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CAS Ratemaking Seminar Price Monitoring - Survival Strategies for a Softening Market March 13,14, 2006. Chris Nyce Senior Manager KPMG LLP. Brian Hughes Senior Vice President Arch Insurance Group. Disclaimer. The views expressed in this presentation are those of the speakers; and

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Chris nyce senior manager kpmg llp

CAS Ratemaking SeminarPrice Monitoring -Survival Strategies for a Softening MarketMarch 13,14, 2006

Chris Nyce

Senior Manager

KPMG LLP

Brian Hughes

Senior Vice President

Arch Insurance Group


Disclaimer

Disclaimer

  • The views expressed in this presentation are those of the speakers; and

  • They are not necessarily the views of the CAS, KPMG, Arch Insurance or any other sponsor of this seminar;

  • Anyone who says otherwise is not only wrong, but is itching for a fight.


Contents for the presentation

Contents for the Presentation


Backdrop 2006 or why measure pricing

Backdrop 2006 or “Why Measure Pricing”?

  • CIAB Pricing Survey shows prices are declining in the last year

  • Yet III shows Industry consolidated ROE at 11% - Marginal even at the height of the cycle; below all industry average every year for past 15 years

  • Conclusion: Company must be better than average to earn a return equivalent to peers in other industries


Historical price changes implied by reported industry results compared to actual results

Historical Price Changes Implied by Reported Industry Results Compared to Actual Results

Note initially reported results stable from 1996-1999, but actual results deteriorated markedly

Rate adequacy changes implied in reported results lag actual by 23%!

Source: AM BEST Aggregates and Averages composite Schd P.


Historical price changes implied by reported industry results compared to actual results1

Historical Price Changes Implied by Reported Industry Results Compared to Actual Results

Similarly for other commercial casualty lines, rate adequacy changes implied by reported results lagged actual adequacy declines by:

CMP - 8.8%

Workers’ Comp - 24.9%

Casualty Re - 46.2%

Source: AM BEST Aggregates and Averages composite Schd P.


Chris nyce senior manager kpmg llp

While Actuarial Approaches Need Improvement - Need Focus also onIntegrating Price Monitoring into a Comprehensive Underwriting Program


What can be done considerations

What Can be Done - Considerations

  • No rate plan is bulletproof

  • Active implementation of that rate plan is key

  • Manual rates can be nearly irrelevant

    • Market rates are key, and manual plans need to include flexibility to achieve clearly articulated targets

  • Underwriters reacting to the market can defeat any rate plan, and often do

  • Achieving profits in a soft market is not easy, it’s hard

    • Average profit levels of insurers, even over a cycle, are below shareholders acceptable levels

  • Generic solutions don’t always work for specialty or excess large lines

    • But there is a way


Risk quality by class

Risk Quality by Class

  • Best solution: Equal rate adequacy in each class

    • But even if manual rates are equally adequate, charged rates may not be

    • Regulation, or filing difficulties may prevent achieving the perfect rate plan

  • Segmentation and tracking price by segment may be necessary

  • Need to consider existing off balances

    • Departures of charged rate from manual (think new vs. renewal)

  • Need to consider emerging threats

    • Mold, CD, Waste, for example


  • Quality of risk within class

    Quality of Risk Within Class

    • Standard underwriting execution is key

      • Reasonable authorities and delegations

      • Data and risk validation

      • Field audit schedules

      • Self audit and management reviews

      • Strong field and home office referral processes

  • Underwriting Audits should include data quality

    • Exposure information, coverage additions if not considered in the price monitor

  • Rating plan refinements may be needed

    • Any recognition of variation of loss cost within a rating segment is candidate for new rating variable

    • If no manual rating differential, needs to be segmented and tracked


  • Discussion of a general approach for standard commercial lines

    Discussion of a General Approach for Standard Commercial Lines

    • Today we will discuss general renewal monitoring

    • New business (to benchmark) can be generalized in an analogous manner

    • Note also that Actuaries are critical to the business management process:


    Chris nyce senior manager kpmg llp

    Standardized Formula for Small Commercial Business - Basic PropertyState the Rate Change at Expiring or Renewing Coverages

    Expiring Coverages

    Renewing Coverages

    Wind

    Deductible

    AOP Extension

    Ordinance

    And Law

    Sprinkler

    Leakage

    Sprinkler

    Leakage

    Package

    Extension

    Package

    Extension

    Group I&II

    Coverage 100K

    Group I&II

    Coverage 100K

    Deductible Buy-

    down to $250

    No Buydown


    Chris nyce senior manager kpmg llp

    Standardized Formula for Small Commercial Business - Basic PropertyState the Rate Change at Expiring or Renewing Coverages

    Expiring Coverages

    Renewing Coverages

    Wind

    Deductible

    AOP Extension

    Ordinance

    And Law

    Option I: Rerate to

    Expiring coverages

    Sprinkler

    Leakage

    Sprinkler

    Leakage

    Benefit: Not “making

    up” expiring premium

    and then measuring

    change from fictional

    premium.

