AUTO INSURANCE AND SOCIETY

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AUTO INSURANCE AND SOCIETY
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COMPENSATING AUTO ACCIDENT VICTIMS

• Compulsory Insurance Laws
• Every licensed driver must have auto liability
  insurance to operate a vehicle
  
• Physical Damage is not required
• Enforcement Issue
• In many states, 10 or more of the drivers do not
  carry insurance
  
• Financial Responsibility Laws
• Proof after the accident or conviction
• Usually moderate amounts such as 25K per person
  and 50K per accident for liability
  
• Unsatisfied Judgment Funds
• Uninsured Motorists Coverage
• No pay- no play
• Uninsured driver cannot sue negligent drivers for
  non-economic damages
  
• No Fault Insurance

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Auto Insurance Plans and Non-Standard Auto
Insurers

• The system must make insurance available to
  everyone qualified to purchase it
  
• Most people purchase insurance in the voluntary
  market from mainline insurers such as State Farm,
  Allstate, GEICO, etc.
  
• For higher risk insureds, there are non-standard
  auto insurers who specialize in this business
  
• Higher rates
• More severe merit rating
• Payment plans
• For insureds that cannot obtain insurance in the
  voluntary market, they can obtain auto insurance
  in the Auto Insurance Plans
  
• Industry run systems for allocating insureds to
  participating companies
  
• Uniform rates, contracts, and payment plans
• Everything else by company

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Restrictions on Rating Variables

• State requirement is that rates cannot be
  inadequate, excessive, or unfairly
  discriminatory
  
• Class rating uses age, sex, marital status, use,
  accident and conviction history, credit score and
  other variables to rate
  
• Actuarial data must support use of these rating
  factors
  
• Statistical connection rather than a causal
  connection
  
• Since auto insurance is at least encouraged to be
  purchased by the state, the state has an interest
  in what rating variables are used
  
• Different restrictions by state

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RATEMAKING
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OBJECTIVES OF RATEMAKING

• Distribute premium charges fairly across all
  risks insured
  
• Provide for appropriate premium to cover losses,
  expenses, and profit
  
• Minimize the change in premium from one period to
  the next to minimize renewal churning (renewal
  to renewal change)
  
• Loss prevention
• Satisfy state regulations and so gain approval
• Not inadequate, excessive, or unfairly
  discriminatory
  
• Others

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TYPES OF RATEMAKING

• Based on as many statistics as are available for
  the type of risk insured
  
• Types of ratemaking
• Judgmental
• Underwriters play key role
• Used for large and unusual risks such as bridges
  and tunnels, special events, and so on
  
• Not statistically based for the most part
• Class rating
• Sufficient statistics to separate risks into a
  number of classes
  
• Young drivers/adult drivers
• Drivers without convictions/ drivers with
  convictions
  
• Business use/pleasure use
• Underwriters determine the definition of a
  class/category and into what class a risk goes
  
• Actuaries use loss statistics to determine the
  necessary rate to charge
  
• Used for the mass market lines auto, homeowners,
  workers compensation
  
• Merit rating
• Schedule rating
• Experience
• Retrospective rating

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KEY TERMINOLOGY

• Exposure one unit of risk to be transferred-e.g.
  one car for one year
  
• Annual premium the amount to be charged for one
  exposure per year
  
• Incurred loss the amount of claims payment
  including all reserves
  
• Pure Premium the expected losses per exposure
  per year incurred loss/exposure
  
• Example the pure premium for one car insured for
  one year is 600
  

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Methods of class ratemakingpure premium

• Pure Premium premium must provide for the
  average insured loss per exposure and then be
  loaded for all expenses, contingencies plus
  profit
• Example 10,000 cars with 6,000,000 in total
  losses expenses at 20 of premium
  
• 6,000,000/10,000 600 pure premium
• 600/.80 750 final premium loaded for losses
• Therefore, premium per car is 750 to cover all
  losses and expenses

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Methods of class ratemakingloss ratio

• Loss ratio incurred losses/ premium
• Permissible loss ratio proportion of premium
  devoted to losses, generally 1- expense ratio
  
• Rate level change incurred loss ratio in
  experience period/ permissible loss ratio
  
• Example for 2007 the loss ratio is 75 and the
  expense ratio is 20
  
• The projected loss ratio is 75 without a rate
  change
  
• The permissible loss ratio is 80- that is, 20
  of the premium is devoted to expenses and 80 is
  devoted to losses
  
• Then the rate change is 75/80-1 .9375 1
  -.0625

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RATEMAKING ISSUES STATISTICS

• Source of the statistics
• Statistical plan
• Defined plan for each class if business
• May be at company level or at industry level
• Economies of scale for a large company
• Insurance Services Office
• National Council on Compensation Insurance

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RATEMAKING ISSUES ADJUSTMENTS

• Estimate of incurred losses
• Loss reserving
• The shorter the tail the better the estimate
• Loss development
• Problems with long tailed lines
• Inflation and Trend
• Losses must be adjusted to the level for the time
  period the rates are in effect
  
• What inflation factor to use
• CPI
• Company data on loss trend changes
• How long a period should the losses be adjusted
  for?
  
• Midpoint of experience period to time when
  average loss will occur
  
• Removal of non-repeating or non-allowed expenses
• Punitive damage awards
• Campaign contributions
• Other

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CASE STUDY RATEMAKING FOR PERSONAL AUTOMOBILE
INSURANCE