CAS Ratemaking Seminar
Price Governance I: Price Monitoring for
Standard and Middle Market Commercial
Lines
March 8, 9 2007
Chris Nyce
Senior Manager
KPMG LLP
Brian Hughes
Senior Vice President
Arch Insurance Group
Disclaimer
• The views expressed in this presentation are those of the speakers; and
• They are not necessarily the views of the CAS, KPMG, Arch Insurance or any other sponsor of this
seminar;
• Anyone who says otherwise is not only wrong, but is itching for a fight.
1
Contents for the Presentation
Introductions
Why is price monitoring critical (and failures of the past)
Chris Nyce
Interactions between manual rates and prices charged
Automating approaches:
Standard commercial renewal price monitoring
Price monitoring framework
Brian Hughes
Industry sources of price information
Large commercial lines - Methods 1-5
Challenges and practical issues
Handling less straightforward lines of business
Chris Nyce
Implementation model
2
Backdrop 2006 or “Why Measure Pricing”?
•CIAB Pricing Survey shows prices are declining in the last few years
•Yet III shows Industry consolidated ROE at 11% - Marginal even at the height of the cycle; below all industry average every
year for past 18 years
20%
15%
10%
5%
0%
-5%
19
8
19 7
8
19 8
8
19 9
9
19 0
9
19 1
9
19 2
9
19 3
9
19 4
9
19 5
9
19 6
9
19 7
9
19 8
9
20 9
0
20 0
0
20 1
0
20 2
0
20 3
0
20 4
20 05
06
E
Return on Equity
Comparison of P&C Insurance ROE's with All Industry
All Industries
P&C Insurance
•Conclusion: Company must be better than average to earn a return equivalent to peers in other industries
Source: Insurance Information Institute
3
Historical Price Changes Implied by Reported Industry Results
Compared to Actual Results
General Liability Occurrence
AY
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Total
Earned
Premium
11,193,735
11,362,262
11,982,431
11,678,847
11,523,956
11,732,232
12,334,245
16,814,191
21,007,773
25,007,920
144,637,592
Loss and ALAE Ratio
Reported Reported
Initially
at 24
@
Reported Months 12/2004
79.4%
78.4%
75.1%
78.8%
77.8%
76.2%
79.8%
78.4%
83.7%
77.8%
77.3%
90.9%
75.2%
76.5%
95.5%
75.6%
77.8%
95.2%
87.7%
88.9%
94.0%
70.8%
70.0%
71.5%
67.7%
65.4%
65.4%
65.8%
xxx
65.8%
xxx
xxx
xxx
Subtotal 1996-1999
Change in Rate
Adequacy
Reported Actual
Difference
(Initial to (based on Actual to
24 month) 12/04)
Reported
xxx
xxx
-0.5%
-1.5%
-1.0%
-2.5%
-9.7%
-7.2%
0.8%
-8.7%
-9.5%
2.6%
-5.0%
-7.6%
1.3%
0.3%
-0.9%
-12.9%
1.2%
14.1%
20.4%
23.9%
3.6%
3.3%
8.5%
5.2%
xxx
-0.5%
xxx
xxx
xxx
0.3%
-22.9%
Note initially
reported results
stable from 19961999, but actual
results
deteriorated
markedly
Rate adequacy
changes implied in
reported results lag
actual by 23%!
-23.2%
Source: AM BEST Aggregates and Averages composite Schd P.
