Actuarial Notes

State Rating Laws

Study guide: Exam DISC-IA

State Rating Laws are the statutes under which each U.S. state regulates property and casualty insurance rates: they hold every rate to the standard that it be not excessive, not inadequate and not unfairly discriminatory, and they set the filing method that decides whether an insurer may use a rate before the insurance department has reviewed it. The method ranges from state-made rates and prior approval, through file and use and use and file, to no filing at all, and it can differ by line within one state. The Canadian counterpart is Rate Regulation.

R = m \cdot LC + e

\text{Flex rating: prior approval needed} \iff |\Delta R| > b

  • Symbols: Under the NAIC's model rating laws an insurer may file its final rates, or file a multiplier m and, if applicable, an expense constant e to apply to the prospective loss cost LC that an advisory organization has filed for it, giving the rate R. In the second line, \Delta R is a proposed change in rates as a percentage of the rates on file and b is the state's flex band.
  • The three standards: Rates shall not be excessive, inadequate or unfairly discriminatory. In the NAIC's file and use model, a rate in a competitive market is not excessive, and in a noncompetitive market it is excessive if it is likely to produce a profit unreasonably high for the insurance provided or if expenses are unreasonably high for the services rendered. A rate is inadequate if it is clearly insufficient to sustain projected losses, expenses and special assessments, and, in the model, its use substantially lessens competition or tends to create a monopoly (an optional version ties inadequacy to endangering the insurer's solvency instead). Unfair discrimination exists if, after allowing for practical limitations, price differences fail to reflect equitably the differences in expected losses and expenses.
  • What a rate must consider: Past and prospective loss experience within and outside the state, catastrophe hazards, a reasonable margin for profit and contingencies with all investment income on the line taken into account, dividends to policyholders, and expenses. Risks may be grouped in classifications by any difference shown to have a probable effect on losses or expenses, but no classification may be based on race, creed, national origin or religion. The actuarial version of the same test is that a rate meets all three standards if it is an actuarially sound estimate of the expected value of all future costs of the risk transfer.
  • Prior approval: Rates must be filed with and approved by the insurance department before use. Approval can come through a deemer provision, under which a filing is approved unless denied within a set number of days; existing state waiting periods range from 15 to 90 days. Modified prior approval requires approval only for changes in the expense ratio or rate relativities, while changes based on experience alone are file and use.
  • Flex rating: Prior approval is required only for a change of more than a set percentage above, and sometimes below, the rates on file. Oregon, for example, applies flex rating to commercial casualty with a 15% band.
  • File and use, use and file, no file: Under file and use rates are filed before use, without waiting for approval, and the department may disapprove them later. Under use and file they are filed within a set period after they take effect. Under no file they need not be filed at all, but the insurer keeps the experience and other information behind them for the commissioner. States call the competitive systems by different names: Colorado regulates most lines by "open competition", with rates filed and used unless the commissioner finds them excessive or destructive of solvency.
  • State-made and bureau rates: At the other extreme the state sets the rate. The Texas commissioner sets title insurance rates and the Florida department sets title rates. In North Carolina residential property, private passenger auto and workers compensation rates are filed by a rate bureau for prior approval.
  • One state, several methods: The method often depends on the line. Alabama uses prior approval for personal lines, workers compensation and medical malpractice, file and use for other commercial lines, and prior approval again for any filing seeking an overall increase of 10% or more. The NAIC's chart of rate filing methods (PA-10) records each state's rules by line.

Which Filings Need Approval First? In Oregon, commercial casualty rates are under flex rating with a 15% band, workers compensation rates need prior approval (30 days), and other property and casualty lines are file and use. An insurer plans: (1) a 9% increase in commercial general liability, (2) an 18% decrease in general liability rates for contractors, (3) a 4% workers compensation increase, and (4) a 12% homeowners increase. Which need prior approval?

Answer

  1. No. Commercial casualty, and 9% is inside the 15% band.
  2. Yes. Oregon's band applies to decreases as well as increases, and 18% exceeds it.
  3. Yes. Workers compensation needs prior approval however small the change.
  4. No. Homeowners is file and use: the insurer files and may use the rate, though the department can still disapprove it.

Testing Rates Against the Standards Under a statute worded like Florida's, which standard does each of these fail?

  1. A rate plan, with investment income counted, is clearly insufficient to sustain projected losses and expenses in the class.

  2. A discount far larger than the expense savings and expected loss experience of the discounted risks justify.

  3. A surcharge that bears no reasonable relationship to the expected loss and expense experience of the surcharged risks.

  4. In a noncompetitive market, rates likely to produce an unreasonably high profit for the risk involved.

Answer

  1. Inadequate.
  2. Inadequate as to the premium charged the discounted risks, because the discount exceeds what their expenses and losses justify.
  3. Unfairly discriminatory, because the surcharge doesn't track differences in expected losses and expenses.
  4. Excessive. Under the NAIC file and use model a rate in a competitive market is not excessive, so this test bites only where the market is not competitive.

A Loss Cost Filing An advisory organization files a prospective loss cost of $400 for a class. An insurer files a multiplier of 1.40 and an expense constant of $25. What rate does the insurer charge for the class?

Answer

\begin{align*}
R &= 1.40 \times 400 + 25 \\
&= 585
\end{align*}

The advisory organization supplies the loss cost, and the insurer's own multiplier and expense constant load it for the insurer's expenses and profit. The filing must also show the insurer's reasons for using the advisory organization's figures if the commissioner asks.

How it appears on the exam

  • DISC-IA: The Insurance Regulation section asks how states regulate insurance rates: the three rate standards and the types of rating law, from state-made rates and prior approval to file and use, use and file, flex rating and open competition.
  • Applied questions: A question describes a state's law and a proposed filing and asks whether it needs approval before use, or describes a rate and asks which standard it fails, as in the first two examples.
  • Related objectives: Rate filings travel with form filings (Policy Form Regulation), and rate adequacy is a solvency concern (Solvency Monitoring).

Exam traps

  • File and use is not use and file: File and use files before the rate is used; use and file files after. Neither waits for approval.
  • A deemer is still prior approval: A prior approval filing that is not denied within the deemer period is treated as approved, but it may not be used before then.
  • Flex bands are two-sided in some states: A large decrease can need prior approval as well as a large increase.
  • Inadequate means too low: A rate that will not cover expected losses and expenses fails the inadequacy standard, however much it helps buyers today.
  • Discrimination is not the problem, unfair discrimination is: Rates may differ by classification wherever the difference reflects expected losses and expenses. They may never be based on race, creed, national origin or religion.