Managing Commercial Lines Pricing Levels in a Loss Cost Environment

1. Managing Commercial Lines Pricing Levels in a Loss Cost Environment Lisa Hays Ohio Casualty Group

2. Today’s Challenge • Accurate measurement of pricing changes over time for a book of business • Impact on planned vs. actual results • Production Plan • Loss Ratio Plan • Impact on Rate-level indications (onlevel factors) • Why is this so difficult?

3. Blame the Underwriters • The implemented rate change may not be equal to the filed or intended rate change. • Underwriters have many tools at their disposal • Access to multiple companies • Schedule rating • Must track change in total price level - base rate changes and other rating factors.

4. How are pricing changes tracked today? • Cash-to-cash renewal reports • Policies that renew are matched up to their expiring terms and premiums are compared • PRO - simple to calculate • PRO - necessary data should be readily available • PRO - over entire book of business it should provide an adequate measure of the rate plus exposure change for a book

5. How are pricing changes tracked today? • Cash-to-cash renewal reports (cont.) • PRO - easy for the underwriters to understand and to implement • CON - on individual policies or small segments, significant exposure changes will distort the results • CON - Only renewal business that is retained is evaluated. Omits new business and lost renewals.

6. How are pricing changes tracked today? • Exposure-adjusted renewal reports • Similar to cash-to-cash reports except that expiring rates are multiplied by renewing exposures before being compared to renewing premium • New Business - somewhat hit-and-miss • Monitor change in company usage, discretionary credits, etc.

7. Percent of Loss Cost (PoLC) • Definition - the PoLC is the ratio of the collected premium to the underlying bureau loss cost dollars. • Loss Cost Dollars = Loss Costs * Exposures • Which rating factors are included in the calculation of the underlying loss costs?

8. Potential Factors to include in Loss Costs • Increased Limits Factor • Deductible Factor • Experience Mod • Package Mod • Loss Cost Multiplier (LCM) • Schedule Rating Factor • Company-specific deviations

9. Potential Factors to include in Loss Costs • ILFs and deductible factors should always be considered part of the loss costs - they objectively quantify expected losses. • Obviously judgmental factors such as schedule rating should not be included in the underlying loss costs.

10. Potential Factors to include in Loss Costs • Package mods • If you use rating bureau factors “as is” they should be included in loss costs. • If you filed a significant deviation from the rating bureau, the revised mods (or the difference between filed and suggested) should be tracked as a deviation to loss costs and monitored.

11. Potential Factors to include in Loss Costs • Experience mod - Although experience rating plans are considered to be objective, in practice there are situations where the use of schedule credit or company placement may double-count a risk characteristic underlying the mod. • I prefer to track it as part of the PoLC statistic, but retain ability to exclude it for ad hoc analysis.

12. Potential Factors to include in Loss Costs • General Rule of Thumb: If the rating factor is specifically tied to the level of coverage that you are providing (such as ILFs) it should be included in the loss cost. • If the rating factor results from the pricing actuary’s or the field underwriter’s judgement, it should be captured in PoLC.

13. Percent of Loss Cost (PoLC) • The general formula for the PoLC when all rating factors are multiplicative is: PoLC = Collected Written Premium ΣLoss Costs * Exposures = Σ Loss Costs * Exposures * LCM * OTHR * PKG * SRP * EXPER Σ Loss Costs * Exposures The LCM includes the company deviation.

14. Indexed PoLC • Ideally, to facilitate comparisons through time, the PoLC is calculated by comparing the collected written premium for a given year to loss cost dollars calculated from a base year. • The calculation is simple assuming: • Loss Costs from the Base Year are accessible • You are able to re-rate current exposures with the Base Year loss costs.

15. Indexed PoLC • For Policies written in 1999: Indexed PoLC1999 = Collected Written Premium1999 Σ Loss Costs Base Year* Exposures1999 • Example: If the indexed PoLCs were 90, 97, and 105 for effective years 1998, 1999, and 2000, the changes in pricing were: • 1999 change = (97 / 90) - 1 = +7.8% • 2000 change = (105 / 97) - 1 = +8.2%

16. Indexed PoLC • The +7.8% change for 1999 could be due to changes in: • Underlying loss costs • Use of company deviations • Schedule rating • Any other rating factor • It is NOT due to a change in exposure

17. Calculation of Components • Please refer to this section of the paper for a detailed example for Commercial Auto of how to calculate the contribution from each factor to the overall PoLC. • The example also demonstrates how to handle rating variables that are additive.

18. Workers’ CompensationCase Study (Exhibits 2 and 3) • Using PoLC to manage pricing levels • Correlate the PoLC levels with loss experience • Compute loss ratio and frequency relativities across PoLC ranges • Use these relativities to distribute the overall rate indication • Perform further analysis on ranges that deviate significantly from average.

19. Workers’ CompensationCase Study (Exhibits 2 and 3) • This case study assumes that the underlying loss cost inadequacy or redundancy is the same across states and industry segments. • If you disagree with this assumption you should make appropriate adjustments or perform the analysis at a lower level of detail.

20. Setting Goals and Monitoring Results • Exhibit 4 shows sample monitoring reports that can be produced to track PoLC. • New vs. Renewal business should be monitored separately. • In this example, no pricing improvement for new business in 2000 compared to total in 1999. Renewals increased by 6.7% relative to loss costs.

21. Setting Goals and Monitoring Results • Assuming the sample report in Exhibit 4 is not using indexed loss costs, what should the 2001 PoLC goal be to achieve a rate increase of 20% if we file a loss cost change of +5% effective on 1/1/2001? 88.2% * (1.20 / 1.05) = 100.8%

22. Setting Goals and Monitoring Results • The goal of 100.8% could apply to both new and renewal business. • If you target significant price changes on your renewal book for selected PoLC ranges, policy retention across ranges may not be uniform. • In this case, a renewal price increase report may be a better monitoring tool.

23. Setting Goals and Monitoring Results • Exhibit 5 – based on the Experience Mod and the policy’s PoLC, develop a Target Renewal Price Change for each policy. • Include an additional amount for the overall expected exposure change if you use a cash-to-cash renewal increase report. • For all policies that renew, compare the actual renewal price change to the target.

24. Setting Goals and Monitoring Results • Again, this report will be useful at a countrywide or state level, but can be distorted at the underwriter or agency level if exposure changes are significantly different than the projected average. • Every attempt should be made to produce exposure-adjusted renewal reports for detailed reporting.

25. Caveats • The case studies and examples in the paper assume that the underlying loss costs are inadequate or redundant by the same percentage amount across • states • industry groups • effective years • If this is not so, you need to adjust for mix shift over time.

26. Summary • PoLC is a useful tool • Un-indexed it measures the change in usage of company tiers, schedule credit/debit, etc. over time. • Indexed also incorporates impact of underlying loss cost changes. • Can be correlated with loss experience to develop targeted pricing strategies.