Insurance Rate Development PDF

Chapter 7 Developing Insurance Rates Agenda 1. Ratemaking goals 2. Ratemaking terms 3. Factors that affect ratemaking 4. Ratemaking methods 1. Insurer Ratemaking Goals §Ratemaking - Process to calculate insurance rates - Rate ≠ Premium - Insurer’s primary objective - Rates low enough to be co...

Chapter 7 Developing Insurance Rates Agenda 1. Ratemaking goals 2. Ratemaking terms 3. Factors that affect ratemaking 4. Ratemaking methods 1. Insurer Ratemaking Goals §Ratemaking - Process to calculate insurance rates - Rate ≠ Premium - Insurer’s primary objective - Rates low enough to be competitive and high enough to be profitable - Challenge: Losses and expenses associated with losses are unknown when rates are initially developed Ideal Characteristics of Rates 1. Stability Relatively infrequent changes, not too big or small 2. Responsiveness 3. Provide for contingencies Unexpected losses and expenses 4. Promote loss control 5. Reflect differences in risk exposures Source: CSE Safeguard Insurance Co. (CA Homeowners) Reminder – Regulatory Ratemaking Goals §Adequate §Not Excessive §Not unfairly discriminatory Sample Statute – Oklahoma 2. Ratemaking Terms § Rate = the price per exposure unit for insurance coverage § Rate = § Amount needed to pay future claims and loss adjustment expenses (prospective loss costs) + § Amount to pay future expenses + § Amount for profit and contingencies § Premium = Rate x # of Exposure Units § Premium = price of the insurance coverage provided for a specified period § Pure Premium - Amount to pay losses per exposure unit § Expense Provision - Underwriting expenses = Acquisition, general expenses, premium taxes, licenses/fees § Loss Adjustment Expenses - Expenses to adjust claims § Profit and Contingencies - Cover possibility that actual losses > projected losses Example # autos = 100,000 Historical annual claims = $10 million Historical annual expenses = $3.5 million Amount needed to pay for future claims = 10/0.1 = $100 per auto Amount needed to pay for future expenses = 3.5/0.1 = $35 per auto Thus, insurance rate = $100 + $35 = $135 per auto §Premiums collected are invested - Explicitly considered in rate calculations - Required in some states - Liability v. Property - Investment income has larger effect on liability rates than on property rates Florida Rate Regulation and Investments Florida Regulation – Calculating Impact of Investment Income 3. Factors That Affect Ratemaking §Some factors that impact a coverage’s rate include: 1. Estimation of Losses 2. Delays in Data Collection and Use 3. Change in the Cost of Claims 4. Insurer’s Projected Expenses 5. Target Level of Profit and Contingencies Factors that Affect Ratemaking: Estimation of Losses §Estimate losses from past coverage periods and adjust for future conditions - But past losses may not be completely known §Ultimate Losses - Final amount paid for all losses in an accident year §Incurred Losses = paid losses + unpaid losses §Loss reserves = reserves for unpaid losses Hypothetical Auto Liability Loss Experience at End of 2022 Year (1) (2) (3) Paid Losses Loss Reserves Incurred Losses 2020 $10,000,000 $0 $10,000,000 2021 $7,500,000 $2,500,000 $10,000,000 2022 $2,500,000 $7,500,000 $10,000,000 Total $20,000,000 $10,000,000 $30,000,000 Assume we are looking at data as of 1/1/2023 for: Policies issued in 2020 Policies issued in 2021 Policies issued in 2022 Factors that Affect Ratemaking: Delays in Data Collection §Delays between when data collected and when used à reduces accuracy 1. Delays by insureds in reporting 2. Time required to analyze data 3. Delays in state approval Chronology of a Rate Filing § 1/1, Year 1 ----Start of experience period, first incurred loss § 12/31, Year 1 § 12/31, Year 2 § 12/31, Year 3 ---- End of experience period § 3/31, Year 4 ---- Start of data collection and analysis § 7/1, Year 4 ---- Rates filed with regulators § 9/1, Year 4 ---- Approval of rates received § 1/1, Year 5 ---- New rates initially used § 12/31, Year 5 ---- Rates no longer used § 12/31, Year 6 ---- Last loss incurred under this rate filing Factors that Affect Ratemaking: Change in the Cost of Claims §Frequency and severity can change §Inflation, deflation, legislative / regulatory changes §Rates must include a provision for changes arising during the period in which the rates are in effect Factors that Affect Ratemaking Expenses and Profit/Contingencies §Insurer’s Projected Expenses - Rather than relying on past expenses, it may be more relevant to use judgment or budgeting expenses when conditions change §Target Level of Profit and Contingencies 4. Ratemaking Methods §Methods used to adjust rates or develop new ones include: 1. Class rating 2. Merit rating 3. Judgment rating 4. Combination Class Rating 1. Pure premium method - Develop rates from past experience 2. Loss ratio method - Modify existing rates Pure Premium Method PURE PREMIUM METHOD GROSS RATE Pure Loading for Expenses, Premium Profit, & Contingencies Paid Losses Loss Reserves Allowance for Expenses Allowance for Profit (except investment, LAE) And Contingencies Pure Premium Method Steps are… !"