Thinking about Decision Making

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Thinking about Decision Making

• Rich Clement Underwriting Decisions
• Rick Leavitt Actuarial Decisions
• Issues
• Simulation
• Game Theory

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Underwriting Decisions
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Difficulties In Underwriting
Limited to poor information Quick turnaround
time Competition Acquisition/Irrational
Pricing Multiple Products Tenure of underwriters
size of accounts Economic conditions Evaluation
periods are too short Most volatile time period
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Difficulties In Underwriting
Limited Tools/Consistently Changing
Tools Changing plan designs move to employee
contributions New sales and underwriting
territories Aging workforce Obesity co-morbid
conditions Pressure on underwriting gain from
poor investment income Limitations to Home Office
Partners
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Difficulties In Underwriting
Mind space for LTD Increasing medical
costs Churning business Employers attitude
towards employees Regulatory issues Internal
meetings Profitable Growth Goals
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Traditional U/W Response

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Traditional U/W Response
Risk Analysis Read and Understand the RFP Why
is case out to bid? Who is the broker? Partner
with sales on strategy. Who is employer?
Financial Underwriting Manual rates SIC, OCC,
Area factors
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Traditional U/W Response
Risk Analysis (continued) Plan design
features Experience evaluation Cause and
effect Most recent period is volatile Credibil
ity Other perspectives Claims, actuarial,
similar customers trust yourself
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New Approaches
Track Decisions Competitive advantage Learn
from your mistakes Evaluate of claims Strategic
direction Understand where you make
money Maintain underwriting discipline
mistakes sell Hit them were they aint Ty
Cobb
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Actuarial Decisions
. Harder than I thought
All you need in this life is ignorance and
confidence then success is sure - Mark
Twain The greatest obstacle to discovery is not
ignorance - it is the illusion of knowledge -
Daniel Boorstein
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Actuarial Decision Making
1980s actuary Conduct an experience study and
recommend rate modifications 21st Century
Actuary ???
Actuaries are professionals who provide expert
advice and relevant solutions for business and
societal problems that involve economic risk
.SOA Promotional Material
Given difficult business environment, it is not
enough just to get the pricing right.
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2004 Disability Product Strategy
Strategy Options

• Slow and Steady Wins the Race
• Develop Appropriate Pricing and Stay the Course
• You might need investor and management education

• Decisive and Aggressive
• Identify Target Markets and Attack Aggressively
• Fix Mistakes as you Go

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2004 Disability Product Strategy
Strategy Options

• 3. Market Intelligence Hit em where they
  aint
• Exploit Undeveloped Market Niches

• 4. Execution, execution, execution
• Improve Distribution Efficiency/UW Decision
  Making
• Reduce Administrative Expenses and Cost of
  Capital
• Risk Evaluation Tools Smart Decision Making

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Actuarial Decisions LTD
Why is it so hard to get the pricing right?
1. Volatility of Loss
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Loss Volatility
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Actuarial Decisions LTD
Why is it so hard to get the pricing right?

1. Volatility of Loss Random versus external
   impacts
2. Loss takes a long-time to develop

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LTD Components of Loss
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Actuarial Decisions LTD
Why is it so hard to get the pricing right?

1. Volatility of Loss Random versus external
   impacts
2. Loss takes a long-time to develop
3. Product Complexity

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LTD Product Complexity

• Risk Drivers are Correlated (Isolation of Risk is
  Impossible)

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Example of Risk Dependence
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Actual Manual Rates
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Actual Manual Rates (Cont)
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Actual Manual Rates (Cont)
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Manual Rate Volatility
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Actuarial Decision Making
So Lets see.
Disability Rates are all over the place Trends
are hard to predict and hard to track Some
Carriers are buying Market share Some Carriers
are behaving, uh, irrationally Investors want
short-term results on a long-term product
What is an actuary to do??
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One Approach Simulation
Simulate Reality and Test Various
Strategies But. Need to simplify may
eliminate key dynamics Be careful not to
assume your outcomes Test outcomes and
relationships for Reasonability (Need Reality
Check)
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Example Sales/Profit Model
Assumptions All Carriers have identical
expertise Average Rate Best Estimate of Cost
Sale depends on Rate (5 Threshold) Incumbent
has rate advantage on renewal Some Cases will
take almost any rate increase Some Cases will
leave regardless of renewal action
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New Sales Price Elasticity
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Persistency Model
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Scenario 1 On Target Pricing No Rate Increase
on Renewal
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Scenario 2 Modest AcquisitionBreak-even
Pricing, 10 Increase on Renewal
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Scenario 3 Aggressive AcquisitionPriced at a
Loss, 20 Increase on Renewal
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Scenario 4 Light AcquisitionTwo Renewal
Increases limited to 5
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Scenario 5 Classic Underwriting Cycle
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Scenario Outcomes
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Scenario Outcomes (Years 6-10)
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Other Approaches?
Can Game Theory Help??
The theory of games is a theory of decision
making in complex situations when the outcome is
uncertain (chance) and there are competing goals
(other players)
1944, John Von Neumann Theory of Games and
Economic Behavior 1948, John Nash
Nashs Equilibrium identifies existence
of optimal Strategy
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Game Theory
Categories Zero-Sum versus Non Zero-Sum 2 Person
versus Multi-person Cooperative versus
Non-Cooperative
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Optimal Strategies??
Equilibrium Strategy Defined as a strategy in
which you will have no regrets regardless of what
the other players do
Nash Equilibrium 1948 An equilibrium strategy
exists for all two-person games zero-sum and
non-zero sum
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Prisoners Dilemma
Question What is the equilibrium strategy?
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Prisoners Dilemma
You and your partner are caught leaving the scene
of a crime with no other evidence. You are placed
in separate rooms and pressured to testify. What
should you do?
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Prisoners Dilemma
Best Possible Payoff Keep Silent If you keep
silent and your partner testifies, you will
regret decision If you testify Partner keeps
silent You go free (Good decision)
Partner Testifies Lesser charge (Good
decision)
Both Partners testify Nash Equilibrium
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Prisoners Dilemma
Nash Equilibrium minimizes expected payout. Is
this really the optimal strategy? What
strategy would you use over multiple games?
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Multi-player Games
Complicated by Possibility of
Alliances Start-up company offers the following
bonuses
24K Actuary Underwriter 20K
16K Claims 27K if all three
join
Who should join? How much should each get?
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Multi player Games
Option 1 All three join and get 9K each Option
2 Actuary and Underwriter get 12K each
but wait, Claims person offers the
underwriter 13 (keeping 3) Actuary offers the
claims person 4 (keep 16) Underwriter offers
the claims person 5 (keeping 11) where will
the negotiation end up?
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Multi-player Games
Any solution is unstable. There can always be an
alliance with another player that works better
for one member of the alliance.
No Optimal Solution Too often all parties end
up with nothing
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Game Theory
Interesting, but

• N-player, non-zero sum, cooperative games are
  poorly understood.
• Game Theory can characterize optimal solutions,
  but does not do well at identifying actual
  solutions
• Defining player utility in real life is difficult

Games are more fun to play than they are to study