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

2. 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

3. 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

4. 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

5. 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.

6. 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.

7. 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.

8. 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

9. 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.

10. 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)

11. 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.

12. 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.

13. 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.

14. 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

15. 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

16. 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

17. 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

18. 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?