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Product Pricing Fundamental Equation
Price = Cost + Profit
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Define "Exposure (X)"
Basic Unit of risk underlying the premium
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Define "Premium (P)"
Amount insured pays for insurance policy
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What are the Premium Measurement methods
- Written premium - from policies issued during time period
- Earned premium - from coverage provided during time period
- Unearned premium - portion of written for which coverage has not been provided
- In-force premium - full-term premium for policies that are in effect at certain point in time
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Define "Claim"
Insured request to insurer for indemnication for financial loss from an event covered by the policy
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Define "Claimant"
Individual(s) making the demand for indemnication (claim) by alleging injuries or damages covered by the policy
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Define "Date of Loss"
a.k.a. accident date or occurrence date - date of event causing the loss
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Define "Report Date"
When claimant reports claim to insurer
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Define "IBNR (Incurred but not reported)"
Claims that have occurred, but not currently known by insurer
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Define "Loss"
Amount payable to claimant under the terms of the insurance policy
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Define "Paid Losses"
Amounts that have been paid to claimants
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Define "Case Reserve"
Estimate of unpaid loss for known claims
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Define "Reported Loss (a.k.a. Case Incurred Loss)"
Sum of paid loss and ending case reserve
Reported Losses = Paid Losses + Case Reserve
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Define "Ultimate Loss"
- Amount required to settle all claims for a defined group of policies
- Differs from reported loss due to IBNR and case adequacy (or IBNER)
Ultimate Losses = Reported Losses + IBNR Reserve+ IBNER Reserve
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Define "Allocated Loss Adjustment Expenses (ALAE)"
- Claim related expenses that can directly be attributable to a specific claim
- E.g., legal fees for outside counsel hired to work on a specific claim
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Define "Unallocated Loss Adjustment Expenses (ULAE)"
- Claim related expenses that cannot directly be attributable toa specific claim
- E.g., claims department salaries and rent
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What are some characteristics of Commissions and Brokerage?
- 1. Paid to insurance agents or brokers for generating business
- 2. Usually stated as percentage of written premium
- 3. May vary between new and renewal business
- 4. May be based on quality and/or volume of business written
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In relation to underwriting expenses, what are "Other Acquisitions"?
- Expenses other than commissions to acquire business
- E.g., advertising, mailings, salaries of employees who help write policies
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What is a "General" expense in relation to underwriting expenses?
- Remaining expenses associated with the operations
- E.g., rent, building maintenance, salaries of employees not included in other categories
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What are "Taxes, Licenses, and Fees" in relation to underwriting expenses?
- Taxes and fees for writing business
- Does not include federal income taxes
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Define Underwriting Profit
- Company assumes risk that premium charged is not enough to pay losses and expenses
- Must maintain capital to support this risk
- Entitles company to reasonable expected return on capital
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What are the two main sources of profit?
- Underwriting profit (or operating income): Generated from individual insurance policies
- Investment income: Generated by investing funds held by company
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What is the Fundamental Insurance Equation?
Premium = Losses + LAE + UW Expenses + UW Profit
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Appropriate balance of the Fundamental Insurance Equation must consider facts that:
- Ratemaking is prospective
- Should be achieved on overall and individual level
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What are some examples of items for which experience may need adjustment?
- 1. Rate changes
- 2. Changes in mix of business
- 3. Operational changes
- 4. Law changes
- 5. Inflationary pressures
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Frequency
- Used to:
- Identify trends in claims occurrence or utilization
- Measure effectiveness of u/w actions
- Frequency = Num of Claims / Num of Exposures
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Severity
- Provides information about:
- Loss trends
- Impact of changes in claims handling procedures
- Severity = Total Losses / Num of Claims
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Pure premium or loss cost (L)
- Highlight trends in overall loss costs due to changes in both frequency and severity
- Pure Premium = Total Losses / Num of Exposures = Frequency x Severity
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Average Premium
- Highlight changes in mix of business
- Average Premium = Total Premium / Num of Exposures
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Loss Ratio
Loss Ratio = Total Losses / Total Premium = Pure Premium / Average Premium
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Loss adjustment expense ratio
- Used to:
- Monitor stability of costs associated with claim settlement procedures
- Compare to other insurers to evaluate claims settlement procedures
- LAE Ratio = Total LAE / Total Losses
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Underwriting Expense Ratio
- Monitor and compare actual to expected
- May also compare to other insurers as a benchmark
- UW Exp Ratio = Total UW Expense / Total Premium
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Operating Expense Ratio
- Important when reviewing overall protability
- OER = UW Exp Ratio + (LAE / Earned Prem)
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Combined Ratio
- Primary measure of profitability of a book of business
- Combined Ratio = Loss Ratio + (LAE / Earned Prem) + (UW Expenses / Written Prem)
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Retention Ratio
- 1. Measures percentage of current insureds that renew their policies at expiration
- 2. Useful for product management and marketing
- Used to determine the competitiveness of rates
- Closely monitored following rate changes and major changes in service
- Key parameter in projecting future premium volume
- Retention Ratio = Number of Policies Renewed / Num of Potential Renewal Pols
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Close Ratio (a.k.a. hit ratio or conversion rate)
- 1. Measures rate at which prospective insureds accept a quote for new business
- 2. Useful for product management and marketing
- Close Ratio = Number of Accepted Quotes / Number of Quotes
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What is a rating manual used for?
