RATEMAKING AND REGULATION

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RATEMAKING AND REGULATION

• Charles Bryan

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TYPES OF RATEMAKING

• Based on as many statistics as are available
• Types of ratemaking
• Judgmental
• Underwriters play key role
• Used for large and unusual risks such as bridges
  and tunnels, special events, and so on
• Class rating
• Sufficient statistics to separate risks into a
  number of classes
• Underwriters determine the definition of a class
  and into what class a risk goes
• Actuaries use loss statistics to determine the
  necessary rate to charge
• 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 losses per exposure and 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
• 600/.80 750
• 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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GOVERNMENT REGULATION

• Insurance is a regulated industry
• Insurance is primarily regulated by the states
• In Ohio, the principal regulatory agency is the
  Ohio Department of Insurance
• Rates
• Forms (policies)
• Agent licensing
• Complaints
• Financial
• Premium tax

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Reasons For Government Regulation

• Insurer Solvency
• Analysis and Evaluation of financial statements-
  yellow book
• Minimum capital required
• Risk based capital
• Compensation for inadequate consumer knowledge
• Buying guides
• Complaints
• Reasonable rates
• Not inadequate
• Not unfairly discriminatory
• Class rating
• Credit rating
• Insurance availability

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History of Insurance Regulation

• Creation of insurance commissions in 1850s
• Paul vs. Virginia (1868) insurance is not
  interstate commerce and the states rather than
  the federal government should regulate insurance
• South Eastern Underwriters (1944) insurance is
  interstate commerce and is subject to regulation
  by the Federal government
• McCarran Ferguson Act (1945) continued state
  regulation rather than federal regulation is in
  the public interest
• Financial Modernization Act (1999) different
  types of financial institutions can be combined
  under the same umbrella organization

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Areas of Regulation

• Formation and Licensing of Insurers
• Solvency
• Separate financial statements using statutory
  accounting
• Surplus difference between assets and
  liabilities
• Risk based capital
• Primary means for measuring required surplus
• Risk charge for each element of an insurers
  balance sheet
• Financial examiners
• Investments
• Limited types of investment vehicles in which
  insurers can invest and the asset can be admitted
  for solvency purposes
• Life insurers mostly real estate
• Property-casualty insurers mostly non-taxable
  bonds

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Areas of Regulation Contd

• Rate regulation
• Prior approval
• Modified prior approval
• File and use
• Use and file
• Flex rating
• State made rates
• Open competition
• Agent licensing
• Agents must be licensed by the state and
  appointed by companies
• Examinations
• Complaints against agents

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Current Issues in state regulation

• Bid rigging
• Through a broker, companies secretly agree on a
  price to be offered to the insured company
• Violations of federal and state regulations on
  anti trust market allocation issue
• Example Marsh contacted its companies to protect
  renewals and told competitive companies to offer
  a price higher than the current company was
  offering a renewal
• Questionable accounting practices
• Taking credit for reinsurance when no transfer of
  risk occurred
• General Re- AIG Issue
• CEO of AIG and CEO of General RE forced out
• Criminal indictments

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Federal vs. State Regulation

• Many companies would prefer federal regulation to
  state regulation
• No rate regulation
• Only solvency regulation
• Countrywide rather than state by state
• Repeal of McCarran Ferguson
• Optional Federal charter
• Precedent in savings institutions
• Company would choose
• Other proposals