Instructor: Klara Buysse

Casualty Actuarial Basic Ratemaking

Science
 Casualty Actuarial Science

Text used: Basic Ratemaking

Fifth Edition, May 2016

Geoff Werner, FCAS, MAAA
Claudine Modlin, FCAS, MAAA
Willis Towers Watson

https://www.casact.org/library/studynotes/Werner_Modlin_Ratemaking.pdf
 Chapter 2: Rating Manuals

I. Introduction

Rating Manual = Insurers documentation to:

- classify each risk
- calculate premium for that risk

Premium = price a consumer pays for an insurance policy

- based on a rate per unit of exposure
- vary for risks with different characteristics
Following information necessary to calculate the premium for a given risk:

- Rules
- Rate pages (i.e., base rates, rating tables, and fees) Rating Manual

- Rating algorithm
- Underwriting guidelines Underwriting Manual
II. Rules

The Rules contain:

- Qualitative information to understand the quantitative rating algorithms
- not meant to replicate the detail of the legal insurance contract
In the rules one can find the following information:
- Definitions related to the risk being insured
- Summary of policy forms offered to the insured and summarise what is
covered by each
- Outline any circumstances for limitation or exclusion of coverage
- Outline various premium determination considerations (e.g. refund in the
event of cancellation, surrender, …)
- How to properly classify a risk
- Contains information about optional insurance coverage (a.k.a
endorsements or riders).
III. Rate Pages
The rate pages contain numerical inputs needed to calculate the premium:
- base rates
- rating tables
- fees

Base rate is the rate applicable to the base risk, where:

- Base risk is predefined by the insurer:
- represents a set of risk characteristics that are most common
- can also be chosen based on marketing objectives
In the rating tables one can find the different rating variables:
- These rating variables represent the different risk characteristics
- will modify the base rates by using:
- multipliers,
- addends, or
- some mathematical expression as defined in the rating algorithm.

Type of Insurance Rating Variables

Personal Automobile Driver Age and Gender, Model Year, Accident History

Homeowners Amount of Insurance, Age of Home, Construction Type

Workers Compensation Occupation Class Code

Commercial General Liability Classification, Territory, Limit of Liability

Medical Malpractice Specialty, Territory, Limit of Liability

Commercial Automobile Driver Class, Territory, Limit of Liability

IV. Rating Algorithms
Describes how to combine the various components in the rules and rate pages to
calculate the overall premium charged for any risk that is not pre-printed in a rate
table:
- the order in which rating variables should be considered
- how the effect of rating variables is applied in the calculation of premium
- the existence of max and min premiums
- specifics associated with any rounding that takes place.
V. Underwriting Guidelines
A set of company-specific criteria that can affect decisions made prior to calculating
a rate (e.g. whether or not to accept the risk):
- decisions to accept, decline, or refer risks
- Company placement : distinct companies to sell similar products at
different prices to risks with different underwriting characteristics.
- Tier placement: rating “tiers” that permit companies to charge different
rates within a single company to risks with different underwriting
characteristics.
- Schedule rating credits/debits: given for the presence or absence of
characteristics.
 Type of Insurance Underwriting Characteristics
Personal Automobile Insurance Credit Score, Homeownership, Prior Bodily Injury Limits

Homeowners Insurance Credit Score, Prior Loss Information, Age of Home

Workers Compensation Safety Programs, Number of Employees, Prior Loss Information

Commercial General Liability Insurance Credit Score, Years in Business, Number of Employees

Medical Malpractice Patient Complaint History, Years Since Residency, Number of Weekly Patients

Commercial Automobile Driver Tenure, Average Driver Age, Earnings Stability

IV. Homeowners Rating Manual Example
Homeowners policy with Wicked Good Insurance Company (WGIC).

A. Base Rates
Exposure base = home insured for one year

Coverage Base Rate

All Perils Combined $500
B. Rating and Underwriting Characteristics
1. Amount of Insurance

Amount of insurance (AOI): the amount of coverage purchased to cover damage to

the dwelling and is the maximum amount the insurer expects to pay to repair or
replace the home.