4
Historical Price Changes Implied by Reported Industry Results
Compared to Actual Results
CMP
Earned
Premium
AY
1996
18,001,516
1997
18,339,971
1998
18,289,197
1999
18,609,666
Subtotal 1996-1999
Loss and ALAE Ratio
Change in Rate
Reported Reported Reported Reported Difference
Initially
at 24
@
(Initial to
@
Actual to
Reported Months
12/2004 24 month) 12/2004
Reported
74.3%
74.6%
77.0%
-6.2%
-8.3%
-2.1%
68.0%
67.8%
70.0%
8.8%
9.0%
0.2%
74.0%
74.7%
80.1%
-9.2%
-14.4%
-5.3%
73.8%
74.9%
80.6%
1.2%
-0.6%
-1.8%
-6.2%
-15.0%
-8.8%
Workers' Compensation
1996
27,124,365
1997
25,108,476
1998
24,586,828
1999
22,948,284
Subtotal 1996-1999
71.7%
73.2%
77.8%
79.6%
70.0%
75.5%
79.7%
83.1%
68.3%
78.8%
87.8%
93.6%
-1.6%
-4.7%
-3.0%
0.2%
-8.9%
-5.3%
-15.4%
-11.5%
-6.6%
-33.8%
-3.7%
-10.8%
-8.5%
-6.8%
-24.9%
78.4%
74.9%
81.9%
78.7%
77.2%
90.8%
120.2%
121.2%
-2.1%
2.9%
-7.3%
2.9%
-4.0%
-9.8%
-17.5%
-32.5%
-0.8%
-50.1%
-7.7%
-20.4%
-25.1%
-3.7%
-46.2%
Similarly for other commercial casualty
lines, rate adequacy changes implied by
reported results lagged actual
adequacy declines by:
CMP
- 8.8%
Workers’ Comp - 24.9%
Casualty Re - 46.2%
Casualty Reinsurance
1996
7,892,289
1997
7,869,256
1998
7,337,873
1999
8,428,709
Subtotal 1996-1999
77.6%
76.1%
80.4%
79.6%
Source: AM BEST Aggregates and Averages composite Schd P.
5
Climbing the Continuum: Various Stages of Rate Adequacy Capabilities
Measuring and Acting in Real Time
Reconciling Price Monitoring Data to Financial Systems
Capturing Changes in Classifications
Automating Data Feeds from Policy Systems
Capturing Other Changes in Terms and Conditions
Capturing Changes in Limits, Deductibles, Term
Establishing a Standard Benchmark to Measure New Business
Basic Monitoring of Renewal Price Changes
Climbing the Price Monitoring Pyramid!
6
While Actuarial Approaches Need Improvement - Need Focus also on
Integrating Price Monitoring into a Comprehensive Underwriting Program
Possible Problem
Manifestation
Manual rates may not fully reflect loss potential of each class of risks
Underwriters and Agents will be incented to write the inadequately
priced classes
Loss potential of new business may not reflect the average in class of
the manual rate
Can result when Underwriters and Agents push rate but relax
underwriting quality
Data on which measurements are based may not be accurate
Price management can be defeated if manipulated in field (example,
underestimate or miscode exposures)
Planned price changes may not be communicated or implemented in
the field
Prices are determined at underwriters desk, so clarity at that level is
needed
Even if manual rate adequacy is right by class, charged rates may not
be
An “off-balance” can be created by the credits, e.g. some classes
written at manual, and some well off of manual
7
Quality of Risk Within Class
•Standard underwriting execution is key
– Reasonable authorities and delegations
– Data and risk validation
– Field audit schedules
– Self audit and management reviews
– Strong field and home office referral processes
•Underwriting Audits should include data quality
– Exposure information, coverage additions if not considered in the price monitor
•Rating plan refinements may be needed
– Any recognition of variation of loss cost within a rating segment is candidate for new rating variable
– If no manual rating differential, needs to be segmented and tracked
8
Discussion of a General Approach for Standard Commercial Lines
Today we will discuss general renewal monitoring
New business (to benchmark) can be generalized in an analogous manner
Note also that Actuaries are critical to the business management process:
9
Standardized Formula for Small Commercial Business - Basic Property
State the Rate Change at Expiring or Renewing Coverages
Expiring Coverages
Renewing Coverages
Wind
Deductible
AOP Extension
Sprinkler
Leakage
Package
Extension
Group I&II
Coverage 100K
Deductible Buydown to $250
Ordinance
And Law
Sprinkler
Leakage
Package
Extension
Group I&II
Coverage 100K
No Buydown
10
Standardized Formula for Small Commercial Business - Basic Property
State the Rate Change at Expiring or Renewing Coverages
Expiring Coverages
Renewing Coverages
Wind
Deductible
AOP Extension
Sprinkler
Leakage
Package
Extension
Group I&II
Coverage 100K
Deductible Buydown to $250
Ordinance
And Law
Sprinkler
Leakage
Package
Extension
Group I&II
Coverage 100K
Deductible Buydown to $250
Red coverages are rerated, or “normalized”
Option I: Rerate to
Expiring coverages
Benefit: Not “making
up” expiring premium
and then measuring
change from fictional
premium.
