Managing Overconfidence
Douglas J. Collins, FCAS, MAAA
doug.collins@towersperrin.com
Tillinghast London (Tel: 44 (0)207 170 2162)
CAE Zurich – 23 April 2004
Many factors contribute
to errors (and bias!) in pricing and underwriting
Common Sources of Pricing
and Underwriting Error/Bias (Micro)
 Inadequate internal [historical] data upon which to
develop estimates (e.g., old, incomplete or
inaccurate data; inadequate/inappropriate sample)
Systemic Sources of Pricing
and Underwriting Error/Bias (Macro)
 Long feedback loop
 No skin in the game
 Inability to collect and synthesize all relevant
sources of data within the organization
 Lack of reliable information about external market
conditions and trends (e.g., inflation, tort costs)
 Excessive concern for “competitive pressures”
 Lack of adequate oversight over pricing decisions
 Lack of “metaknowledge” — reinforces inherent
overconfidence when making estimates, forecasts
and predictions
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The results of a recent Tillinghast
“Confidence Quiz” illustrate the prevalence of
overconfidence
Tillinghast Confidence Quiz
The Quiz
 Objective: To test respondents
understanding of the limits of their
knowledge
Raw Scores of Online Respondents
Number of Respondents
0
29
1
 Respondents were asked to answer ten
questions related to their general
knowledge of the global
property/casualty industry
 For each answer, respondents were
asked to provide a range that offered a
90% confidence interval that they would
answer correctly
67
2
56
3
69
4
44
5
44
6
28
7
18
8
 Ideally (i.e., if “well calibrated”),
respondents should have gotten nine
out of ten questions correct
12
9
10
7
0
Note: based on 374 respondents as of 4/5/04.
Profile of respondents: 86% work in P/C industry; 73% are actuaries.
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The best way to manage overconfidence
is to implement a control cycle for pricing and underwriting
The Control Cycle: Retrospective Test of Pricing/Underwriting
1. Pricing and
Underwriting
Process Elements
 Data required
3. Formal
Retrospective
Performance
Testing
 Actuarial methods
 Data accurate and
1. Define/Refine Process
adequate?
employed
 Underwriting policies
and rules
3. Measure
Performance
 Decision authorities
and reporting
 Quality assurance
2. Implement
Process
 Pricing methods
sufficiently robust?
 Policies and rules
effective?
 Decision authorities
appropriate?
 Variances between
projected and actual
experience within
tolerances?
 A control cycle for P/C pricing and underwriting entails identifying, testing and validating all of the
assumptions that underlie the projection of future loss costs used to price and underwrite the business
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While improving pricing/underwriting
requires a sustained commitment over time,
three near-term steps will jump start the process
Retrospective Analysis
 Analyze relevant sample of pricing and underwriting results
to identify/pinpoint specific causes and sources of error
 Define (or refine) and institutionalize an ongoing
Process Design/Refinement
Case-study Training
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process of continuous improvement (i.e., control
cycle) for pricing and underwriting
 Incorporate insights from retrospective
analysis to address key challenges and
deficiencies
 Develop/institute case-study oriented
training modules for underwriters and pricing
actuaries to provide practical experience
and rapid feedback
 Base training materials on past business
where results are already known
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Managing overconfidence in pricing and
underwriting
Pricing Element
Best
Estimate
Standard
Deviation
90% Confidence
Low
High
Historical experience not fully credible
957
5.0%
897
1,020
Historical experience not fully mature
191
20.0%
146
242
1,149
6.7%
1,052
1,249
138
50.0%
67
226
10
200.0%
1
23
1,297
12.0%
1,105
1,500
610
33.0%
383
874
1,906
17.3%
1,508
2,340
-20.9%
22.7%
Subtotal Ultimate Historical Loss Costs
Frequency and severity changes
Mix of business or underlying exposure changes
Subtotal Projected Future (Attritional) Loss Costs
Non-attritional loss elements
Total Projected Expected Future Loss Costs
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