Finance 431: Property-Liability Insurance Lecture 6: Ratemaking

Ratemaking Actuarial functions Ratemaking Loss reserving Data collection and analysis Profitability analysis Competitive analysis Prepare statistical reports Mergers and acquisitions Planning Actuarial services Staff actuaries Consulting actuaries Advisory organizations ISO (Insurance Services Office) AAIS (American Association of Insurance Services) NCCI (National Council of Compensation Insurers) SAA (Surety Association of America)

Ratemaking Principles Corporate objectives Stable Responsive Promote loss control Cover contingencies Understandable Regulatory objectives Rates must be: Adequate Not excessive Not unfairly discriminatory

Which of the following insurance rating practice would be considered unfairly discriminatory? A)To charge higher auto rates for individuals with poor credit scores B)To charge males more than females for auto insurance C)To charge homeowners who live near the ocean more for coverage D)To charge drivers in Chicago more for coverage than drivers in Urbana E)None of the above

Ratemaking Process In a stable world: Calculate amount needed: To pay claims To pay expenses Add these together to find the rate Terminology Gross rate = total premium Pure premium = claims Expense loading = expenses Profit and contingencies = return on capital and risk loading Exposure unit = measure of risk assumed in contract Written premium = premiums booked Earned premium = pro-rata portion of premiums exposed to loss

Ratemaking in the Real World Loss reserves Case reserves Incurred But Not Reported (IBNR) Inflation Other time dependent factors (auto insurance) Traffic density Gas prices Law enforcement efforts Legal rules governing loss settlements Trending adjusts for time dependent factors Severity = average loss Frequency = number of claims per exposure

Risk Classification For automobile insurance Age of driver Sex and marital status of driver Type of vehicle Use of vehicle Driving record of driver Mileage driven Territory where vehicle is garaged Credit score

Ratemaking Methods Judgment method Loss ratio method Percent rate change = (A-E)/E A = Actual loss ratio E = Expected loss ratio Pure premium method G = (P+F)/(1-V) G = Gross premium P = Pure premium = Frequency x Severity F = Fixed expenses V = Variable expenses

Examples Loss Ratio Method Actual LR = 66% Expected LR = 60% Percent rate change = (66-60)/60 = +10% Pure Premium Method Pure premium = $400 Fixed expenses = $50 Variable expenses = 25% Gross premium = (400+50)/(1-.25) = 600

Calculate the gross premium based on the following information: Loss frequency10% Loss severity900 Fixed expenses 10 Variable expenses20% A)90 B)120 C)125 D)500 E)None of the above

Other Factors in Ratemaking Investment Income Investment income Realized capital gains Unrealized capital gains Profit Rate Regulation Statutory standards Administration State-made rates Mandatory bureau membership Prior approval File and use Open competition

Under which rate regulatory law do can insurers change rates without approval? A)State made rates B)Mandatory bureau rates C)Prior approval D)File and use E)Open competition

Development of Data Collection of statistics Policy year Calendar year Accident year Calendar year calculations Earned Premium = Beginning UEP Reserve + Written Premium - Ending UEP Reserve Incurred Losses = Paid Losses + Ending Loss Reserve - Beginning Loss Reserve

Calculate the calendar year earned premium for 2007 based on the following information: Written premium in 2007 $10 million Unearned premium reserve 12/31/ million 12/31/ million A)$7.5 million B)$9.5 million C)$10.5 million D)$12 million E)None of the above

Calculate the calendar year incurred losses for 2007 based on the following information: Paid losses in 2007$10 million Loss reserve 12/31/ million 12/31/ million A)$7.5 million B)$9.5 million C)$10.5 million D)$12 million E)None of the above

Ratemaking Adjustment of statistics Loss development factors Trending Linear Exponential Territorial relativities Class relativities

Example 2004 Incurred Losses = $10,000,000 Trend Factors Frequency = 1.02 Severity = 1.04 Rates for coverage in effect for 2008 Number of years of trending = 4 Trended incurred losses = 10,000,000x(1.02) 4 x(1.04) 4 = 12,662,923 Earned exposures for 2004 = 20,000 Pure premium = 12,662,923/20,000 =

Rate Filings Schedule of proposed rates Percentage change in statewide average rates Percentage change by territory and class Statistical support for changes Investment income calculation Expense loading data Explanatory material