No, Really, You Can Use DFA for Ratemaking, Too! Rob Walling & Tom Hettinger Paratus Consulting Limited 2000 CAS DFA Seminar

Welcome to: Who wants to be a DFA Actuary?

$4,000 Question Why is ratemaking a dynamic process? A. The actual future outcome may vary from historical results. B. The ratemaking action may lead to consumer reactions which directly impact the company. C. The actuary already tests different scenarios to help identify the range of possible outcomes. D. If Regis says so then it must be so.

A. Loss frequencies and severities $8,000 Question Which of the following are stochastic variables in the ratemaking process? A. Loss frequencies and severities B. Investment returns C. Claims inflation D. Payment patterns which directly impact investment returns E. Insured demand & retention @ given rate levels F. Random, illogical, politically-motivated decision-making

$16,000 Question Which variables does inflation impact? A. The adequate future premium level B. The duration of liabilities C. The cash available for investment D. Exam raises

A. Adverse selection could impact frequency $32,000 Question How will your results be affected if rates are deemed non-competitive by the marketplace? A. Adverse selection could impact frequency B. New business growth ~ new business penalty C. Overall premium levels may decline D. Renewal ratio may deteriorate E. None – The Indication is Always Right

$64,000 Question How does the underwriting cycle impact rates? A. Dictates how much you can grow given your rate level. B. May bring greater numbers from the involuntary market into the voluntary market. C. May be correlated with economic environment. D. May be correlated with catastrophic events.

$250,000 Question What items are affected by your rates? A. Premium volumes B. New business levels C. Loss levels D. Investment income E. Surplus

A. Loss Development B. Trends/Inflation C. Catastrophes D. Reinsurance $500,000 Question Which of the following “Considerations” from the Ratemaking Statement of Principles are also listed as “Risks” in the “Dynamic Financial Models” paper? A. Loss Development B. Trends/Inflation C. Catastrophes D. Reinsurance E. Expenses

$1,000,000 Question Is the Traditional Rate Level Indication Always Optimal ? A. Yes B. No

The Hypotheses Traditional Actuarial Ratemaking is not Universally Optimal Market Position & Market Conditions Impact Optimal Rate Change Impact of Pricing on Retention is Key Growth/New Business Penalty also has Impact

The Approach Test the Hypothesis Using a Simple Model One State, One Line in DynaMo Model Several Rate Level Influences Indicated Rate Need Market Cycle/Demand Curve Inflation Competitive Position Retention Examine which Mixes of Strategies Optimize 2-Year Surplus Risk/Return

Modeling Retention Premium Retention can be modeled as: where: P1 = Proposed Rate Level P0 = Current Rate Level PM = Market Level

Modeling Retention Renewal Rate (R) 100% R = f(P) Demand Curve 0% Price (P)

Modeling Retention Renewal Behavior Depends on: Suggested Curve: Customer Characteristics Change in Pricing on Renewal Competitive Positioning Suggested Curve: Has Flexible Shape Accommodates GLM Estimation Creates Actuarially Intuitive Scenarios

The Base Case Illinois-only WC writer $50M in Direct Written Premium 1:1 Premium-to-Surplus Ratio 5% Exposure Growth going forward +7.2% Rate Indication Rates Comparable to Market Pricing Historical Retention in Low 70’s Immature Soft Market

Base Case Results

Base Case Results

Variation 1 0% Growth

0% Growth Results

0% Growth Results

Variation 2 15% Growth

15% Growth Results

15% Growth Results

Variation 3 15% Growth 75% of General & Other Acquisition Expense is Fixed (Not Variable)

15% Growth/Fixed Expense Results

15% Growth/Fixed Expense Results

Variation 4 5% Growth +/- 5% jurisdictional cap with 6 month lag

Jurisidictional Restriction Results

Jurisidictional Restriction Results

Variation 5 Mature Soft Market Indicated Rate Change +20% Uncompetitive Rates

Soft Market/Adverse Selection Results

Soft Market/Adverse Selection Results

Future Enhancements Tie in Competitive Analysis Refine Retention Modeling Tools Pricing Optimization Integrated Actuarial Tools

Optimal Pricing Strategy Risk Premium Model Expenses Renewal Model PRICE Optimisation Algorithm Most Loyal Most Profitable MOST VALUABLE

The Evolving Actuarial Universe Competitive Analysis DFA Reserve Analysis Actuarial Rate Studies (New & Old) Stronger