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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 Goal of Ratemaking?
To have a balanced fundamental insurance equation
- In accordance with 2nd CAS Ratemaking Principle
- *A rate provides for all costs associated with the transfer of risk
- *Achieve equilibrium at the aggregate level
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
Why is it common to use relevant historical experience to estimate future costs?
Must adjust experience to expected future level when rates to be in effect
1st CAS Ratemaking Principle: A rate is an estimate of the expected value of future costs
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
Frequency = Num of Claims / Num of Exposures
- Used to:
- 1.Identify trends in claims occurrence or utilization
- 2.Measure effectiveness of u/w actions
- Provides information about:
- 1.Loss trends
- 2.Impact of changes in claims handling procedures
- Severity = Total Losses / Num of Claims
- Can vary:
- Paid Severity = Paid Loss/Closed Claims
- Reported Severity = Rpt Loss/Rpt Claims
Pure premium or loss cost (L)
- 1. Highlight trends in overall loss costs due to changes in both frequency and severity
- Pure Premium = Total Losses / Num of Exposures = Frequency x Severity
- 1. Highlight changes in mix of business
- Average Premium = Total Premium / Num of Exposures
- 1. Used to measure rate adequacy
- Loss Ratio = Total Losses / Total Premium = Pure Premium / Average Premium
Loss adjustment expense ratio
LAE Ratio = Total LAE / Total Losses
- Used to:
- 1. Monitor stability of costs associated with claim settlement procedures
- 2. Compare to other insurers to evaluate claims settlement procedures
Underwriting Expense Ratio
- 1. Monitor and compare actual to expected
- 2. May also compare to other insurers as a benchmark
- UW Exp Ratio = Total UW Expense / Total Premium
Operating Expense Ratio
OER = UW Exp Ratio + (LAE / Earned Prem)
- 1. Important when reviewing overall protability
- 2. Operational expenditures: measure portion of each prem $ used to pay for UW expenses and Loss Adjustment
- 1.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)
Close Ratio = Number of Accepted Quotes / Number of Quotes
- 1. Measures rate at which prospective insureds accept a quote for new business
- 2. Useful for product management and marketing