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1
Price Optimization Overview
Casualty Actuarial Society
Committee on Ratemaking
Price Optimization Working Party
November 2014
2
Summary
Introduction
Historical Practice
Current Practice
Points of consideration
3
Introduction
Ratemaking Process– Actuarial Cost Estimates– Goals– Resource limitations– External Environment
• Regulatory• Competitive
– Brand/Reputation– Target customers
Price Optimization helps quantify pieces of the ratemaking process.
4
Introduction
Definition of Price Optimization– The supplementation of traditional actuarial
loss cost models to include quantitative customer demand models for use in determining customer prices.
– The end result is a set of proposed adjustments to the cost models by customer segment for actuarial risk classes.
Evolution of P&C Pricing
Progression follows advances in science and technology
Since GLM’s, analytic efforts have gone beyond customer
costs.
1900’s
2000’s2010’s
Overall Rate Indication
One-way Segment Analysis
GLM’s
Customer Lifetime
Value
Price Optimization
HISTORICAL
RECENT
CURRENT
Customer Demand Analysis
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Historical Practices
Making adjustments to the actuarially indicated rates is not a new practice. Often described as actuarial judgment.
Process was not objective or quantified
Segment Exposure %Actuarial Indication Selected
Mono-Line 42.78% 1.0000 1.0000
Mulit-Line 57.22% 0.9151 ?
Simplification
Consistency
Competitive
Disruption
Marketing
Regulation
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Current Practice
Key similarities– Adjustments are made directly to filed and
approved actuarial risk classes; and,– Adjustments are made with user-defined
business goals in mind.
Key differences from historical practice– Market demand and customer behavior are
quantified instead of being subjectively determined; and
– The effect of the rate deviation from the loss cost on business metrics is mathematically measured.
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Current Practice
Optimization Engine
Actuarial Loss Cost Models
Reasonable Profit and
Growth Goals
Regulatory Considerations
Market Considerations / Competition
Adjusted Actuarial Models
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Current Practice
Quantity
Pro
fit
• Cost-based prices
Optimized prices
Goals determine which direction you want to go
Regulations determine how objectives can be achieved.
Market considerations connect profit and quantity
Optimization engine finds the prices that best achieve your goals.
10
Points of Consideration
Historical methods of assessing impact of a rate change assume overall distribution of risks will remain unchanged.– Significant asymmetry regarding which customers will accept the new pricing
and which customers will choose to leave.– New customers will not always have the same profile as customers lost.– In the interests of actuaries to anticipate these changes.
Low-income customers– Price optimization works at a rating factor level and income is not a rating
factor.– Low income customers do not all have the same price sensitivity.– For a given company, price sensitivity exhibited by customers to that company
is heavily dependent on that company’s prices, which can vary widely.
Enables companies to measure multi-year customer costs.
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Price Optimization Working Party– Morgan Bugbee, FCAS, MAAA, Chair– Bob Matthews, FCAS, – Sandra Callanan, FCAS, MAAA– John Ewert, FCAS, MAAA, CPCU, ARM, ARe– Serhat Guven, FCAS, MAAA– LeRoy Boison, FCAS, MAAA– Christine Liao, FCAS, MAAA
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