    Package

    Extension

    Package

    Extension

    Group I&II

    Coverage 100K

    Group I&II

    Coverage 100K

    Deductible Buy-

    down to $250

    Deductible Buy-

    down to $250

    Red coverages are rerated, or “normalized”


    Chris nyce senior manager kpmg llp

    Standardized Formula for Small Commercial Business-Basic PropertyState the Rate Change at Expiring or Renewing Coverages

    Expiring Coverages

    Renewing Coverages

    Wind

    Deductible

    Wind

    Deductible

    Option II: Rerate to

    Renewal coverages

    AOP Extension

    AOP Extension

    Ordinance

    And Law

    Ordinance

    And Law

    Benefit: Capturing all renewal coverages, but at the cost of adding fictional coverages to the expiring

    Sprinkler

    Leakage

    Sprinkler

    Leakage

    Package

    Extension

    Package

    Extension

    Group I&II

    Coverage 100K

    Group I&II

    Coverage 100K

    Deductible Buy-

    down to $250

    No Buydown

    Red coverages are rerated, or “normalized”

    Purple coverages are deleted


    Chris nyce senior manager kpmg llp

    Balancing Capture of Complete Information with Accuracy of MeasurementLine of Business and Coverage - Basic Property Example

    • Perform calculations at the coverage level so you can include or exclude coverages depending on renewal status:

    Consider whether to treat each coverage at each location

    as separate calculation, or alternatively “normalize”

    Instead of one

    coverage :

    “Basic Group I-Building”

    “Property Coverage”

    “Basic Group II-Building”

    “Basic Group I-Contents”

    “AOP-Building”

    “Off Premises Power”

    “Basic Group II-Contents”

    “Earth Movement”

    “Adjacent Structures”

    “AOP-Contents”

    “Money and Securities

    “Brands and Labels”

    “Packaged Extension”

    “Fire Dept Charges”

    “Sprinkler Leakage”

    “Ordinance and Law”

    “Accounts Receivable”

    “Off Premises Contents”

    “Debris Removal”

    And so forth…….


    Chris nyce senior manager kpmg llp

    Balancing Capture of Complete Information with Accuracy of MeasurementRating Factors to Normalize - Basic Property Example

    • Which coverage factors should be normalized? Examine the rating algorithm and classify each factor:

    • Generally normalize those that give or take real coverage, such as:

    • Increased limits factors, Deductibles, Wind Exclusions, Exposures

    • Not those that reflect real exposure to loss characteristic of the risk, such as:

    • Territory, Class

    • Not those that are used to achieve target pricing, such as:

    • IRPM, Schedule Rating

    • Then make a decision on the gray areas:

    • Mold/Lead/Terrorism exclusions, Dispersion credits, Experience rating, Expense reduction, Commission contribution, Loss free discount


    Calculating a normalized renewal rate change basic formula

    Calculating a Normalized Renewal Rate Change - Basic Formula

    • Assume the “expiring coverage” approach (and decide to normalize based on expiring or current rates)

    • Define a “normalizing factor” for each coverage

    • Expiring factor/Renewal factor (example: Expiring ILF/Renewal ILF)

    • A robust and automated approach to renewal price change is then:

    Normalized Renewal Rate/Expiring Rate =

    (Normalized Renewal Premium/Renewal Exposure)

    (Expiring Premium/Expiring Exposure)

    • Where:

    Normalized Renewal Premium=Charged Renewal Premium × Normalizing Factor


    Price monitoring and the quote issuance renewal cycle

    Business is

    quoted by

    underwriter

    (not issued)

    Monthly quotes

    are issued to

    agents/insureds

    Quarterly

    reviews of

    business

    performed

    Price Monitoring and the Quote/Issuance Renewal Cycle

    Step in the process

    Practical Opportunity to Act

    On Price Monitoring

    Prices

    Measured When?

    Real Time

    Option

    Can influence underwriters

    to change quotes before

    issuance

    Batch

    Option

    Can react to influence

    next months quotes

    Can react a quarter in

    arrears to influence prices

    or just use to set ELR’s


    Introducing brian hughes

    Introducing Brian Hughes,

    Break for Brian’s Presentation


    Price monitoring in situations that are not straightforward examples

    Price Monitoring in Situations that are not Straightforward - Examples

    • Example 1: Excess Casualty (Re)insurance

      • Use benchmark approach

      • Establish pricing model, with pricing parameters such as LDF’s, excess factors, even manual rating built in

      • Measure new and renewal business as a percentage of manual

    • Example 2: Excess Property (Re)insurance

      • Examine CAT models to determine expected loss

      • Measure price to expected loss benchmark

      • Don’t forget risk margin

    • Inland Marine or Other Judgment Rated Risks

      • Measure benchmarks to schedule of ELP’s


    Driving price by segment

    Driving Price by Segment

    2. Divide the book into a manageable number of segments (stratify into A,B,C, for example)

    1. Analyze book

    of business by

    overall rate

    need and

    by meaningful

    segment

    3. Get agreement on the price need by larger segments

    4. Set up segmentation model to drive price achievement by segment, and communicate to all underwriters

    5. Monitor, Measure, Report Deviations

    Drive Underwriting Quality Throughout the Process


    Segmentation approaches understand the business

    Segmentation Approaches – Understand the Business

    • Understand internal experience

    • Understand market experience

      • Suggest at collected level, not manual

      • If performing Premium on Level, must account for discretionary price changes

  • Understand market rate adequacy

    • Again at collected premiums, not manual

    • Rating Bureaus can be a decent source for this information


  • How are the segments defined

    How are the Segments Defined?

    • Meaningful segments that company/underwriters manage

    • Common Examples

      • NAICS code

      • Class code

      • Program

      • Geographical region

      • Size of risk

      • Combination of the above


    Business drivers set specific targets

    Business Drivers – Set Specific Targets

    • Price change on renewals

    • Price on new business to benchmarks

    • Renewal retention desired

    • Underwriting approach


    Chris nyce senior manager kpmg llp

    Basic Implementation Model for Segmented Pricing Targets


    Sample action grid for underwriters and or agents

    Sample Action Grid for Underwriters and/or Agents


    Chris nyce senior manager kpmg llp

    Sample Appetite Guide


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