Actuarial Notes

Statement of Principles Regarding Property and Casualty Insurance Ratemaking

By Casualty Actuarial Society · 1988

Study guide: Exam 5

The CAS statement identifying and describing the principles that apply to the determination and review of property and casualty insurance rates. Adopted by the CAS Board of Directors in May 1988, it is limited to the part of ratemaking that estimates the costs associated with the transfer of risk, and consists of four parts: definitions, principles, considerations and a conclusion. The Board rescinded it in December 2020 and reinstated it in May 2021, for reference for U.S.-regulated ratemaking.

On the syllabus

  • Exam 5 — objectives A4 and A16; the statement of May 1988.

I Definitions

  • Ratemaking is the process of establishing rates used in insurance or other risk transfer mechanisms; the Statement is limited to the estimation of future costs — claims, claim settlement expenses, operational and administrative expenses, and the cost of capital.
  • The costs are summarised as incurred losses; allocated and unallocated loss adjustment expenses; commission and brokerage; other acquisition expenses; taxes, licenses and fees; policyholder dividends; and general administrative expenses.
  • The underwriting profit and contingency provisions are the amounts that, considered with net investment and other income, provide an appropriate total after-tax return.

II Principles

  • Ratemaking is prospective because the rate must be developed prior to the transfer of risk.
  • 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 — so that the insurance system is financially sound.
  • Principle 3: a rate provides for the costs associated with an individual risk transfer — so that equity among insureds is maintained; when an individual risk's experience is not a credible basis, the aggregate experience of similar risks may be considered.
  • 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.
  • Cost estimates based on Principles 1, 2 and 3 are actuarially sound, and comply with the four criteria commonly used by actuaries: reasonable, not excessive, not inadequate, and not unfairly discriminatory.

III Considerations

  • Regardless of the methodology, material assumptions should be documented and available for disclosure; the actuary need not be completely bound by precedent.
  • Exposure Unit
    • The exposure unit should vary with the hazard and be practical and verifiable.
  • Data
  • Organization of Data
  • Homogeneity
  • Credibility
    • Credibility is a measure of the predictive value the actuary attaches to a body of data; each situation requires balancing homogeneity and the volume of data.
  • Loss Development
  • Trends
  • Catastrophes
  • Policy Provisions
  • Mix of Business
  • Reinsurance
  • Operational Changes
  • Other Influences
  • Classification Plans
  • Individual Risk Rating
    • When an individual risk's experience is sufficiently credible, its premium should be modified to reflect that experience.
  • Risk
    • The rate should include a charge for the risk of random variation from expected costs, reflected in the underwriting profit provision, and a charge for systematic variation of estimated from expected costs, reflected in the contingency provision.
  • Investment and Other Income
  • Actuarial Judgment

IV Conclusion

  • By applying the principles, the actuary derives an estimate of the future costs associated with the transfer of risk; other business considerations are also part of ratemaking, and through interaction with underwriting, marketing, law, claims and finance the actuary has a key role in the process.

Sources