Actuarial Notes

Short Term Disability Example

By Kristi Bohn · Society of Actuaries · 2020 · CP321-102-25

Study guide: Exam CP-321

A Society of Actuaries study note giving an example of mathematical calculations related to short term disability insurance. It evaluates the profitability of an insurer's short term disability block of business in order to reset the manual rate structure, including base rates and factors, and then uses the new manual rates, combined with experience, to underwrite a group.

On the syllabus

Introduction

  • A highly simplified example: the insurer offers one short term disability plan design, marketed to small employers (groups with 100 or fewer employees), with no experience rating or credibility assigned to any employer's own experience.
  • The rating factors are not normalized to 1.00; normalization takes place in the base rate, so the base rate is not an average rate.
  • Claim trend is assumed to be 0%; disability premiums are generally based on rate schedules whose unit of exposure is salary dollars, so premiums increase with wage inflation even though rates may not change.
  • The reader is the actuary determining in 2019 the base rate and rating adjustments for 2020, from the assumptions and rating methods used for 2018 and 2019.

Rating Factors

  • Retention
  • Group Size Premium Adjustment
  • Industry Premium Adjustment
  • Age/Gender Premium Adjustment

2018 Experience

  • Premiums and Expenses
  • Premiums and Claims by Group Size
  • Premiums and Claims by Age/Gender
  • Premiums and Claims by Area
  • Premiums and Claims by Industry
  • Premium and Claims by Contribution and Participation

Part a: 2018 Profit and Experience against the Pricing Assumptions

  • Profit = Premium – Incurred Claims – Expenses from all sources, which comes to $(80,000) in the example.
  • Incurred claims exceeded the target by $500,000, equal to the entire risk and profit margin, and administration costs were 10% higher than expected.

Part b: New Retention, Base Rate Increase and Rating Factors for 2020

  • Full credibility is given to 2018 claims and expense experience for the base rate and retention; the rating factors give 67% weight to the prior factors and 33% to 2018 experience.
    1. Retention and base rate increase (%)
    • The base rate increases by 8% to satisfy the revised retention schedule for 2020.
    • The actuary should not presume that experience revises the target loss ratio for the product.
    1. Age/Gender
    1. Area
    1. Group size
    1. Industry
    1. Contribution and Employee Participation

Part c: Renewal Increase for a Midwest Medical Clinic

  • Renewal increase = base rate change x any factor changes – 1; the example's result for the clinic is a 32.5% increase.

Rating Factor Discrimination Concerns

  • A regulator might request information on conjoint experience to ensure that the experience from one factor has not already been taken into account through other rating factors, so that claims experience is not counted against one class of consumers more than once.

Sources