Chapter 3 - ACTSC 363 Chapter 3 Ratemaking 3.1 Introduction...

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ACTSC 363 Chapter 3 Ratemaking 3.1 Introduction 3.2 Objectives of Ratemaking 3.2.1a Essential Objectives of Ratemaking - Rates must cover the costs (expected losses and expenses) - Take advantage of ability to earn investment income ie vt btwn the time you receive premium and pay the benefits - Each cohort of policy holders pay its own way - There should be no subsidies across generations or across risk classifications - Insurance is priced prospectively – set rate now to cover future risks of the policyholder; if incur losses, insurer has to pay - If a policy holder has a pure accidental loss, there is no way to recapture that money given that characteristics of policyholder do not change. Use subsidies to recover losses. Ex: waterloo policyholders are making a lot of losses, charge Toronto block a higher premium to cover losses. - If risk profile doesn’t change, you can’t hike up prem next yr b/c ppl can’t afford it and there is competition. If another company doesn’t incur these loses, that company continues to charge at a lower rate and you will lose your business to them. - You must cover the ultimate cost = expected value of cost to the insurance company of having that policyholder (not able to calculate right away). Estimate for each generation of policyholder or book of business the expected value of costs. - Strategy: selling at a loss to gain market share (losses will be funded by shareholder’s money) 3.2.1b Essential Objectives of Ratemaking - every once in a while, you will have a really bad event (ie hailstorm, flood, hurricane), these are low frequency events. - Need to produce rates that make adequate provision for contingencies (since we cannot raise prem and cut it afterwards) - May run into friction with the government (tax authorities) as insurers try to set a prudent level of reserves for contingencies, known as actuarial reserves. Actuarial reserves are not taxed. Tax authorities will then question whether reserve funds are too high and money is simply put aside to evade tax payments. 3.2.1c Essential Objectives of Ratemaking - use rates to provide economic incentives for the policyholders to do the right thing to encourage loss control ex: good driving record discount, alarms, sprinkler systems - loss control may impact frequency and/or severity 3.2.1d Essential Objectives of Ratemaking - must satisfy rate regulatory agencies (ie rate review board) - will require actuarial evidence proving rates are based on experience/ loss records - rates must be adequate – why would a government keep insurance rates up? To prevent bankruptcies and orphaned policyholders - government need to make sure insurer is solvent - rates must not be excessive - rates must be not unfairly discriminatory - Discrimination: to differentiate b/c of distinctive features o ex: different life insurance based on age, sex and marital status o Problem: should young males get charged more for car insurance o Statistics show that married males used to pay less than single males (this was once allowed in Ontario)
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Chapter 3 - ACTSC 363 Chapter 3 Ratemaking 3.1 Introduction...

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