Key Concepts in Insurance Pricing Methods

Underwriting Methods

• Judgment Rating:

  • Used when historical data is not available.

  • Relies on the underwriter's subjective assessment to determine insurance premiums based on perceived risk.

Class or Manual Rating

• Definition:

  • A method foundational for personal lines of insurance (e.g., car, homeowners).

  • Insurers classify individuals into groups (pools) based on their level of risk (low, medium, high).

• Pooling:

  • All individuals in the same risk category pay the same premium, ensuring coverage costs are shared among the group.

Premium Calculation Methods

1. Pure Premium Method:

   • Formula: (Losses + Loss Adjustment Expenses) / Number of Exposures.

   • Initial method for determining premium for a class based on expected losses.

2. Rate Adjustment Method:

   • Follows the pure premium.

   • Uses actual loss data to adjust premiums based on performance over time.

• Loss Ratio Method (a form of rate adjustment):

  • Formula for change in premium (delta): δ = (A - B) / B.

  • A = actual loss ratio (incurred losses + loss adjustment expenses) / premiums earned.

  • B = expected loss ratio.

  • A positive delta leads to increased premiums, while a negative delta results in decreased premiums.

Merit Rating

• Definition:

  • An individualized method of rating insurance based on the risk profile of each insured party, mainly used in commercial lines.

• Telematics:

  • A device placed in vehicles that tracks driving behavior to tailor premiums more accurately to good or bad driving habits.

Types of Merit Rating Plans

1. Schedule Rating Plan:

   • Starts with a class rating and adjusts it for individual risk characteristics (e.g., safety features in businesses).

2. Experience Rating Plan:

   • Adjusts premiums based on a business's loss history and includes a credibility factor that indicates the reliability of the data.

   • Formula: δ = [(A - B) / E] * Credibility Factor.

3. Retrospective Rating Plan:

   • A system where a business’s loss experience during the policy period directly impacts their premiums.

   • Allows for refunds or additional charges at the end of the year based on claims made vs. expectations.

Regulation in Insurance

• Importance:

  • The insurance industry is strictly regulated to protect consumers and ensure fair practices.

• Rate Regulations:

  • Prevent excessive premiums while ensuring they are sufficient to cover losses and expenses.

  • States may require prior approval for rate increases.

Claims Settlement Process

• Key Responsibilities:

  • Verify coverage, assess losses, and ensure prompt payment.

  • Adjusters inspect claims and settlements, which are regulated to ensure fairness.

• Types of Adjusters:

  • Staff Adjusters: Employed by insurance companies, assess claims directly.

  • Independent Adjusters: Hired externally to manage claims, especially during high volume (e.g., post-disasters).

  • Public Adjusters: Represent the insured, often used when disputes arise between insurers and policyholders.

Reinsurance and Risk Management

• Concept of Reinsurance:

  • Insurers transfer part of their risk to reinsurers to manage potential losses better and avoid catastrophic financial impacts.

• Ceding: The process of transferring risk from insurance companies (primary insurers) to reinsurers.

• Retrocession: The further transfer of risk among reinsurers to diversify portfolios further across geographic and risk scales.

Conclusion

• These insurance pricing methods and regulatory considerations ensure stability and fairness in premium rates and claims handling, protecting consumers and businesses alike.

Study Tips:

• Focus on understanding each rating method and how they differ.

• Familiarize yourself with calculation formulas and their applications.

• Review examples of each type of claims adjuster and their roles in the claims process.