S1 - Nonlife V04_Prodcut Pricing & Other Actuarial Aspects

8/9/2019 S1 - Nonlife V04_Prodcut Pricing & Other Actuarial Aspects

http://slidepdf.com/reader/full/s1-nonlife-v04prodcut-pricing-other-actuarial-aspects 1/37

1

Product Pricing and Other

Actuarial Aspectsby

S. P. Chakraborty

&P. K Maiti

IRDA

Seminar on General Insurance, 30th October, 2009, Mumbai



2

Agenda:

Basic Principles of non-life product pricing

Product Pricing ±Basic Elements

Illustration on application of rate relativities Practical considerations in product pricing

File & Use application ± Basic requirements of the regulator

File & Use Application ± Information onactuarial importance

File & Use Application ± A case study



3

Basic Principles of non-life product

pricing

Should be an estimate of the expected value of future costs.

Should provide all costs associated with thetransfer of risk.

Should maintain proper balance at both theindividual and aggregate level.

R esulting rates should not be excessive,inadequate or unfairly discriminatory for

any individual exposure.



4

Basic Elements Contd..

Exposure:

Indication of the amount of risk

Reasonableness

Ease of determination

Responsiveness to change

R isk Factors

Subjective, hence may not be easilymeasurable

Bearing on risk



5


R ating Factors:

Proxies of risk factors

Objective

Identifiable

Verifiable

Inexpensive to administer



6


Typical Rating variables:

Personal Automobile: Driver age andgender, model year and accident year

Home owners: Amount of insurance, Ageof Home and construction type

Workers compensation: Occupationclass code

Commercial Automobile: Driver Class,Territory, Limit of Liability.



7


R ating R elativities:

Better reflection of underlying risk

Minimizes cross subsidy & anti selection.

Need analysis of past claims and pastexposures

Completeness, accuracy and overall

quality of data Statistical and analytical techniques are

used



8


Exposure rating:

Premium is based on risk characteristics of

the insured Identification of risk characteristics

Establishment of relationships of premiumwith risk characteristics ± rating relativities

Significant correlation between the ratingfactors and cover provided

Period of application rates



9


Experience R ating:

Loss history of an individual risk is used toset the premium

Prospective or Retrospective

Requires adjustments to the materialchanges to the risk being insured or to the

T & C of the cover. Credibility of data



10

Basic Elements Contd..Pure R isk Premium (PR P) covers the expected claim amounts estimated from past claims and exposure data for new products, external data sourced from reinsurers and industry data

and other sources depending on the applicability.

PR P = Expected Claim Frequency per policy X Expected Cost per claim

AEPP

Burning Cost Premium (BCP) = Total Claims / Total Exposure to risk(or)

Average Claim amount x Claims Incident rate

Future R isk Premium = BCP projected forward after adjustingfor past inflation, trends,

relevance, changes in coverage of new policy,reinsurance and future inflation.



11


PRP is loaded for expenses , commission , contingency ,profit margin and cost of reinsurance , if any.

GP (Gross Premium) = [ CF x (CA + CE) + FE + VE] /

(1-C-v-p)- CF: E(Claim Frequency)

- CA: E (Average Claim Amount)

- FE & VE: Fixed and variable expenses per policy.

- CE: Claim Expenses

- p:Profit and contingency loading- v: Variable expenses other than commission as a% of GP.



12


Importance of data in rate making

Sources of data ±

- Internal ± Risk and accounting data

- External data ± Aggregate marketstatistics, competitors¶ data, reinsurersdata, other sources.



13

An Illustration on application of Rate

Relativities

A complete documentation is needed whenapplying rate relativities to price individualrisks. It should have the following

components:- Rules of rating

- Base Rates and Rating Tables

- Rating algorithm.- Underwriting guidelines



14

An Illustration of application of rate

relativities Contd«

Homeowners rate computation:

Base rate: Rs.900

Variables: Amount of insurance,Territory, Protection class and constructiontype, Underwriting tier, Deductibles,Miscellaneous Credit, additional optional

coverage etc.



15

An Illustration of application of rate

relativities Contd«



16

Practical issues in pricing

Recognition of complexities associatedwith

- Competitive Insurance market

- Company¶s internal operations

- Range of exposures and riskenvironment insured

- Complex social, economic, legal,Regulatory and operational forces.



17

File & Use application ² Basic

requirements of the Regulator

Product design and pricing should be on soundand prudent actuarial and underwriting basis.

Products should have real risk transfer and no

financial guarantee. Protection of policyholders¶ interest should be

observed.

Product pricing should be supported byappropriate data and involves actuarial judgment.

Actuarial assumptions should be consistent withthe insurer¶s experience.



18

File & Use application ² Basic requirements

of the Regulator

Documents required:

- As per Para 25 of File & Use Guideline following documentsare required:

- Particulars of product: Form A- Certificate by CEO: Form B

- Certificate by AA: Form C

- Certificate by Company Lawyer: Form D.

