1 Price Monitoring - Practical Approaches CAS 2007 Ratemaking Seminar, session COM-5 Brian A. Hughes SVP & Chief Actuary Arch Insurance Group

2 Disclaimer The views expressed here are those of the speaker and not necessarily the views of this panel, Arch Insurance Group, the CAS or any other sponsor of this seminar

3 Introduction Price Monitoring – what is it and why is it important? Method #1 – basic data Method #2 – more extensive aggregate data Method #3 – individual policy data Method #4 – benchmark approach Method #5 – measuring homogenous books Summary

4 Price Monitoring – What is it? My definition: a measurement of the change in effective rate levels from one period to another It does not take into account loss trend When loss trend is factored in, it allows a projection of historical loss ratios to a future period

5 Price Monitoring – Purpose & Uses To understand how rate levels are changing over time while attempting to adjust for exposure changes Allows for the projection of historical loss ratios to a future period for profitability and forecasting purposes Allows for measuring whether target rate changes are being achieved Allows for measuring whether target returns on equity are being achieved

6 Industry Price Monitoring - CIAB One source of industry price monitoring is the survey put out each quarter by the Council of Insurance Agents & Brokers They survey their members and summarize the rate changes being seen in the market by line of business & size of account The survey can be found on the Council’s website at

7 Industry Price Monitoring - Tillinghast Tillinghast compiles a quarterly price monitor survey called CLIPS – Commercial Price Monitoring Survey Survey data is captured for all major commercial lines by size of account and region Participating companies receive the survey results and how their company compares to overall averages

8 Method #1 – Basic Data For some lines of business, only basic data may be available: policy effective period, premium, policy limit, (maybe) attachment point or deductible Exposures aren’t available, and individual policy data may or may not be available The accuracy of this method increases as mix of business change is limited or renewals can be matched up

9 Method #1 - Example Total Premium Total Limits Average Premium per million Rate Change Renewal$448,000$60,000,000$7, % Expiring$445,000$57,000,000$7,807

10 Method #1 - Example Company Premium Company Limit Premium per million Rate Change Expiring premium at current terms RenewalPolicy #1$75,000$15,000,000$5, %$67,000 Policy #2$217,000$25,000,000$8, %$231,250 Policy #3$156,000$20,000,000$7, %$175,455 $448,000$60,000,000$7, %$473,705 ExpiringPolicy #1$67,000$15,000,000$4,467 Policy #2$185,000$20,000,000$9,250 Policy #3$193,000$22,000,000$8,773 $445,000$57,000,000$7,807

11 Method #1 - Advantages Can be calculated with a minimum of information If the universe of policies is limited to renewals with no change in limit or attachment, the result is more accurate

12 Method #1 - Drawbacks Not adjusting for exposure changes is a major drawback Limiting the calculation to “apples-to- apples” policies can eliminate a large portion of the subject book of business

13 Method #2 – Aggregate Data This method outlines an approach when only aggregate data (for the renewal and expiring books of business) is available Available data includes: policy effective period, premium, the company’s policy limit, the 100% policy limit, and attachment point or deductible

14 Method #2 - Example Company Premium Company Limit100% LimitAttachment # of policies Layer Exposure Rate per $1,000 of layer exposureRate Change Total448,00060,000,000100,000,00090,000,0003 Average149,33320,000,00033,333,33330,000, % (ILF at $63.33 mil – ILF at $30 mil) [Co premium/ (Co limit/1000)] Layer Exposure Total445,00057,000,00099,000,00091,000,0003 Average148,33319,000,00033,000,00030,333, (ILF at $63.33 mil – ILF at $30.33 mil)

15 Method #2 - Advantages Allows for a more accurate calculation even though renewals may not be able to be matched up with their expiring policies Takes into account changes in attachment point and share of layer The method can easily be expanded to incorporate aggregate underlying exposures and policy term changes

16 Method #2 - Drawbacks Since aggregate data is being used, mix of business changes are not being captured For large account business, one or two policies can distort the averages and the result Shifts from primary to excess (or vice versa) can cause distortions (ie. the layer exposure calculation is only as good as your ILFs)

17 Method #3 – Individual Policy Data This method matches up individual policy renewals and calculates a rate change for each renewal Available data needed for each policy – both renewal and expiring: policy effective period, premium, the company’s policy limit, the 100% policy limit, attachment point or deductible, exposure and policy term

