Loss-Sensitive Rating Plans

Question 1

Advantages to insured, LSRPs

Answer 1

Incentive for loss control

Immediate reflection of good experience

Cash flow benefits

Reduction in premium taxes

Question 2

Disadvantages to insured, LSRPs

Answer 2

Uncertain costs

Immediate reflection of bad experience

Impact on future financial statements

Ongoing administrative costs

Question 3

Advantage for insurer, LSRPs

Answer 3

Insured incentive for loss control

Less capital required to write policies

Ability to write otherwise unacceptable policies

Question 4

Disadvantages to insurer, LSRPs

Answer 4

Credit risk of insured

Reduction in cash flow

Tendency for insured to second guess (profit provision, handling of claims)

Question 5

General retrospective premium formula

Answer 5

P = (B + cL)T

Losses are as of 18, 30, or 42 months

Question 6

Components of retro premium formula

Answer 6

B = basic premium; reflects fixed charges

c = loss conversion factor; reflects variable expenses

T = tax multiplier = 1 / (1 - tax rate)

Question 7

Balance principle

Answer 7

Retro premium = E[Guaranteed Cost premium]

Flawed because the transfer of risk and amount of required capital is different between the two plans

Question 8

LRARO

Answer 8

Large Risk Alternative Rating Option

Question 9

Common features of LRARO

Answer 9

Rating based on mutual agreement as insureds are knowledgeable and sophisticated

Can use losses on paid basis

Max/min ratable losses agreed upon

Question 10

Why LDD plan can be priced similarly to retro plan

Answer 10

Deductible ~ per-occurrence ratable loss limit

Aggregate limit ~ aggregate ratable loss limit

Question 11

Main differences between SIR and a large deductible plan

Answer 11

Regulator approval required for WC and auto

Insured responsible for adjusting/paying claims

Insurer does not inherit credit risk

Policy limit not eroded by SIR

Question 12

Dividend plan

Answer 12

Dividends are paid if insured’s losses are lower than expected

Question 13

Clash coverage

Answer 13

If multiple LOBs and policies impacted, clash deductible < sum (individual deductibles)

Question 14

Basket aggregate coverage

Answer 14

Cap insured aggregate reimbursable or ratable losses across multiple LSRPs at a single aggregate retention, up to a specified limit.

Question 15

Adjustments needed on a multi-year plan

Answer 15

Allow for exposures to change over term

Loss trends must be built in

Question 16

Captive reinsurer

Answer 16

Insurer serves parent company and writes policies and cedes losses to captive

Question 17

Ways insurers can protect themselves from credit risk

Answer 17

Require security (collateral of some sort)

Loss Development Factors to use in premium calculation

Holdbacks (delay premium adjustments until later maturity)

Question 18

Four considerations when deciding upon retention levels

Answer 18

Insured keeps predictable (working layer) of losses

Be within insured’s risk tolerance

Reflect insured’s financial capacity

Should increase with loss trend

Question 19

Compare profit provision on LSRP to traditional policies

Answer 19

Capital is not reduced in proportion to loss sharing – profit provision becomes higher % of insured loss

Question 20

Dissolutions of LSRPs

Answer 20

Closeouts – apply LDFs to determine final premium

LPT/Buyout - insurer assumes liabilities in deductible layer

SIRs often dissolved by LPT/Buyout

Question 21

Costs included in Basic Premium

Answer 21

Profit/UW not included in T

Expected per-occurrence excess losses if a per-occurrence ratable limit is selected

Expected aggregate excess loses if aggregate ratable limit selected (insurance charge)

Credit if minimum aggregate ratable loss amounts are selected (insurance savings)