Course on Course on ProfessionalismProfessionalismStatement of PrinciplesStatement of Principles

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IntroductionIntroduction

Statement of Principles for Statement of Principles for Ratemaking, Loss Reserving, Ratemaking, Loss Reserving, Valuations and Risk ClassificationValuations and Risk Classification

Specific guidance on definitions, Specific guidance on definitions, principles, considerations, and principles, considerations, and conclusionsconclusions

Template for items to include in the Template for items to include in the documentationdocumentation

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Ratemaking - Ratemaking - DefinitionsDefinitions

Incurred LossesIncurred Losses ALAE / ULAEALAE / ULAE Commission and brokerage expensesCommission and brokerage expenses Other Acquisition expensesOther Acquisition expenses Taxes, licenses and feesTaxes, licenses and fees Policyholder DividendPolicyholder Dividend General ExpensesGeneral Expenses Underwriting profit and Contingency Underwriting profit and Contingency

provisionsprovisions

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Ratemaking - Ratemaking - PrinciplesPrinciples

1: A rate is an estimate of the expected 1: A rate is an estimate of the expected value of future costsvalue of future costs

2: A rate provides for all costs associated 2: A rate provides for all costs associated with the transfer of riskwith the transfer of risk

3: A rate provides for the costs associated 3: A rate provides for the costs associated with an individual risk transferwith an individual risk transfer

4: A rate is reasonable and not excessive, 4: A rate is reasonable and not excessive, inadequate, or unfairly discriminatory if it inadequate, or unfairly discriminatory if it is an actuarially sound estimate of the is an actuarially sound estimate of the expected value of all future costs expected value of all future costs associated with an individual risk transferassociated with an individual risk transfer

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Ratemaking - Ratemaking - ConsiderationsConsiderations

Data – relevance, organization, Data – relevance, organization, homogeneity, credibilityhomogeneity, credibility

Loss development, trends, Loss development, trends, catastrophes, policy provisions, mix catastrophes, policy provisions, mix of businessof business

Reinsurance, operational changes, Reinsurance, operational changes, external factorsexternal factors

Class plans, individual risk rating Class plans, individual risk rating Actuarial judgmentActuarial judgment

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Question #1Question #1

Which of the following are required for a rate to Which of the following are required for a rate to be reasonable and not excessive, inadequate or be reasonable and not excessive, inadequate or unfairly discriminatory:unfairly discriminatory:

A: A rate needs to be an estimate of the expected A: A rate needs to be an estimate of the expected value of future costsvalue of future costs

B: A rate needs to provide for all costs associated B: A rate needs to provide for all costs associated with the transfer of riskwith the transfer of risk

C: A rate needs to provide for the costs associated C: A rate needs to provide for the costs associated with an individual risk transferwith an individual risk transfer

D: All of the aboveD: All of the above

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Loss Reserving - Loss Reserving - DefinitionsDefinitions

Loss reserveLoss reserve Case reserveCase reserve Provision for future development on Provision for future development on

known claimsknown claims Reopened claimsReopened claims Provision for claims incurred but not Provision for claims incurred but not

reportedreported Claims in transitClaims in transit

Loss adjustment expensesLoss adjustment expenses

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Loss Reserving - Loss Reserving - PrinciplesPrinciples

1: Actuarially sound loss reserve …is 1: Actuarially sound loss reserve …is a provision, … for the unpaid amount a provision, … for the unpaid amount required to settle all claims, whether required to settle all claims, whether reported or not, ….reported or not, ….

2: Actuarially sound loss adjustment 2: Actuarially sound loss adjustment expense reserve …is a provision, … expense reserve …is a provision, … for the unpaid amount required to for the unpaid amount required to settle all claims, whether reported or settle all claims, whether reported or not, ….not, ….

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Loss Reserving – Loss Reserving – PrinciplesPrinciples (continued) (continued)

3: The uncertainty inherent in the 3: The uncertainty inherent in the estimation… implies that a range of estimation… implies that a range of reserves can be actuarially soundreserves can be actuarially sound

4: The most appropriate reserve 4: The most appropriate reserve within a range… depends on both within a range… depends on both the relative likelihood of estimates the relative likelihood of estimates and the financial reporting contextand the financial reporting context

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Question #2Question #2

Which is Which is notnot true for the following true for the following question: The most appropriate question: The most appropriate reserve within a range depends on:reserve within a range depends on: A. The size of the reserveA. The size of the reserve

B. The relative likelihood of the B. The relative likelihood of the estimatesestimates

C. The financial reporting contextC. The financial reporting context

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Loss Reserving - Loss Reserving - ConsiderationsConsiderations

Data – relevance, organization, Data – relevance, organization, homogeneity, credibility, availabilityhomogeneity, credibility, availability

Loss development, trends, catastrophes, Loss development, trends, catastrophes, freq/severity mix of business, form of freq/severity mix of business, form of coveragecoverage

Reinsurance, operational changes, Reinsurance, operational changes, external factors, discountingexternal factors, discounting

Uncertainty, reasonableness, methodologyUncertainty, reasonableness, methodology Standards of practiceStandards of practice

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Valuations - Valuations - DefinitionsDefinitions

ValuationValuation Risk bearerRisk bearer CashflowCashflow AssetAsset ObligationObligation ConsiderationConsideration

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Valuations - PrinciplesValuations - Principles

1: Every obligation, consideration or asset is 1: Every obligation, consideration or asset is associated with one or more items of cash associated with one or more items of cash flowflow

2: Value of every item depends on:2: Value of every item depends on: OccurrenceOccurrence AmountAmount TimingTiming Interest rateInterest rate

