Introduction to Case Study #3: “The

Case Study #3
This case study revolves around “large account pricing” for commercial insurance. For
many lines of P&C insurance, actuaries determine what rates should be charged average
members of homogeneous groups based on similar characteristics; this is referred to as
manual ratemaking. [CAS Basic Ratemaking, Werner and Modlin] In Basic Ratemaking,
Werner and Modlin discuss adjustments that are often needed for commercial lines
For many commercial insurance products, the creation of homogenous
groups for ratemaking purposes is not feasible, and without adjustment,
individual risk experience can be expected to vary widely around the
average group rate. In addition, some commercial risks are sufficiently
large that their historical experience can be used in whole or in part to
derive an individual rate. Consequently, commercial lines ratemaking
employs special techniques that address the heterogeneity and credibility
of commercial risks.
In large account pricing often uses the individual entity’s own experience as the basis for
determining the premium to be charged, supplementing it to the extent necessary with
industry or other collateral data. Rates for large accounts are largely unregulated, as the
buyer is usually assumed to be sophisticated and knowledgeable enough not to need
“consumer protection”.
The expense loads also often vary from manual ratemaking, because loss control, claims
management, or other risk management services are often part of the insurance solution
offered to the entity or are performed by the entity itself. To a much greater extent than in
other ratemaking work, the choice of data used in large account pricing and the types of
adjustments made to that data are left to actuarial judgment.
The insured entity often employs its own risk manager (who may or may not have an
actuarial background) or contracts for the services of one through an insurance brokerage
firm. As part of the insurance purchasing process, the risk manager or broker may want to
negotiate the data and/or methodological choices made by the pricing actuary. He or she
may also hire or contract another actuary to perform a similar study with the same data to
compare and contrast it with the work of the insurance company’s actuary. Thus, the
professionalism of both the insurance company pricing actuary as well as the independent
actuary becomes integral to the business process, potentially giving rise to situations such
as the one in this case study.
Case Study #3
Page 1
You are responsible for pricing a large and profitable General Liability renewal that your
company, The Feelings Mutual Insurance Company (the Company), has written for five
years. The final price quote will be the responsibility of your boss, the Chief
Underwriting Officer (CUO). The risk is primarily Premise and Operations and is written
within a Comprehensive General Liability policy with a policy limit of $1 million. Your
company also writes a $10 million limit Umbrella policy for this insured, which has been
loss free.
The insured, Ronnell McDonnell Douglass (RMD), is represented by their Risk Manager,
who has a number of (non-actuarial) insurance designations and considers himself to be
very knowledgeable about insurance pricing. Every year the Risk Manager reminds you
that he believes your price is too high. You know he has stayed with the Company
because of your top-notch loss control and claims services, but you are not certain of the
dollar value he puts on these services.
You develop the basic limit portion of the rate for RMD’s primary policy (i.e., the $1
million limits policy) based on RMD’s own claims and exposure experience. Because
RMD’s excess loss experience is not credible, you determine the price for the excess
policy by multiplying the rate underlying the primary policy by the appropriate rating
bureau increased limits factor (ILF) for the layer $10 million excess $1 million, which is
consistent with the Company’s published internal procedures.
The Risk Manager insists that the rating bureau ILF is not appropriate for RMD. He goes
on to say that RMD is a “frequency” risk with minimal “severity” potential, where the
rating bureau data includes both frequency and severity risks. He supports this statement
by referring to RMD’s actual loss experience, and insists that the one large loss RMD had
was simply poor luck and should not happen again. To exacerbate the situation, the
indicated rate has increased 10% this year because you increased your underwriting profit
requirements to reflect the sustained environment of weak interest rates; your overall
target ROE, as established by senior management, has not changed.
The Risk Manager states that a competitor, The Fly Bye Night Insurance Company (Fly
Bye Night), who has taken many of your better risks and seems to be targeting your book,
has quoted a price 25% below the quoted renewal price for the total account at the same
coverage terms. He goes on to say that Fly Bye Night has used the same interest rate
assumption in pricing that you used last year (which is three points higher than your
current value), and Fly Bye Night used RMD’s actual large loss experience in
Case Study #3
Page 2
determining their quoted price. He feels this proves that he is right about the rating
bureau ILF’s and you are wrong.
The Risk Manager says the Company will lose the account, including the Umbrella, if
you do not lower the price to meet Fly Bye Night’s quote. If you are submitting the
pricing suggestion to the CUO, what pricing suggestion do you make?