11
Standardized Formula for Small Commercial Business-Basic Property
State the Rate Change at Expiring or Renewing Coverages
Expiring Coverages
Renewing Coverages
Wind
Deductible
Wind
Deductible
AOP Extension
AOP Extension
Ordinance
And Law
Sprinkler
Leakage
Package
Extension
Group I&II
Coverage 100K
Ordinance
And Law
Sprinkler
Leakage
Package
Extension
Group I&II
Coverage 100K
Deductible Buydown to $250
Option II: Rerate to
Renewal coverages
Benefit: Capturing all
renewal coverages, but at the
cost of adding fictional
coverages to the expiring
No Buydown
Red coverages are rerated, or “normalized”
Purple coverages are deleted
12
Balancing Capture of Complete Information with Accuracy of Measurement
Line of Business and Coverage - Basic Property Example
Perform calculations at the coverage level so you can include or exclude coverages depending on renewal
status:
Instead of one
coverage :
Consider whether to treat each coverage at each location
as separate calculation, or alternatively “normalize”
“Basic Group I-Building”
“Property Coverage”
“Basic Group II-Building”
“Basic Group I-Contents”
“AOP-Building”
“Off Premises Power”
“Basic Group II-Contents”
“Earth Movement”
“Adjacent Structures”
“AOP-Contents”
“Money and Securities
“Fire Dept Charges”
“Brands and Labels”
“Packaged Extension”
“Sprinkler Leakage”
“Ordinance and Law”
“Accounts Receivable”
“Off Premises Contents”
“Debris Removal”
And so forth…….
13
Balancing Capture of Complete Information with Accuracy of Measurement
Rating Factors to Normalize - Basic Property Example
Which coverage factors should be normalized? Examine the rating algorithm and classify each factor:
Generally normalize those that give or take real coverage, such as:
Increased limits factors, Deductibles, Wind Exclusions, Exposures
Not those that reflect real exposure to loss characteristic of the risk, such as:
Territory, Class
Not those that are used to achieve target pricing, such as:
IRPM, Schedule Rating
Then make a decision on the gray areas:
Mold/Lead/Terrorism exclusions, Dispersion credits, Experience
Expense reduction, Commission contribution, Loss free discount
rating,
14
Calculating a Normalized Renewal Rate Change - Basic Formula
Assume the “expiring coverage” approach (and decide to normalize based on expiring or current rates)
Define a “normalizing factor” for each coverage
Expiring factor/Renewal factor (example: Expiring ILF/Renewal ILF)
A robust and automated approach to renewal price change is then:
Normalized Renewal Rate/Expiring Rate =
(Normalized Renewal Premium/Renewal Exposure)
(Expiring Premium/Expiring Exposure)
Where:
Normalized Renewal Premium=Charged Renewal Premium × Normalizing Factor
15
Price Monitoring and the Quote/Issuance Renewal Cycle
Step in the process
Real Time
Option
Batch
Option
Prices
Measured When?
Business is
quoted by
underwriter
(not issued)
Monthly quotes
are issued to
agents/insureds
Quarterly
reviews of
business
performed
Practical Opportunity to Act
On Price Monitoring
Can influence underwriters
to change quotes before
issuance
Can react to influence
next months quotes
Can react a quarter in
arrears to influence prices
or just use to set ELR’s
16
Introducing Brian Hughes,
Break for Brian’s Presentation
© 2004 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A. 27365atl.
KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.
17
Price Monitoring in Situations that are not Straightforward - Examples
•Example 1: Excess Casualty (Re)insurance
– Use benchmark approach
– Establish pricing model, with pricing parameters such as LDF’s, excess factors, even manual rating built in
– Measure new and renewal business as a percentage of manual
•
Example 2: Excess Property (Re)insurance
– Examine CAT models to determine expected loss
– Measure price to expected loss benchmark
– Don’t forget risk margin
•
Inland Marine or Other Judgment Rated Risks
– Measure benchmarks to schedule of ELP’s
18
Driving Price by Segment-Mainstreet Commercial Example
1. Analyze book
of business by
overall rate
need and
by meaningful
segment
2. Divide the book
into a manageable
number of
segments (stratify
into A,B,C, for
example)
3. Get agreement on
the price need by
larger segments
4. Set up
segmentation
model to drive price
achievement by
segment, and
communicate to all
underwriters
5. Monitor, Measure, Report Deviations
Drive Underwriting Quality Throughout the Process
19
Segmentation Approaches – Understand the Business
•Understand internal experience
•Understand market experience
– Suggest at collected level, not manual
– If performing Premium on Level, must account for discretionary price changes
•Understand market rate adequacy
– Again at collected premiums, not manual
– Rating Bureaus can be a decent source for this information
20
How are the Segments Defined?
•Meaningful segments that company/underwriters manage
•Common Examples
– NAICS code
– Class code
– Program
– Geographical region
– Size of risk
– Combination of the above
21
Business Drivers – Set Specific Targets
Price change on renewals
Price on new business to benchmarks
Renewal retention desired
Underwriting approach
22
Basic Implementation Model for Segmented Pricing Targets
A
Classes
Starting Position.
(1) Proportion of the book
(2) Loss and ALAE Ratio with no rate change
(3) Rate change on renewals
(4) Loss and ALAE ratio on new business (drive same price
as renewal, but assume loss ratio is 5% worse)
(5) Net loss/exposure trend
(6) Assumed unit count retention ratio
(7) Resulting premium retention
(8) New business as percent of expiring premium
(9)
(10)
(11)
(12)
Position after one year.
Resulting premium growth
Resulting distribution of business
Resulting loss and ALAE ratio on renewals
Resulting overall loss and ALAE ratio
B
Classes
C
Classes
Total
Book
29.0%
52.0%
46.0%
69.0%
25.0%
119.0%
100.0%
76.6%
10.0%
25.0%
50.0%
20.8%
51.8%
1.5%
90.0%
99.0%
40.0%
59.2%
1.5%
70.0%
87.5%
35.0%
82.7%
1.5%
20.0%
30.0%
0.0%
56.1%
1.5%
63.3%
76.5%
27.7%
39.0%
38.7%
48.0%
49.1%
22.5%
54.1%
56.0%
56.9%
-70.0%
7.2%
80.5%
80.5%
4.2%
100.0%
54.7%
55.1%
(13) Renewal experience if rate change alone were applied=
(14) Renewal Loss and ALAE ratio better due to segmentation strategy by
64.3%
9.7%
23
Sample Action Grid for Underwriters and/or Agents
Underwriters Targets for XXX Line of Business
Class Group
A
B
C
Retention
90%
70%
20%
Renewal Price Change
+10%
+25%
+50%
New Business Appetite
Aggressively Seek
Open
None
Target % of Manual
Rate
90%
100%
125%
24
Sample Appetite Guide
Class Group
Offices
Services
BuildingOwners
Light Manufacturing
Contracting
Wholesalers-Durable Goods
Office Condo
Residential Condos
Line of
Business I
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
Line of Business II Line of
Business III
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
Shopping Centers
Churches
Clubs
Hotels
Restaurants
Retail-not separately listed
Listed Retail Classes
Auto Services
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
A or B or C
25