Used to classify and calculate rate for a risk
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Written manuals are used to do what?
- Help agents understand the rating process
- File with insurance regulators
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What information is needed to calculate premium for a given risk?
- Rules
- Rate pages
- Rating algorithm
- Underwriting guidelines
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What do rating manual rules contain?
- Contains qualitative information which helps user with rating algorithms
- Summary of available policy forms
- Premium determination considerations
- Classification of risk
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What do Rate Pages contain?
- Contains the numbers needed to calculate premium
- E.g., base rates, rating factors, fees
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What are Rating Algorithms and what type of items do they include?
- Provides the detail instructions to calculate the policy premium
- 1. Uses information in rules and rate pages
- 2. Includes such items as: Order to consider rating variables, How rating variables are applied (e.g., multiplicative, additive), Maximum and minimum premiums (or sometimes maximum discount or surcharge, Rounding instructions
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What are the Underwriting Guidelines?
- Company-specific criteria for acceptance or placement of a risk
- Decisions to accept, decline, or refer risks
- Company placement
- Tier placement
- Schedule rating credits/debits
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What is a Ratemaking Review?
- 1. Analyze adequacy of existing rates
- Generally use internal or industry historical data to project future costs
- Company should collect and maintain relevant and consistent historical data
- 2. Pricing new products
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What should you do when ratemaking data is limited?
- Must be aware of the impact on the analysis
- Should examine how sensitive the results are to various assumptions
- Select data that minimizes distortions in results
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What should you review internal data for?
- 1. Appropriateness for the intended purpose of the analysis
- 2. Reasonableness and comprehensiveness of the data elements
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Risk Data used for Ratemaking
- Need to link policy exposure an premium with corresponding claims and losses
- Use Policy database and Claims database
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Accounting information needed for Ratemaking
- 1. May not even be specific to one line of business
- 2. Expenses that fall into this category
- Underwriting expenses - incurred in acquisition and servicing of policies
- ULAE
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What three objectives apply to Data Aggregation?
- 1. Accurately match losses and premium for the policy
- 2. Use the most recent data available
- 3. Minimize data collection and retrieval costs
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Aggregation by Calendar Year
- Transactional data
- Primary use:
- Aggregation of exposures
- May be used for LOBs or coverages in which losses are reported and settled quickly
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Advantages of Calendar Year Data
- No future development - the value remains fixed and doesn't change over time
- Readily available - most financial reporting on a calendar year basis
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Main Disadvantage of Calendar Year Data
- Mismatch in timing between premium and losses
- Earned premium comes from policies in force during the year
- Losses may come from payments or reserve changes on policies from previous years
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Aggregation by Accident Year
- Losses grouped according to date of occurrence, regardless of when pol written or claim reported
- Will develop over successive CYs with more information and as new claims are reported
- Most common grouping of claims data for the actuarial analysis of unpaid claims
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Advantage of Accident Year Aggregation
Better match of premium and losses than calendar year
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Disadvantage of Accident Year Aggregation
- Must estimate future development on claims
- May select valuation date several months after end of year to improve estimate because allows some time for loss emergence
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Aggregation by Policy Year or Underwriting Year
- Group premiums and losses by year in which policy was written
- Losses arising from a PY can extend over a 24-month calendar period
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Advantage of Policy Year Aggregation
True match between claims and exposures
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Disadvantage of Policy Year Aggregation
Extended time frame - data takes longer to develop
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Aggregation by Report Year
- Group claims according to date of report to the insurer
- Claims-made coverage is dependent on the report date
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Advantage of Report Year Aggregation
Number of claims is fixed at close of the year
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Overall versus Classification Analysis
- Overall analysis
- Reviewing the adequacy of the overall rate level
- Data can be highly summarized
- Classication analysis
- Data must be at a more detailed level
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Sometimes the desired data for analysis is unavailable, how do you deal with this?
- Must work with available data and use actuarial judgment to deal with data deficiencies
- E.g., if missing earned premium by territory, may use in force premium by territory to estimate
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External Data
- Statistical Plans
- Other Aggregated Industry Data
- Competitor Rate Filings/Manuals
- Other Third-Party Data
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