Town Hall Session/ RCM-2 CAS 2006 Ratemaking Seminar, March 13, 2006

1. Town Hall Session/ RCM-2 CAS 2006 Ratemaking Seminar, March 13, 2006 Louise Francis, FCAS, MAAA Francis Analytics and Actuarial Data Mining Louise.francis@data-mines.com www.data-mines.com

2. How Many Risk Load Actuaries Can Dance on the Head of a Shamrock?

3. Remarks • Risk adjusted discount rates/internal rate of return approaches still relevant • Alternative beta calculations • Alternative denominator for cost of equity • Some older approaches such as risk loads based on percentiles still make sense in some contexts • The market seems to allow for superior strategy returns • Should we think of Risk Load as a topic within ERM? • Should we charge a “bad data” risk load?

4. Financial & Actuarial Perspective Converge? • Risk Load= Systematic + Frictional Cost

5. Simpler Methods are Sometimes Better • To some managements, our methods of computing risk loads seems very complex • Loads based on percentiles still used often for self-insurance pools and captives

6. Augmentations of Beta • Base on correlation with insurance liabilities • SUMBETA – (Ibbotson, Risk Premium Project) • Take lag effects into account • For insurance companies generally results in larger betas

7. Cost of Capital Denominator • What is an appropriate denominator • Usually GAAP surplus • Smith says this is the wrong denominator • Economic Value of Company = Market value of assets - Discounted value of liabilities + franchise value – insolvency put • Measure change in this value

8. Return for Having an Edge: Geometric Maximization

9. “Bad Data” Risk Load • Moral Hazard problem • Customers supplying bad data may be poorer risks due to poorer management • Information has a cost • More uncertainty is associated with pricing based on sparse or inadequate data