Methods for Including Investment Income in Rates Richard A. Derrig, PhD President, Opal Consulting LLC Visiting Professor, Temple University CAS Ratemaking Seminar March 17, 2008 Boston, MA

Major Regulatory Changes, 1970-2000 Massachusetts Private Passenger Automobile Insurance Year Regulation 1971 No-fault auto insurance effective 1975 State rate-setting extended to all auto coverages 1977 Competitive rate-setting allowed 1978 State rate-setting reinstituted 1989 Automobile Insurance Reform Law effective 1991 Insurance Fraud Bureau began operation 1996 Competitive Discounts and Deviations begin at -7.4% 2006 Competitive Discounts and Deviations stabilize at -1.7% 2007 Competitive rate-setting allowed 4/1/08

MASS PPA MANAGED COMPETITION Effective April 1, 2008 New Regulation (211CMR 79) and Filing Forms Underwriting Profit Calculation Required “Reasonable Return on Capital” “Due Consideration of Investment Income” Filing Form, Sheet 8: Show How Investment Income is Considered in Rate Calculation No Required Method

First Round for April 1, 2008 General Ingredients Expected Income Invested Assets Capital at Risk, Return Expected Premium Held Loss, Expense, and Taxes Model Framework

First Round for April 1, 2008 Specific Ingredients Expected Income: Embedded v Prospective Invested Assets: Calendar v Policy Flows Capital at Risk: Proportional Premium v Reserve Return Expected: Management v Market Premium Held: Policy Term v Flow Loss, Exp, Taxes: Policy Term v Flow Model Framework: Cal Year Acct v Cash Flow

Initial Profit Provisions Liability v Physical Damage

Initial Return on Equity/Capital Pre-Tax Return on Investment

Initial Return on Equity/Capital Rate Change from 2007

Modeling Supply and Demand Prices Modeling Framework Depends on Supply or Demand Pricing Supply Paradigm: IRR Cash Flow Models Demand Paradigm: Myers-Cohn Model Equilibrium for expected market clearing. Short description and references available