Chapter 18: Rating methodologies and bases

Question 1

Methodology used to calculate premiums will depend on:

Answer 1

• The class of business being priced
• The availability of relevant data
• The market in which the company is operating

Question 2

Components of the risk premium

Answer 2

• The pure risk rate based on previous years’ experience
• A loading for catastrophe and/or large loss claims

Question 3

Components of the office premium

Answer 3

• Loading for net cost of reinsurance
• Loading for expenses including commission
• Capital charge to reflect the cost of capital (aka profit loading)
• Investment income
• Tax

Question 4

Steps involved in calculating the pure risk premium:

Answer 4

• Collect relevant data, including past exposure and claims arising from that exposure
• Adjust data to make it more relevant
• Group data into risk groups
• Select most appropriate rating model or estimation process for specific case
• Analyse the data to pick up trends
• Set assumptions required by the model or process
• Test the assumptions for goodness of fit or likelihood probability
• Run the model or process to arrive at an estimate of future claims costs
• Perform sensitivity and scenario testing, or apply other methods, to check the validity of the estimates

Question 5

Changes in risks arise because of changes in:

Answer 5

• The mix of underlying risks
• Cover/policy conditions
• Claims handling/underwriting strategy
• The method of distribution
• The level of reinsurance coverage