##$% $&"'() "* +(,'%%-. #"//-/ 1. Calculate pure premium = 0'&1-% "* -$%(-. -23"/'%- '(+)/ 2. Estimate expenses per exposure unit 3. Determine profit and contingencies factor 4. Calculate the rate per exposure unit Loss Ratio Method §Compares actual and expected loss ratios to modify a current insurance rate §Rate change = (Actual LR – Expected LR) / Expected LR §If positive – increase rate §If negative – decrease rate Loss Ratio Method §Example: Suppose a class has an expected loss ratio of 80% and at the end of the year it has an actual loss ratio of 100%. What rate change does the loss ratio method suggest? §Rate change = (Actual LR – Expected LR) / Expected LR = (100-80)/80 = 20/80 = ¼ = 25% = 25% is positive, so 25% rate increase Merit Rating § Schedule - Debits and credits based on characteristics - Take into consideration individual characteristics § Experience - (Actual LR – Expected LR) / Expected LR * credibility factor - Workers’ Compensation EMOD § Retrospective Experience Rating Method §Example: Suppose a firm has an expected loss ratio of 80% and at the end of the year it has an actual loss ratio of 100%. It has a credibility factor of 0.5. What rate change does the experience rating method suggest? §Rate change = (Actual LR – Expected LR) / Expected LR * credibility factor = (100-80)/80 * 0.5 = 20/80 * 0.5 = 1/8 = 12.5% = 12.5% is positive, so 12.5% rate increase Ratemaking Process Overview Steps taken to create or revise rates: 1. Collect data 2. Adjust data 3. Calculate overall rate change 4. Determine territorial and class relativities 5. Prepare and submit the rate filing Collecting the Data §In general, need data on: - Losses (paid, unpaid, LAE) - Earned premium - Expenses including profit/contingencies §May be needed by rating class and/or territory Adjusting the Data §Actuaries adjust premium and loss data in the following ways: 1. Adjust historic experience for future development 2. Apply trending Adjust Historic Experience for Future Development §Open and unreported claims §Need to estimate the final, total cost to pay all claims for a given period to estimate future losses §Loss development factors - An actuarial means for adjusting losses to reflect future growth in claims due to both increases in the incurred amount for reported losses and incurred but not reported (IBNR) losses. Adjust data: Loss Development Factors §Look at past data (loss triangles) for trends in development §Calculate development factors §Apply development factors to immature data §Get a more realistic idea of developed losses Development Calculation Developed Losses Developed Losses and Claims Apply Trending to Losses and Premium § Trending - Project past trends into the future - Reflects conditions expected in the future § Linear - Assumes series will increase or decrease by fixed amount each year § Exponential - Assumes series will increase or decrease by a fixed percentage § Exponential usually results in higher projected losses and in higher premiums Choice §Based on theoretical grounds or observation §If straight line – linear §If accelerating – exponential §Inflation is a major factor Rising Accident Costs Increase in Loss Costs, 2016:Q1–2018:Q1 Bodily Injury Property Personal Injury Collision Comprehensive Damage Protection 9.0% 6.6% 2.6% 6.1% 27.6% From 2016 to 2018, the cost of accidents has risen dramatically. By contrast, consumer prices overall rose 4.8 percent during 2015 and 2017. Source: Fast Track Monitoring System. Insurance Information Institute, https://www.iii.org/presentation/insurance-market-trends-and-more-090518 Source: University of Oxford Calculate Overall Indicated Rate Change §Use one of the ratemaking methods discussed previously (e.g., LR method or PP method) to produce an indicated rate - Indicated rate = the amount that the loss experience suggests that the insurer should charge to cover costs Determine Territorial and Class Relativities §Territorial - Relativities reflect the extent to which various geographic territories in a state deserve rates that are higher or lower than the statewide average - Compare estimated loss ratio for each territory with statewide average loss ratio §Class - Compare estimated incurred loss ratio for each rating class to average Prepare and Submit Rate Filings § Generally must submit: - Schedule of proposed rates - Statement about the percentage change in the statewide average rate - Explanation of differences between the overall statewide change in rate and the percentage change of the rates of individual territories or rating classes - Data to support the proposed rate changes, including territorial and class relativities - Expense provision data - Target profit provision included in the rates and supported calculations - Additional explanatory material Rate Filings and Advisory Organizations §Companies that use an advisory organization are assumed to adopt the filings made by the organization automatically. §When loss costs are filed by an advisory organization, the insurer is responsible for filing its expense provisions which yield the final rates. Source: Mississippi Rate Bulletin Role of Actuaries in Ratemaking §Ratemaking based on prior loss data. §Estimation of unpaid liabilities and adequacy of loss reserves. §Also predictive modeling, reinsurance, assessing insurer risk, providing info to regulators Insurer use of Actuaries §Internal (staff actuaries), external (consultants), or both §Can also rely on advisory organizations for rates and loss costs - Insurance Services Office (ISO), National Council on Compensation Insurance (NCCI), American Association of Insurance Services (AAIS) - Collect data from members to calculate loss costs - Loss costs = rate that covers projected claim payments and loss adjustment expenses