CAS Exam 9 Spring 2019, Question 15
Study guide: Exam 9
Consider the following information for two insurance companies that write private passenger automobile business in the same state:
| Company A | Company B | |
|---|---|---|
| Lines of business | Monoline auto | Multiline |
| Writes business in | Single state | Multistate |
| 2017 written premium (millions) | $24 | $825 |
| 2018 written premium (millions) | $45 | $813 |
| Premium-to-surplus ratio | 3:1 | 1.5:1 |
| Policy premium | $1,000 | $1,000 |
| Expected loss ratio | 65% | 70% |
| Expense ratio | 30% | 28% |
| Investment yield | 5% | 6% |
For both companies:
- Premium is collected at policy inception
- Expenses are paid in the middle of the first year
- Losses will be paid at the end of each year according to the following pattern:
| Year 1 | Year 2 | Year 3 |
|---|---|---|
| 50% | 35% | 15% |
- The overall market return is 7%
- The risk-free rate is 4%
- Ignore taxes
Part a (1 point)
For Company A, calculate the expected opportunity cost to an insured.
Part b (0.5 points)
Identify and briefly describe whether Company A's expected operating profit from writing this policy should be more or less than the expected opportunity cost to the insured in part a. above.
Part c (1.5 points)
The state's rate regulator is proposing to implement a benchmark return-on-equity that all companies must use in their ratemaking, where return is to be calculated by discounting all expected underwriting cash flows using each company's own investment return rate. Fully describe two reasons why this proposal does not constitute equitable rate regulation.
Part d (0.5 points)
Identify an alternative basis for rate regulation and briefly explain why it is preferable to the proposal in part c. above.
No current syllabus covers this question; it is kept for the record.
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