are some examples of items for which experience may need adjustment?
- 1. Rate changes
- 2. Changes in mix of business
- 3. Operational changes
- 4. Law changes
- 5. Inflationary pressures
- Used to:
- Identify trends in claims occurrence or utilization
- Measure effectiveness of u/w actions
- Frequency = Num of Claims / Num of Exposures
- Provides information about:
- Loss trends
- Impact of changes in claims handling procedures
- Severity = Total Losses / Num of Claims
Pure premium or loss cost (L)
- Highlight trends in overall loss costs due to changes in both frequency and severity
- Pure Premium = Total Losses / Num of Exposures = Frequency x Severity
- Highlight changes in mix of business
- Average Premium = Total Premium / Num of Exposures
Loss Ratio = Total Losses / Total Premium = Pure Premium / Average Premium
Loss adjustment expense ratio
- Used to:
- Monitor stability of costs associated with claim settlement procedures
- Compare to other insurers to evaluate claims settlement procedures
- LAE Ratio = Total LAE / Total Losses
Underwriting Expense Ratio
- Monitor and compare actual to expected
- May also compare to other insurers as a benchmark
- UW Exp Ratio = Total UW Expense / Total Premium
Operating Expense Ratio
- Important when reviewing overall protability
- OER = UW Exp Ratio + (LAE / Earned Prem)
- Primary measure of profitability of a book of business
- Combined Ratio = Loss Ratio + (LAE / Earned Prem) + (UW Expenses / Written Prem)
- 1. Measures percentage of current insureds that renew their policies at expiration
- 2. Useful for product management and marketing
- Used to determine the competitiveness of rates
- Closely monitored following rate changes and major changes in service
- Key parameter in projecting future premium volume
- Retention Ratio = Number of Policies Renewed / Num of Potential Renewal Pols
Close Ratio (a.k.a. hit ratio or conversion rate)
- 1. Measures rate at which prospective insureds accept a quote for new business
- 2. Useful for product management and marketing
- Close Ratio = Number of Accepted Quotes / Number of Quotes
What is a rating manual used for?
Used to classify and calculate rate for a risk
Written manuals are used to do what?
- Help agents understand the rating process
- File with insurance regulators
What information is needed to calculate premium for a given risk?
- Rate pages
- Rating algorithm
- Underwriting guidelines
What do rating manual rules contain?
- Contains qualitative information which helps user with rating algorithms
- Summary of available policy forms
- Premium determination considerations
- Classification of risk
What do Rate Pages contain?
- Contains the numbers needed to calculate premium
- E.g., base rates, rating factors, fees
What are Rating Algorithms and what type of items do they include?
- Provides the detail instructions to calculate the policy premium
- 1. Uses information in rules and rate pages
- 2. Includes such items as: Order to consider rating variables, How rating variables are applied (e.g., multiplicative, additive), Maximum and minimum premiums (or sometimes maximum discount or surcharge, Rounding instructions
What are the Underwriting Guidelines?
- Company-specific criteria for acceptance or placement of a risk
- Decisions to accept, decline, or refer risks
- Company placement
- Tier placement
- Schedule rating credits/debits
What is a Ratemaking Review?
- 1. Analyze adequacy of existing rates
- Generally use internal or industry historical data to project future costs
- Company should collect and maintain relevant and consistent historical data
- 2. Pricing new products
What should you do when ratemaking data is limited?
- Must be aware of the impact on the analysis
- Should examine how sensitive the results are to various assumptions
- Select data that minimizes distortions in results
What should you review internal data for?
- 1. Appropriateness for the intended purpose of the analysis
- 2. Reasonableness and comprehensiveness of the data elements
Risk Data used for Ratemaking
- Need to link policy exposure an premium with corresponding claims and losses
- Use Policy database and Claims database
Accounting information needed for Ratemaking
- 1. May not even be specific to one line of business
- 2. Expenses that fall into this category
- Underwriting expenses - incurred in acquisition and servicing of policies
What three objectives apply to Data Aggregation?
- 1. Accurately match losses and premium for the policy
- 2. Use the most recent data available
- 3. Minimize data collection and retrieval costs
Aggregation by Calendar Year
- Transactional data
- Primary use:
- Aggregation of exposures
- May be used for LOBs or coverages in which losses are reported and settled quickly
Advantages of Calendar Year Data
- No future development - the value remains fixed and doesn't change over time
- Readily available - most financial reporting on a calendar year basis
Main Disadvantage of Calendar Year Data
- Mismatch in timing between premium and losses
- Earned premium comes from policies in force during the year
- Losses may come from payments or reserve changes on policies from previous years
Aggregation by Accident Year
- Losses grouped according to date of occurrence, regardless of when pol written or claim reported
- Will develop over successive CYs with more information and as new claims are reported
- Most common grouping of claims data for the actuarial analysis of unpaid claims
Advantage of Accident Year Aggregation
Better match of premium and losses than calendar year
Disadvantage of Accident Year Aggregation
- Must estimate future development on claims
- May select valuation date several months after end of year to improve estimate because allows some time for loss emergence
Aggregation by Policy Year or Underwriting Year
- Group premiums and losses by year in which policy was written
- Losses arising from a PY can extend over a 24-month calendar period
Advantage of Policy Year Aggregation
True match between claims and exposures
Disadvantage of Policy Year Aggregation
Extended time frame - data takes longer to develop
Aggregation by Report Year
- Group claims according to date of report to the insurer
- Claims-made coverage is dependent on the report date
Advantage of Report Year Aggregation
Number of claims is fixed at close of the year
Overall versus Classification Analysis
- Overall analysis
- Reviewing the adequacy of the overall rate level
- Data can be highly summarized
- Classication analysis
- Data must be at a more detailed level
Sometimes the desired data for analysis is unavailable, how do you deal with this?
- Must work with available data and use actuarial judgment to deal with data deficiencies
- E.g., if missing earned premium by territory, may use in force premium by territory to estimate
- Statistical Plans
- Other Aggregated Industry Data
- Competitor Rate Filings/Manuals
- Other Third-Party Data