18 Method #3 - Example RenewalCo Prem Company Limit100% Limit Total Attach Underlying Exposures Policy Term Layer Expos Rate per $1,000 of Layer Exposure Rate Chg Expiring Prem at current terms Policy #175,00015,000,00025,000,000 26,000, %68,569 Policy #2217,00025,000,000 15,000,00057,000, %209,226 Policy #3156,00020,000,00050,000,000 55,000, %179, ,00060,000,000100,000,00090,000,000138,000, %457,000 Expiring3.230 / =-2.4% Policy #167,00015,000,00030,000,00020,000,00023,500, Policy #2185,00020,000,00025,000,00015,000,00063,000, Policy #3193,00022,000,00044,000,00056,000,00047,000, ,00057,000,00099,000,00091,000,000133,500,

19 Method #3 - Example Calculation of Rate per $1,000 of Layer Exposure Co premium / (co limit/100% limit) x (12/term) Underlying exposures x layer exposure Where layer exposure reflects the amount of exposure within the subject layer (using ILFs or size of loss curves)

20 Method #3 - Advantages An effective rate change is calculated for each and every renewal This eliminates distortions within a book of business Additional adjustments can be added on a per policy basis. For example, if a coverage was eliminated at renewal, an estimated effect of that coverage change could be reflected

21 Method #3 - Drawbacks While this is the ideal calculation to be done for renewals, it does not reflect new business rate levels Reflecting terms and conditions changes can be difficult to estimate and capture on books of business with large numbers of policy counts

22 Method #4 - Benchmarking This method requires a standardized or “benchmark rate” to be used to calculate a “benchmark premium” for each policy The benchmark rates must reflect all exposures It can be a manual rate plan or something similar Changes to the benchmark rates must be tracked over time; alternatively, they can be set and “locked” The ratio of actual to benchmark is tracked over time

23 Method #4 - Example New/ Ren Company Premium Company Limit100% Limit Attachment Underlying Exposures Policy Term Bench- mark Rate Layer Exposure Benchmark Premium Actual/ Benchmark Policy #1Ren75,00015,000,00025,000,000 26,000, , Policy #2Ren217,00025,000,000 15,000,00057,000, , Policy #3Ren156,00020,000,00050,000,000 55,000, , Policy #4New123,00010,000,00020,000,00010,000,00037,000, , Policy #5New89,0005,000,00010,000,000 19,000, , Policy #6New45,00015,000,00050,000,000 45,000, , TotalRen448,000425, TotalNew257,000269, GrandTotal705,000695,

24 Method #4 - Example Calculation of Benchmark Premium Benchmark rate x exposures x layer exposure x (Company limit/100% limit) x (term/12)

25 Method #4 - Advantages Benchmarking allows for tracking both new and renewal business, or more importantly, whether one is priced stronger or weaker than the other Many lines of business already have a well established benchmark – manual rates

26 Method #4 - Drawbacks This method can produce misleading results if the relative rate adequacy of the benchmark rates varies for different classes, territories and coverage Tracking benchmark rates that change over time can be cumbersome

27 Method #5 – Homogenous Books This method calculates an overall change in rate level on an entire book of business The risks must be fairly homogenous with a standardized rating base Last year’s average rate level is adjusted to this year’s mix of business and then compared to this year’s average rate level

28 Method #5 – Example RenewalPremiumPolicy Limit Underlying Exposures Average Rate Average Policy Limit Average Limit ILF Rate Change Adjusted Expiring Premium Class #1576,0001,228,000,0002, , % $580,361 Class #2487,000927,000,0002, , % $504,960 Class #31,123,0001,962,000,0003, , % $986,724 2,186,0004,117,000,0008, ,4735.5% $2,072,045 Expiring Adjusted Avg Rate Class #1623,0001,367,000,0002, , Class #2598,0001,150,000,0002, , Class #3945,0001,921,000,0003, , ,166,0004,438,000,0008, ,269239

29 Method #5 - Advantages A fairly accurate rate change can be calculated across the entire book

30 Method #5 - Drawbacks Many classes, territories and coverage sections can quickly make this a complex calculation This method is not practical or accurate for many commercial lines of business

31 Large Account Challenges Terms and conditions including coverage sublimits and exclusions are very difficult to measure The accuracy of ILF’s at higher limits is questionable Should risk loaded ILF’s be used? Is a renewal a renewal?

32 Practical Issues Each line of business may have different price monitor components that are important – requiring different database structures Garbage in, garbage out The results need to feed back to Underwriting, Reserving, and Senior Management

33 More Practical Issues Should benchmark premium be displayed at time of pricing? Should a credibility index be assigned for different methods and lines of business?

34 Summary There are many ways to monitor rate levels – how accurate the method usually depends on the available data There are no perfect methods – identifying possible weaknesses in the approach may determine how heavily the results are relied upon Any method is better than none at all! Start with a simple method and build on it over time