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

2. Welcome to: Who wants to be a DFA Actuary?

3. $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.

4. 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 & given rate levels
F. Random, illogical, politically-motivated decision-making

5. $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

6. 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

7. $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.

8. $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

9. 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

10. $1,000,000 Question Is the Traditional Rate Level Indication Always Optimal ?
A. Yes
B. No

11. 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

12. 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

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

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

15. 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

16. 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

19. Base Case Results

20. Base Case Results

21. Variation 1
0% Growth

22. 0% Growth Results

23. 0% Growth Results

24. Variation 2
15% Growth

25. 15% Growth Results

26. 15% Growth Results

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

28. 15% Growth/Fixed Expense Results

29. 15% Growth/Fixed Expense Results

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

31. Jurisidictional Restriction Results

32. Jurisidictional Restriction Results

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

34. Soft Market/Adverse Selection Results

35. Soft Market/Adverse Selection Results

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

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

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