1. What are the issues relating to Standards of Practice?
2. What alternatives are open to you and your company?
3. What actuarial guides, standards or principles apply here?
4. What action would you take?
Facilitators’ topics to address:
General Approach
If asked, suggest to the Group, that the impact of the change in your interest rate
assumption is approximately 10%. In other words, without this change there would be no
change in the indicated rate.
The difficulty if this situation is that you have a responsibility to your Company to make
the best business decision possible, under the circumstances, and you also have a
responsibility to perform your actuarial duties in a manner consistent with the standards
of your Actuarial Standards Board. In theory these two responsibilities do not conflict,
but they might in practice.
What are the issues?
Issues are similar to some extent as that noted for Case Study #2 – in Canada, there is the
issue of best estimates (see notes from prior case study) – important issue of when acting
(and calculating) as an actuary and when making business decisions – documentation is
absolutely critical
a. What is a reasonable range of rates? This can only be determined by
performing a sensitivity analysis, using a reasonable range of values for each
parameter. The focus of the discussion should be on how to determine a
reasonable range and what do to if the competitor’s rate is outside this range.
b. Can you justify using the same interest rate that was used last year?
c. Can you justify deviating from the rating bureau ILFs
iii) in general?
iv) for this insured?
d. How do you measure excess loss credibility?
e. What if you believe it is reasonable to deviate from the rating bureau ILFs in
this situation, even though Company policy does not condone it? What is the
expected ROE if you meet your competitor’s quote (25% below expiring)? Is
this an acceptable result to your Company for this risk?
f. Should the profitability of the umbrella policy affect your estimate of a
reasonable range of rates?
g. Are you permitted to make a “business decision”?
What alternatives are open to you?
Some alternatives from a business perspective are:
i. stick to your guns.
ii. offer to compromise at the expiring rate.
iii. meet the competitor’s quote.
iv. offer the minimum rate you would be comfortable with, based on a
sensitivity analysis.
Which of these alternatives are supportable from an actuarial perspective?
What actuarial guides, standards, or principles apply here?
CAS Code of Professional Conduct/CIA Rules of Professional Conduct
Rules/Code of Professional Conduct (CIA Rule/CAS Precept):
Professional Integrity (Rule 1/Precept 1)
Qualifications Standards (Rule 2/Precept 2)
Standards of Practice (Rule 3/Precept 3)
Disclosure (Rule 4/Precept 4)
Conflict of Interest (Rule 5/Precept 7)
Control of Work Product (Rule 6/Precept 8)
Confidentiality (Rule 7/Precept 9)
Courtesy and Cooperation (Rule 8/Precept 10)
Advertising (Rule 9/Precept 11)
Titles and Designations (Rule 10/Precept 12)
Collateral Obligations (Rules 11, 12, 13)
CIA Standards of Practice 2600 Ratemaking: Property/Casualty Insurance
The actuary should select appropriate methods, techniques and assumptions
recognizing that such elements depend on the circumstances of the case and that a
variety of actuarial methods may be appropriate to derive an indicated rate.”
CAS Statement of Principals Regarding Property and Casualty Insurance Ratemaking:
Principle 1: A rate is an estimate of the expected value of future costs
Principle 2: A rate provides for all costs associated with the transfer of risk.
When the experience of an individual risk does not provide a credible basis for estimating
these costs, it is appropriate to consider the aggregate experience of similar risks.
Principle 4: A rate is reasonable and not excessive, inadequate, or unfairly discriminatory
if it is an actuarially sound estimate of the expected value of all future costs associated
with an individual risk transfer.
Considerations: Individual Risk Rating – When an individual risk’s experience is
sufficiently credible, the premium for that risk should be modified to reflect the
individual experience. Consideration should be given to the impact of individual risk
rating plans on the overall experience.
CIA Standards of Practice – 1000 General Standards and 2000 Standards of Practice –
Practice-Specific Standards for Insurance
The Standards apply in all situations and some with particular relevance to this case
1500 – The work
 1510 Approximation
 1530 Data
 1560 Documentation
1700 – Assumptions
o 1720 Selection of assumptions
o 1730 Appropriate assumptions
1800 – Reporting
What action would you take?
There are a couple of possibilities:
a. Does your “reasonable range of rates” include the competitor’s quote? If so,
perhaps you can justify, from an actuarial perspective, lowering your price.
b. You might discuss the possibility of a “business decision” to lower your price
with a superior. Your responsibility is to clearly document your work, the
resulting indicated rate, and the range of reasonable rates. You are also
responsible for communicating these results to all involved individuals in your
Company, along with your estimate of expected profitability at the indicated
rate versus the competitor’s quoted rate. This does not preclude the
possibility of a business decision to meet the competitor’s quote, although
your role and input into such a decision should be documented, especially if
you disagree with the decision from an actuarial perspective.