- Proposal form, Policy forms and standard endorsements.

- Copy of prospectus or sales literature.- Copy of the UW manual



19

File & Use application ² Other issues of

Actuarial Importance.

- Claims procedure

- Consistency between underwriting policyand product design, rating, terms &

conditions.

- AA should attend the board meeting

- Financial viability of each product.





21

Information of actuarial importance (contd.)

Exclusions/Restrictions, if any

Declined Risks

Deductibles/co payments/coinsurance

Policy Renewal, Cancellation, treatment of UnpaidPremiums.

Treatment of Change in Risk.

Intermediaries¶ Commission and Brokerage

Reserving methodology for long term product.



22

Further issues in pricing & Reserving

Details of the Methodology used to calculate rates Proper justification with regard to adequacy of data and

hence impact on rating. Rating Algorithm Rating factors and other factors used for rating Any underwriting adjustment in rating Details of expense assumptions & inflation rate Cancellation provision Past and prospective loss experience. Insurers are expected to carry out experience

analysis on regular basis (as per periodicity of reviewin form C).



23

Further Issues (Contd.)

Grouping of Risks

Catastrophic risk

Margin for profit and contingencies.

Taxation

Cost of Capital and solvency margin

Reinsurance



24

File & Use application ² Financial Projections

Require to provide a projection of volume of business in thenext five years.

Channel wise projection is required. Initial strain due to NB. Profit Criteria to be specified (Profit Margin, IRR, DPP,

whichever is applicable) Detail cash flow is required for various model points to be

constructed by considering relevant variables. Necessary for both short term (One year) and longer term

products. Identify the most sensitive Parameters.

Accordingly construct Three Scenarios ± Base, Optimisticand Pessimistic.



25

Contd.

Accordingly compute the profit criteria as set by thecompany

Tabulate the results against each model points in respectof each of the scenarios

Repeat the procedure with add on benefits

(endorsement). In respect of one year term contract, additional

projection is required for the next 5 years by estimatingthe persistency rates for each year.

Sensitivity tests are to be performed by varying(adversely) each base assumptions at a time and

tabulating the results to demonstrate the effect of eachparameter

One sample cash flows for specific model points arerequired to be submitted.



26

A case study on a 3 year term

health insurance product

Product Features:

Three year term regular premium healthinsurance product

Individual and family floater basis

Indemnity basis subject to an annual limit

Benefit structure:

Accidental death of any member

Medical expenses: Hospitalization for a minimum

of 24 hours, hospitalization of less than 24 hoursand pre and post medical expenses for the firsttwo cases.



27

A case study (Contd.)

Actuarial issues:

Treatment of unutilized annual limit

Policyholders¶ option

Waiting period for specified diseases/preexistingconditions

Existence of any co pay

Exclusions

Review-ability of premium rates at the end of theterm.



28


Actuarial issues:

Any territorial discrimination

Treatment of subsequent change in risk ±occupation change

Grace period (for long term product).

Scale of commission and distribution

channel



29


Pricing Assumptions:

R ates of Mortality ± 90% of the IALM (94-96)Ultimate (for decrement)

R ates of Morbidity: Should not be just basedon reinsurance rates. Proper justification isrequired. May derive the expected claim costfrom the reinsurers rates by eliminating theexpenses components coupled with inflation. Anyage adjustment and smoothing exercise is to be

disclosed.



30


R ate of policy termination: Preferably inrespect of each mode of premium payment. Forexample, 30%, 15% and 5%

R ate of interest: 7% p.a.

Surrender scales: To be specified

Commission Scales: Specific Commission ratesfor each intermediary.

Expenses: First Year and Renewal both by

Premium related and Per policy basis and claimexpenses.

Taxation: Rate to be specified. Average SumInsured: Rs.250000 /-



31


Pricing Methodology: Cash Flowapproach. Details of sample cash flow andPricing formula is required for premium,

Gross and net profit. Mix of business, if any assumed in the projection should bedisclosed.

Profit Criteria: Profit Margin calculated at

RDR of 15% p.a.



32


R eserving: Expected that the insurerscalculate both by URR and UPR ( based onday) method and take the higher of these

two. R eserving assumptions: Any

contingency margin applied to pricingassumptions.

Business volume projection and initialstrain over the next five years



33


Model Points and Scenario/Sensitivityanalysis:

R ating Variables: Age and Annual Limit

Parameters: Investment return,Expenses and claim amount

Scenarios ± Base, Pessimistic and

Optimistic



34


Profit Margin in each of the model pointsand scenarios to be tabulated.

Sensitivity of the results to each

parameter to be quantified.

Effect of withdrawal to be measuredseparately.

Negative profit margins are to be analyzedwith special care and to be eliminated.



35




36




37

Thank You