1. 2007 Annual Meeting ● Vancouver IP 40 LTD & STD Pricing ● Andrew Ryan 2007 Annual Meeting ● Vancouver IP 40 LTD & STD Pricing ● Andrew Ryan Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2. LTD Pricing Purpose of this presentation: illustrate inefficiencies in standard LTD pricing methodology –Is LTD pricing efficient? –What are the causes of inefficiency? –What can be done to fix inefficiencies? –Consequences of quick fixes 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

3. LTD Pricing – Is it Efficient? observed industry quotes on a variety of representative cases –I have selected a random assortment of 6 cases from the Fraser 2006 Market View survey –15 insurers participated in Market View –I deleted 4 insurers who did not quote on all 6 cases Market View is a proprietary and confidential study. Fraser Group has released the data used in this presentation. 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

4. LTD Pricing – Is it Efficient? Assumption: all Canadian insurers have similar cost structures (contracts, adjudication practices, expense structure, profit requirements etc.) Under this assumption, efficient pricing would lead to a very narrow range of quoted rates by all competing insurers –true cost of a case is a random variable with a common expected mean amongst all insurers Relaxing the assumption would widen the expected range somewhat –true cost of a case is a random variable, but the expected mean varies amongst insurers –insurers with the competitive advantage should always have the lower cost 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

5. LTD Pricing – Is it Efficient? The following charts illustrate the quoted rate for each of the 11 insurers –Quoted rate shown as a percentage of the sold rate for each case –more later on how I have defined the “sold rate”; for now, assume that the industry avg sold rate contains a 10% profit margin 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

6. LTD Pricing – Is it Efficient? 2007 Annual Meeting Assemblée annuelle 2007

7. LTD Pricing – Is it Efficient? 2007 Annual Meeting Assemblée annuelle 2007

8. LTD Pricing – Is it Efficient? 2007 Annual Meeting Assemblée annuelle 2007

9. LTD Pricing – Is it Efficient? 2007 Annual Meeting Assemblée annuelle 2007

10. LTD Pricing – Is it Efficient? 2007 Annual Meeting Assemblée annuelle 2007

11. LTD Pricing – Is it Efficient? 2007 Annual Meeting Assemblée annuelle 2007

12. LTD Pricing – Is it Efficient? Observations: –Maximum rate is often double the minimum rate –No clear consensus on the true cost of a case (high variance around the mean) –The lowest quote on any given case is generally below cost (as indicated by red-dotted line) –No insurers are consistently high or low (which indicates that the variance is not due to different cost structures by insurer) Conclusion: –Group insurers cannot accurately price a given case within a reasonably narrow range  i.e. LTD pricing is inefficient 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

13. LTD Pricing: Causes of Inefficiency Rating factors vary from insurer to insurer –Slope of base rates by age –Range and slope of industry and occ factors –Miscellaneous adjustment factors (CPP offsets, elim period, replacement ratio etc.) Interpretation of rating factors internally within any given insurer –Classification of industry –Classification of employee occs 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

14. LTD Pricing: Fixing Inefficiency Reduce rate basis components that are too conservative, and increase components that are too aggressive –Review industry and occ factors for reasonability –ensure base rates are consistent with recent experience Easier said than done, as group actuaries generally don’t get: –Objective competitive rate feedback –Case-level demographic data upon which to evaluate every component of the rate basis 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

15. LTD Pricing: Fixing Inefficiency Suggestions for future industry research –More frequent industry incidence and termination rate studies –Termination and incidence experience by broad industry and/or occ classification 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

16. LTD Pricing: Quick Fixes Consequences of “across the board” x% increases or decreases to the rate basis –Where original rate was above the pack, no impact as neither original rate nor new rate will be sold (eg. #1 or #5) –Where original rate was mid-pack, rate reductions will increase sales at lower margins, whereas rate increases will reduce sales at higher margins (eg. #6 or #11) –Where original rate was a market leader, rate reductions will not change sales but will reduce margins, whereas rate increases may not reduce sales but will increase margins (eg. #2 or #7) 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

17. LTD Pricing: Quick Fixes Estimating the impact of a “quick fix” basis change requires a demand curve assumption The industry avg sold rate is based upon the distribution of quoted rates, weighted per the above market share assumption 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

18. LTD Pricing: Quick Fixes Assume that the average sold rate contains a 10% profit margin –breakeven rate is 90% of the average sold rate –An insurer’s expected profit margin is based on its quoted rate relative to the breakeven rate, weighted by expected sales volume given the ranking of the quoted rate 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

19. LTD Pricing: Quick Fixes What would happen if each insurer, independently, changed rates by plus or minus 5% –Assume that a 5% rate increase increases profit margin by 5% –Assume that a 5% rate reduction reduces profit margin by 5% 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

20. LTD Pricing: Quick Fixes Observations: –Optimal strategy (in terms of maximizing dollar profit) varies from company to company Generally, a quick fix rate increase is more effective for insurers with lower profit margins, whereas a quick fix rate reduction is more effective for insurers with higher profit margins –Any quick fix change is suboptimal relative to fixing the components of the rate basis 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007

21. LTD Pricing: Summary LTD pricing appears to be inefficient –Opportunities for improvements in actuarial research at both the insurer level and industry level Group actuaries should not give the impression to Senior Management that case rates are more accurate than they really are –Recognize that case rates are potentially biased estimators with a wide range of uncertainty Do not allow Sales to dictate rating based on the lowest common denominator –Chasing the lowest quote on any given case will generally lead to pricing below cost 2007 Annual Meeting Assemblée annuelle 2007 2007 Annual Meeting Assemblée annuelle 2007