3: Degree of uncertainty depends on:3: Degree of uncertainty depends on: NatureNature Environment (regulatory, judicial, social, financial)Environment (regulatory, judicial, social, financial) Predictive valuePredictive value

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Valuations - PrinciplesValuations - Principles

4: Value of items … are not only uncertain, 4: Value of items … are not only uncertain, they are also not independent of each other. they are also not independent of each other. Uncertainty should reflect interactionsUncertainty should reflect interactions

5: Value of every item is equal to the 5: Value of every item is equal to the combined values of its constituent items of combined values of its constituent items of cash flowcash flow

6: Result of a valuation is the combined value 6: Result of a valuation is the combined value of the items involved with due recognition of of the items involved with due recognition of receipts and disbursementsreceipts and disbursements

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Valuations – PrinciplesValuations – Principles (continued)(continued)

7: Principles can apply to all items or 7: Principles can apply to all items or only specific segmentsonly specific segments Commitments made on or before Commitments made on or before

valuation datevaluation date Commitments made after the valuation Commitments made after the valuation

datedate BothBoth

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Valuations - Valuations - ConsiderationsConsiderations

Data – relevance, organization, Data – relevance, organization, homogeneity, credibilityhomogeneity, credibility

Operating conditions, Environmental, Operating conditions, Environmental, Loss and LAELoss and LAE

Rules and Assumptions, Valuation Rules and Assumptions, Valuation variablesvariables

UncertaintyUncertainty Interaction with other professionalsInteraction with other professionals Actuarial JudgmentActuarial Judgment

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Valuations - Valuations - ConsiderationsConsiderations

Valuation RiskValuation Risk Asset Risk - Asset Risk - The risk that the occurrence, amount The risk that the occurrence, amount

or timing of items of cash flow connected with assets or timing of items of cash flow connected with assets will differ from that anticipated as of the valuation will differ from that anticipated as of the valuation date for reasons other than a change in the interest date for reasons other than a change in the interest environmentenvironment

Obligation and Consideration Risk - Obligation and Consideration Risk - The risk The risk that the occurrence, amount or timing of items of that the occurrence, amount or timing of items of cash flow connected with obligations and cash flow connected with obligations and considerations will differ from that anticipated as of considerations will differ from that anticipated as of the valuation date for reasons other than a change in the valuation date for reasons other than a change in the interest environmentthe interest environment

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Valuations - Valuations - ConsiderationsConsiderations

Interest Risk – Interest Risk – The risk that different The risk that different amounts of change in the anticipated amounts of change in the anticipated values, and the degree of uncertainty values, and the degree of uncertainty therein, of obligations and of the assets therein, of obligations and of the assets and considerations with which the and considerations with which the obligations are being compared will obligations are being compared will occur due to changes in the interest occur due to changes in the interest environmentenvironment

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Question #3Question #3

Which of the following is Which of the following is notnot considered a Valuation Risk?considered a Valuation Risk? A. Asset RiskA. Asset Risk

B. Parameter RiskB. Parameter Risk

C. Obligation & Consideration RiskC. Obligation & Consideration Risk

D. Interest Rate RiskD. Interest Rate Risk

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Risk Classification - Risk Classification - PurposePurpose

Protection of Program’s Financial Protection of Program’s Financial SoundnessSoundness Primary solvency threat is through Primary solvency threat is through

adverse selectionadverse selection Enhanced FairnessEnhanced Fairness Economic IncentiveEconomic Incentive

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Risk Classification - Risk Classification - PrinciplesPrinciples

1.1. System should reflect expected cost System should reflect expected cost differences.differences.

2.2. System should distinguish among risks System should distinguish among risks on the basis of relevant cost-related on the basis of relevant cost-related factors.factors.

3.3. System should be applied objectively.System should be applied objectively.4.4. System should be practical and cost System should be practical and cost

effective.effective.5.5. System should be acceptable to the System should be acceptable to the

public.public.

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Risk Classification - Risk Classification - ConsiderationsConsiderations

UnderwritingUnderwriting MarketingMarketing Program DesignProgram Design

Includes degree of choice available to buyer, Includes degree of choice available to buyer, experience based pricing, and premium payerexperience based pricing, and premium payer

Statistical ConsiderationsStatistical Considerations HomogeneityHomogeneity CredibilityCredibility Predictive StabilityPredictive Stability

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Risk Classification – Risk Classification – Considerations Considerations

(continued)(continued) Operational ConsiderationsOperational Considerations

ExpenseExpense ConstancyConstancy Availability of CoverageAvailability of Coverage Avoidance of Extreme DiscontinuitiesAvoidance of Extreme Discontinuities Absence of AmbiguityAbsence of Ambiguity ManipulationManipulation MeasurabilityMeasurability

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Risk Classification – Risk Classification – Considerations Considerations

(continued)(continued) Hazard Reduction IncentivesHazard Reduction Incentives Public AcceptabilityPublic Acceptability

Not differentiate unfairly among risksNot differentiate unfairly among risks Based upon clearly relevant dataBased upon clearly relevant data Respect personal privacyRespect personal privacy Risks tend to identify with their Risks tend to identify with their

classificationclassification CausalityCausality ControllabilityControllability

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Question #4Question #4

Which of the following is Which of the following is notnot one of the one of the stated purposes of a risk classification stated purposes of a risk classification system?system? A. Enhance FairnessA. Enhance Fairness

B. Full Employment of ActuariesB. Full Employment of Actuaries

C. Protection of Financial Soundness of C. Protection of Financial Soundness of SystemSystem

D. Promote economic incentivesD. Promote economic incentives