(1) Addressing an Imbalanced Fundamental Insurance equation
First read Statement of Principles for Ratemaking
- The profit target may be too high (risk of losing market) or too low (bad). We cannot touch losses since they are exogenous.
- Do nothing, if rates are competitive
- Change UW profit (consider long term profits, or lower the target)
- Change UW expenses (commission rates or laying off)
- Change LAE (approach of defending claims)
- Change Premium: rates restated (ok), re-state exposure def (not done in practice)
- Goal of ratemaking is to balance the fundamental equation
- 4 principles: future losses, provides for all costs, individual risk transfer (ideal: perfect pricing), and thus: reasonable and NOT excessive, inadequate or unfairly discriminatory.
- Considerations:
- Internal (change in rates) or External (change in social behavior, people driving lesser cars than in the historical period) changes.
- Credibility: tradeoff between homogeneity and volume of data.
- Provisions (deductibles, subrogation etc.).
- Cost of purchasing reinsurance.
- Risk profile: “High risk, High returns!” (i.e. UW profit)
- Investment income should be consider (the higher it is, the UW profit should be lowered)
- Methods to address: guess, non-insurance data, competitor rates, industry data (NCCI and ISO) and using insurer’s historical data adjusted to reflect future.
- “Future”, how to adjust Historical data:important
- Remove large event and anomalies: price for average, or model them
- One-time change (rate changes) “On-level”
- Trend: changes in cost over time (inflation, mix of business change)
- Development: open claims to ultimate levels
- Load for UW Expenses and ULAE
- Setting UW profit target: Investment income, company goals
- Reinsurance costs: explicit costs
- Credibility: weighted-average
- extra-important 1995 Q28
(2) Large Events and Anomalies
- Lowest limit offered by the insurer for that coverage (the limit that is assumed in the insurer’s base rate while calculating premiums)
- Adjustment for shock losses
- Cap loss to basic limits (to estimate LR, need to adjust historical premiums to use basic limits rates)
- Cap losses and apply an excess loss loading
- Remove the shock loss and apply a factor to non-shock loss to load for expected shock loss
- How to select the cap levels?
- Balance 2 goals: as many non-shock losses (high enough), minimize volatility of non-shock losses (low enough).
- Cap using actuarial judgement or percentile of loss distribution or “percentage of insured value”.
- Loading factor?
- Long term average
- Decide how many years to consider: responsiveness vs stability
- Average claim severity over time changes
- Trend excess and non-excess losses to a future policy period and cap at the future period price.
- Index cap (cap varies by year)