ASOP 12

Question 1

List the 7 considerations in selecting risk characteristics

Hint: Rates Can Only Be Perfect If Legal

Answer 1

1. Relationship with Expected Outcomes
2. Causality
3. Objectivity
4. Practicality
5. Applicable Law
6. Industry Practices
7. Business Practices

Question 2

Briefly explain the “relationship with expected outcomes” consideration.

Answer 2

The actuary should select a risk characteristic that is related to expected outcome (i.e. it can be shown that the variation in actual or anticipated experience correlates to the risk characteristic).

Ex: Using pure premium differences between (…) would reflet expected cost differences between those policies.

Question 3

Briefly explain the “causality” consideration

Answer 3

It is not necessary for the actuary to establish a cause and effect relationship between the risk characteristic and expected outcome to use it.

Ex: It is not obvious how (…) would cause different expected losses.

Question 4

Briefly explain the “objectivity” consideration.

Answer 4

The actuary should select risk characteristics that can be objectively determined (i.e. based on readily verifiable observable facts that cannot be easily manipulated).

Ex: Insureds can manipulate (…) in order to get a cheaper rate.

Question 5

Briefly explain the “practicality” consideration.

Answer 5

The actuary’s selection of a risk characteristic should reflect the tradeoffs between practical and other relevant considerations.

Ex: Since the insurer already knows (…) there would be no additional cost of obtaining this information.

Question 6

Briefly explain the “applicable law” consideration.

Answer 6

The actuary should consider whether compliance with applicable law creates significant limitations on the choice of risk characteristics.

Ex: Not likely to be allowed by insurance departments since implies invasion of privacy.

Question 7

Briefly explain the “industry practices” consideration.

Answer 7

The actuary should consider usual and customary risk classification practices for the type of financial or personal security system under consideration.

Ex: It is not common to use (…) in reflecting pure premiums differences.

Question 8

Briefly explain the “business practices” consideration.

Answer 8

The actuary should consider limitations created by business practices and whether such limitations are likely to have a significant impact on risk classification system.

Ex: If the company’s operations would be impacted by use of this variable, then it may not be worth implementing.

Question 9

List the 4 considerations in establishing risk classes

Hint: ROUA

Answer 9

1. Intended Use
2. Actuarial Considerations
3. Other Considerations
4. Reasonableness of Results

Question 10

Briefly explain the 3 “Actuarial Considerations” in establishing risk classes

Answer 10

1. Adverse Selection
   The actuary should establish risk classes such that each has sufficient homogeneity with respect to expected outcomes to satisfy the purpose of risk classification system.
2. Credibility
   Risk classes should be large enough to allow credible statistical inferences regarding expected outcomes.
3. Practicality
   The actuary should use professional judgment in balancing the potentially conflicting objectives of accuracy an efficiency while minimizing potential effects of adverse selection.

Question 11

Identify the 3 “Other Considerations” in establishing risk classes.

Answer 11

1. Comply with applicable law
2. Consider industry practices for that type of system as known to the actuary
3. Consider limitations created by business practices as known to the actuary

Question 12

Identify the 4 ways to test the risk classification system

Answer 12

1. Assess the potential adverse selection effects of design or implementation. If material, the actuary should estimate potential impact and recommend appropriate measures to mitigate.
2. Consider using a different set of risk classes for testing long-term viability.
3. Testing effects of classification system or business/industry practices changes in accordance with the guidance of this standard.
4. Consider performing quantitative analyses of the impact of significant limitations.

Question 13

Identify 2 examples of significant limitations

Answer 13

1. Significant limitations due to compliance with applicable law
2. Significant departures from industry practices
3. Significant limitations created by business practices
4. Determination that experience indicates significant need for a change
5. Any expected material effects of adverse selection

Question 14

Other than the 5 significant limitations, list 4 other things that should be documented.

Answer 14

1. Disclosure of any material assumption or method prescribed by law
2. Disclosure of reliance on other sources
3. Disclosure if the actuary has deviated from guidance of ASOP12
4. Disclosure of any recommendations developed to mitigate potential impact of adverse selection