AOI (in thousands) Rate Relativity AOI (in thousands) Rate Relativity
$ 80 0.56 $305 1.28
$ 95 0.63 $320 1.32
$110 0.69 $335 1.36
$125 0.75 $350 1.39
$140 0.81 $365 1.42
$155 0.86 $380 1.45
$170 0.91 $395 1.48
$185 0.96 $410 1.51
$200 1.00 $425 1.54
$215 1.04 $440 1.57
$230 1.08 $455 1.60
$245 1.12 $470 1.63
$260 1.16 $485 1.66
$275 1.20 $500 1.69
$290 1.24 Additional $15K 0.03
2. Territory

Homeowners insurers typically group similar geographic units (e.g. zip codes).

Territory Rate Relativity

1 0.80
2 0.90
3 1.00
4 1.10
5 1.15

3. Protection Class and Construction Type

Wicked Good’s homeowners rates vary by fire protection and type of construction.

Construction Type
Protection Class
Frame Masonry
1-4 1.00 0.90
5 1.05 1.00
66 1.10 1.05
7 1.15 1.10
8 1.25 1.15
9 2.10 1.75
10 2.30 1.90
4. Underwriting Tier

The underwriting characteristics are used to place insurance policies into one of the
four distinct underwriting tiers based on the overall riskiness of the exposure to loss.

The definition of these Tier are usually not shown in the Rating manual.

Tier Rate Relativity

A 0.80
B 0.95
C 1.00
D 1.45

5. Deductible

The policyholder can choose the deductible.

Deductible Rate Relativity

$250 1.00
$500 0.95
$1,000 0.85
$5,000 0.70
6. Miscellaneous Credits

Wicked Good offers discounts for new homes, insured who are claim-free in the
previous five years, and insureds with multiple policies.

Miscellaneous Credit Credit Amount

New Home Discount 20%

5-Year Claims-Free Discount 10%

Multi-Policy Discount 7%

7. Additional Optional Coverages

The policyholder can choose for additional coverages:

Jewelry Coverage Rate Liability/Medical Rate

Limit Additive Limit Additive
$ 2,500 Included $ 100,000/$500 Included
$ 5,000 $35 $300,000/$1,000 $25
$10,000 $60 $500,000/$2,500 $45
C. Expense Fee
Policy Fee
The expense Fee is $50 per policy: $50

D. Homeowners Rating Algorithm for WGIC

Total Premium = All-Peril base Rate

x AOI Relativity

x Territory Relativity

x Protection Class/Construction Type Relativity

x Underwriting Tier Relativity

x Deductible Credit

x (1.0 - New Home Discount - Claims-Free Discount)

x (1.0 - Multi-Policy Discount)

+ Increased Jewelry Coverage Rate

+ Increased Liability/Medical Coverage Rate

+ Policy Fee.

WGIC rounds to the penny after each step and to the whole dollar at the final step.
E. Homeowners Rate Calculation Example for WGIC
WGIC is preparing a renewal quote for a homeowner currently insured with Wicked
Good, with the following characteristics:
- Amount of insurance = $215,000

- The insured lives in Territory 4

- The home is frame construction located in Fire Protection Class 7

- Based on the insured’s credit score, tenure with the company, and prior loss history, the policy has been
placed in Underwriting Tier C

- The insured opts for a $1,000 deductible

- The home falls under the definition of a new home as defined in Wicked Good’s rating rules

- The insured is eligible for the five-year claims-free discount

- There is no corresponding auto or excess liability policy written with WGIC

- The policy opts to increase coverage for jewellery to $5,000 and to increase liability/medical coverage
limits to $300,000/$1,000.
The following numbers are used:

Entries from Rating Manual

Base Rate $500

AOI Relativity 1.04

Territory Relativity 1.10

Protection Class/Construction Type Relativity 1.15

Underwriting Tier Relativity 1.00

Deductible Credit 0.85

New Home Discount 20%

Claims-Free Discount 10%

Multi-Policy Discount 0%

Increased Jewelry Coverage Rate $35

Increased Liability/Medical Coverage Rate $25

Expense Fee $50

The rating algorithm from the rating manual can be applied to calculate the final premium for the policy:

$501 = $500 x 1.04 x 1.10 x 1.15 x 1.00 x 0.85 x (1.0 - 0.20 - 0.10) x (1.0 - 0) + $35 + $25 + $50