Basic Ratemaking Version 5 May 2016 2

Basic Ratemaking Version 5 May 2016 2 Basic Ratemaking Version 5 May 2016 Part 2 This document outlines the core principles and methods of basic ratemaking building upon the foundations laid out in Basic Ratemaking Version 5 May 2016 Part 1 This section focuses on practical application and advanced considerations within the framework of ratemaking I Building the Rate A Loss Costs 1 Pure Premium Represents the expected cost of losses per unit of exposure calculated as the sum of all losses divided by the total exposure units Formula Pure Premium Total Losses Total Exposure Units 2 Loss Adjustment Expense LAE Expenses incurred in the process of adjusting and settling claims including salaries of claims adjusters legal fees and investigation costs Typically expressed as a percentage of the pure premium Formula LAE Percentage of Pure Premium x Pure Premium 3 Expense Loading Covers all costs associated with underwriting policy administration marketing and other business operations Expressed as a percentage of the sum of pure premium and LAE Formula Expense Loading Percentage of Pure Premium LAE x Pure Premium LAE 4 Profit Loading Represents the insurers desired profit margin typically expressed as a percentage of the sum of pure premium LAE and expense loading Formula Profit Loading Percentage of Pure Premium LAE Expense Loading x Pure Premium LAE Expense Loading B Combining Elements The final rate is calculated by combining the pure premium LAE expense loading and profit loading Formula Rate Pure Premium LAE Expense Loading Profit Loading C Applying the Rate 2 The calculated rate is then applied to the individual policyholders exposure units to determine the premium amount This process ensures that premiums accurately reflect the expected costs of providing coverage II Advanced Ratemaking Concepts A Credibility Refers to the reliability of historical data used in ratemaking Less credible data necessitates a higher reliance on external factors or industry averages Credibility Weight This represents the proportion of the rate based on the specific insureds data versus the overall industry experience Formula Credibility Weight Number of Exposure Units in Insureds Data Total Number of Exposure Units in Industry x Credibility Factor Credibility Factor This factor adjusts the weight based on the statistical reliability of the insureds data B Trend Factors Account for changes in loss costs over time due to inflation changes in technology or other factors Trend Analysis This involves examining historical data to identify patterns and project future trends Trend Factor Application The trend factor is applied to the pure premium to adjust for anticipated future changes C Catastrophe Risk Risk of largescale infrequent events such as earthquakes or hurricanes Catastrophe Models These use statistical and probabilistic methods to estimate the potential impact of catastrophic events Catastrophe Loading This premium component is added to cover the expected costs of catastrophic events calculated based on the risk profile and modeling results D Rate Regulation Many jurisdictions have regulations governing the ratemaking process ensuring fairness and transparency Rate Filing Insurers are typically required to file their proposed rates with regulatory authorities for review and approval Rate Review Regulators assess the adequacy and reasonableness of proposed rates ensuring they are not excessive or unfairly discriminatory III Challenges and Considerations 3 A Data Quality Accuracy and completeness of data are crucial for reliable ratemaking Data cleansing and validation processes are essential to ensure data integrity B Predicting Future Losses Ratemaking relies on historical data to project future losses which can be influenced by various factors Sophisticated modeling and actuarial expertise are required to manage uncertainty and adjust for potential changes in risk profiles C Social and Ethical Considerations Ratemaking practices must balance the need for financial stability with the broader societal implications of pricing insurance Considerations include affordability access to insurance and potential discrimination D Emerging Risks The insurance industry faces a constantly evolving landscape of risks such as cyberattacks climate change and emerging technologies Ratemaking must adapt to these new risks and incorporate appropriate risk assessments and mitigation strategies IV Conclusion Effective ratemaking is crucial for the financial sustainability of insurance companies and the provision of affordable and equitable coverage for policyholders This document has provided a comprehensive overview of key ratemaking concepts including loss cost calculation advanced techniques and practical challenges By understanding these principles and employing sound actuarial practices insurers can develop rates that accurately reflect risks and ensure a stable and viable insurance market