Insurance Risk Factors

Questions and Answers

How does the experience period affect the rate in insurance premium calculations?

The rate is determined solely based on the initial premium collected.

The rate remains constant throughout the experience period.

The rate may change often as the experience period extends over several years. (correct)

Rates only change if there is a significant loss during the period.

What is the primary purpose of the loss development method?

To determine the direct premium before reinsurance commissions.

To predict future claims development using past experience. (correct)

To directly adjust premiums based on recent claims.

To analyze market competition in setting rates.

What factors can cause an upward trend in loss severities affecting ratemaking data?

Allied risks and unforeseen natural disasters.

Reduction in accident claims.

Changes in legislation regarding insurance payouts. (correct)

Stable medical costs and inflation.

How is historical premium adjusted to current levels in loss ratio calculations?

By employing good rating software for rate adjustments. Signup and view all the answers

What role does loading play in the context of loss projections?

It includes unallocated loss adjustments treated as expenses. Signup and view all the answers

What is the main purpose of loading factors in insurance pricing?

To account for expenses and profit Signup and view all the answers

What distinguishes prospective systems from retrospective systems in individual risk rating?

Prospective systems determine future costs based on past experience. Signup and view all the answers

Which risk element in ratemaking is associated with the selection of parameters for model application?

Parameter risk Signup and view all the answers

What effect can the implementation of mandatory seat belt legislation have on frequency factors in insurance?

It can reduce frequency factors due to fewer accidents. Signup and view all the answers

How do loading factors influence the profit objectives of insurers?

They are a critical element in determining profit expectations. Signup and view all the answers

Study Notes

Frequency and Loading Factors

Frequency factors affect insurance rates and can be influenced by court interpretations or legislation, such as mandatory seat belt laws.
In the absence of sufficient internal claims data, external statistical data sources from both industry and independent entities are utilized.
Loading factors encompass various expenses including commissions, taxes, and management costs, calculated based on direct written premiums.
Profit in insurance pricing reflects the insurer's profit objectives, expected investment returns, and regulatory frameworks governing profits.
Contingency loading is designed to mitigate adverse deviations in risk assessment.

Risk Elements in Ratemaking

Two key risk elements in ratemaking:
- Parameter risk: associated with incorrect selection of model parameters, potentially leading to underpricing.
- Process risk: arising from the variability of future projections and contingencies.

Individual Risk Rating

Individual risk rating is applicable when risks are large enough to provide credible experience.
Reasons for individual rating include accurate pricing for large risks, promotion of risk control programs, and specific coverage modifications.
Two types of individual risk rating systems:
- Prospective Systems: Use past data to set future coverage costs.
- Retrospective Systems: Based on actual experience in the period, adjusting for volatility and encouraging risk control.

Trended and Projected Ultimate Losses

Important for rate-making, these projections can be based on pure losses or allocated expenses, with unallocated losses typically included in expense loading.
The loss development method is employed to predict unpaid and unreported losses, utilizing historical patterns for projections.
Claims data is organized by accident year to form a triangle of known values, facilitating analysis.

Claims Development and Link Ratio

Claims development is represented as:
- Horizontal movement: indicates claims development over time.
- Vertical movement: reflects changes in exposure levels.
- Diagonal movement: illustrates evaluation data trends.
Link ratio: derived from age-to-age development factors used to calculate projected ultimate values.

Trends Affecting Ratemaking

Trends in severity can significantly impact ratemaking due to factors such as inflation, court awards, and medical costs.
Frequency of losses is also subject to trends; discrepancies in competitor data can lead to adverse selection for an insurer.

Risk Characteristics Assessment

Rating plans evaluate risk characteristics using a matrix of frequency versus severity of losses.
For example, higher frequency may be observed in buildings with combustible materials or poorly maintained structures, while high-value properties are associated with greater severity of losses.

Ratemaking Process Introduction

Ratemaking typically follows one of two approaches:
- Pure premium method: focused on calculating sufficiency of premiums to cover losses.
- Loss ratio method: compares losses to earned premiums to set rates.

Pure Premium Method

Example: In a small town, the theft of insured cars is analyzed to derive the pure premium.
Formula: Pure premium = (Total losses / Total value) x 100.
If 5 out of 1000 cars valued at Rs. 5 lac each are stolen over 10 years, total losses amount to Rs. 25 lacs, resulting in a pure premium of 0.5% or Rs. 2500 per car.

Final Rate Calculation

The pure premium serves as the base, which is then loaded to account for additional business procurement costs and other expenditures required to sustain insurance operations.

Description

This quiz explores the impact of frequency factors and loading factors on insurance policies. It covers how court interpretations and legislation can change these factors, as well as the role of internal and external data in understanding claims experience. Test your knowledge on statistical data sources and related expenses.