Determining the Price of Personal Auto Insurance Chapter 8 Introduce yourself (name. where you work, job title) and topic

Underwriting How insurance companies evaluate risk Selective about who they choose to have as customers Looking for that ideal customer Goal is to insure customers with few claims

Insurance Application Includes: Age of driver Number of tickets Number of accidents Type of vehicle Age of vehicle Vehicle use They also rely on the opinion of the insurance agent Make sure you are honest. Not telling the truth might jeopardize coverage by the insurance company – denying your claim

Underwriting Underwriters can accept or reject the application They can also accept the risk with higher premium (your payment) OR… Reduce the insurance coverage – Higher Deductible (what you pay before the insurance company pays the claim) Insurance companies need to determine the best risk for their company

You Decide Today you are the underwriter for a personal automobile insurance company. You receive two applications: 25 year old – no accidents or tickets or previous losses 25 year old – no accidents or tickets but has five broken windshield claims. Each windshield costs $450 What would you do with these risks? Answer- underwriter would write both applicants but the 25 year old with broken windshields increase the deductible to $500 so they don’t have to pay these small claims.

Pricing Insurance Losses are not known until after the policy is written Insurance companies need to pay: Expenses - salaries, losses, operation costs AND make a PROFIT. Insurance is state regulated so they can not charge whatever they wish. Can not be too high, too low or unfairly discriminate.

Actuaries Helps insurance companies Trained in math and statistics determine pricing figure out how many people will have a claim Trained in math and statistics Use past loss history to predict the future to develop a rate Explain law of large numbers. Instructor 5 minutes: Set up NERF basketball hoop or waste can that students can throw Nerf balls into. Select one student randomly but pick a non-athletic appearing person, to shoot into basket. Before they shoot ask the group to decide out of five throws how many will make the basket……record answer on board. Have student throw one ball…did they make it? Ask class if it is now easier to predict how many completions will be made? Have student throw three more balls….total of four balls. Ask class if they can now predict the outcome of the fifth ball? This is theory behind law of large numbers…..the more data or exposures or balls the easier it is to predict outcome. Ask group what characteristics they might look for in next student in order to improve our odds of completion. Someone more athletic looking, maybe male, young, someone who has thrown a lot (years of experience). This could be similar to rating or selection criteria of insurance companies in determining who pays more or less for insurance based on chances of loss.

Law of Large Numbers Since insurance companies do not know how much they will pay out in claims They use the Law of Large Numbers to Price Insurance

Law of Large Numbers A statistical principle that indicates that the larger the number of examples, the more accurate and predictable the statistic will be Loss frequency How often they expect a claim to occur Loss severity How much damage or injury they predict will happen in a loss Activity: 5 minutes: Set up NERF basketball hoop or waste can that students can throw Nerf balls into. Select one student randomly but pick a non-athletic appearing person, to shoot into basket. Before they shoot ask the group to decide out of five throws how many will make the basket……record answer on board. Have student throw one ball…did they make it? Ask class if it is now easier to predict how many completions will be made? Have student throw three more balls….total of four balls. Ask class if they can now predict the outcome of the fifth ball? This is theory behind law of large numbers…..the more data or exposures or balls the easier it is to predict outcome. Ask group what characteristics they might look for in next student in order to improve our odds of completion. Someone more athletic looking, maybe male, young, someone who has thrown a lot (years of experience). This could be similar to rating or selection criteria of insurance companies in determining who pays more or less for insurance based on chances of loss.

You Do the Math Start with 100 individuals driving a Honda Accord Cost: $25,000 Assume that if involved in an accident your vehicle is a total loss Assume the chance of being in an accident : 1 out of 100 people Total loss: _______ / # insureds_______ = base rate Answer: 25,000 / 100 = $250 base rate or minimum insurance premium ( this ignores insurance company profit and operating expenses which would be added to minimum)

How is the Cost of Auto Insurance Determined? Base rate reflect Loss Frequency AND Loss Severity Adjusted up or down based on coverage you choose higher limits makes rate go up Based on average If you are higher risk and have more chances of loss you will pay more Explain and use examples to illustrate this concept.

Who Do You Think Should Pay More in Insurance Premium? Individuals living in a large city Individual living in a small town or rural area Losses in urban or large cities tend to be higher due to greater population density, more vehicles on road, and more theft and vandalism. Some insurance companies may feel that large cities might have better police protection and better mass transit reducing time spent on the road. Different insurance companies like different risk factors.

Primary Secondary Other Rating Factor Age, gender, marital status Annual miles on vehicle Use of auto Driving Record Secondary Age, make, model of vehicle Number of vehicles Garaging location of vehicle Other Rating Factor Limits of liability, deductibles, discounts Driver Training Credit Good Student Credit Student Away at School Credit Multi-Car Credit Do male or female drivers have more accidents? Are speeding tickets indicator of chance of accident? What vehicles stolen more often? What is safety/crash record of a given vehicle? What are weather conditions? North winters vs. South winters Go over different risk factors contributing to auto insurance rates. Share the results of vehicle you rated in the territory of this school. Ask students if this is the pricing they expected.

Calculating the Final Insurance Premiums Base rate x (primary + secondary rating factors) = Premium Base rate may be same for group, but once you factor in: Age Driving record Type of vehicle Credits, etc. Each person gets a different insurance premium

How Can You Help Lower Insurance Premium? Control risk factors by: Buy car with safety features- side air bags, adaptive cruise control Defensive driving- education courses Security systems: electronic locks, disabling devices Use public transit Car pooling Formal agreements not to drink and Buying homeowners and automobile insurance from the same insurance company Purchase higher deductibles

Where Does Your Insurance Premium Dollar Go? Premium – (Claims Company Pays + Expenses) = their Profit Every $1.00 collected in insurance premium the insurance company pays out: 70 in claims 28 in salaries, commission to agent, utilities and rent or mortgage That leaves 2 for profit

Investment Income When insurance company pays out more than premiums collected – UNDERWRITING LOSS (ex. tornados) Investing premiums that the insurance company is holding until they have to pay claims – money they make – INVESTMENT INCOME increases the profit they make on handing insurance Investments are very conservative and regulated by law. Typical low risk items such as U.S. treasury notes and bonds

Insurance Careers Now that you know more about insurance and how it is priced, would you like to be an: Actuary Underwriter Agent when you graduate?