Chapter 14 – Automobile Insurance Ratemaking

Factors in ratemaking

· Different premiums apply to different makes and models of auto, where they are kept, its sue and certain characteristics of the owners or drivers

· Many rating categories were developed and this resulted in a multitude of premium permutations

· Auto risks are usually divided into the following major classes:

o Private passenger (pleasure and business use)

o Commercial vehicles (trucks and delivery autos)

o Public auto (buses, and taxicabs)

o Recreational vehicles (motorcycles, snowmobiles, ATV)

o Garage risks (road hazard and dealership risks)

o Non-owned auto

· Each risk is then considered based on the hazard presented by any or all of the following:

o Territory

o Class of auto and its use

o Drivers

o The auto itself

· Autos present a liability hazard (BI or death and property damage) as well as physical loss/damage to the auto itself (collision, comp, SP). AB may be available for defined insured persons

Territory

· The exposure for third party and collision losses is greater in cities than in the country – we should expect to find higher rates for these coverages in urban than in rural areas

· For rating purposes, each province is divided into a number of zones each w/ a symbol or letter and a rate. Great cities, together w/ their immediate adjoining municipalities are generally the highest rated

· W/in territories, rates fluctuate over the years resulting from the loss experience

Class of automobile and use

· There is a wide variation in third party rates when one is using his auto for private pleasure and business use compared to a taxicab

· The exposure on a taxicab is far greater as it is frequently used 24 hrs a day, there is constant pressure to drive a fare as fast as possible in order to return to a base to pick up another fare and take risks which would not otherwise be taken by a driver of a private passenger auto

· A heavy truck will likely sustain less damage in a collision with an auto but b/c of its weight, it will likely cause more damage to the auto w/ which it collides

Drivers

· Statistics indicate that there is a higher rate of accidents among certain classes of drivers

· Young drivers pay more while experienced drivers and senior citizens pay less

· Young women may be charged lower premiums than young men b/c statistics show they have fewer/less severe accidents

· Due to legislative changes, insurers in NB, Nfld, NS can no longer use age or marital status as u/w variables

· Insurers in Nfld are also prohibited from using gender, marital status and whether the driver has other policies w/ the company or is currently in Facility as reasons to refuse coverage

The automobile itself

· In the early days rates for public liability and property damage were based solely on the horsepower of the auto. That method was abandoned in favour of rates based on:

o The list price of the auto for physical damage coverages and

o The sue of the auto, the age of the drivers and their accidents records for liability coverage

· The cost and age of the auto and its susceptibility to damage are rate considerations for physical damage coverage

· Nfld – insurers are not permitted to refuse coverage based on the age of the vehicle but they may request an inspection after 8 yrs

· Today there is not much difference in the fire hazard b/w models b/c mechanical improvements and stricter laws respecting construction

· Rating vehicles according to their list price have some drawbacks:

o Many claims require the vehicle to be repaired rather than replaced, and the list price of the vehicle does not necessarily determine the repair cost

o Equipment such as anti-theft devices and airbags that can lower claims costs or the likelihood of claims could increase the list price of the vehicle resulting in a higher insurance premium

· CLEAR (Canadian Loss Experience Automobile Rating) – the premium for the physical damage insurance is based on the vehicles’ likelihood of being involved in claims and what it will typically cost to settle each claim

Ratemaking

· The ratemaker has to fix the selling price b4 all the costs are known. A large part of the insurer’s future costs are losses

Statistical and actuarial rating

· The law of large numbers can be applied to individual risks by keeping statistical loss records on a large number of such risks

· The experience is tabulated and analyzed by statisticians and the resulting statistics are used by actuaries to establish rates for various coverages

· The final premiums may have to be submitted for approval to the provincial Superintendent of Insurance or to the rate board

Components of rate

· There are 2 components of an auto insurance rate:

o Pure premium – the amount required to pay only the anticipated losses

o Expense loading – added to the pure premium and includes:

§ Acquisition costs – commission and cost of the insurer’s sales structure

§ Processing and servicing costs – administration

§ Taxes – federal, provincial, municipal

§ Contingencies – catastrophes, extra large losses and reinsurance costs

§ Profit

Statistical body and data collection

· All private insurers who write business in Canada must record and file auto experience data – this info is used to provide industry-wide statistics for analysis by regulators and ratemakers

· The Insurance Bureau of Canada performs this function and the cost is shared among the insurers

· In Quebec, the Groupement des assureurs automobiles performs this function

· The results are published annually in the Green Book (the Grey book in Quebec) and the exhibits show a 5 year history for:

o Private passenger auto – excluding farm vehicles

o Farmer’s private passenger auto

o Commercial auto

o Snow vehicles

o Motorcycles

o Inter-urban trucks

o Public classes (buses, taxis)

o Some miscellaneous classes

· Data is exhibited per:

o Policy year – the experience of all policies w/ policy effective dates w/in the year is grouped together. All claims arising from these policies are taken into account regardless of when they occur (late reported claims included so that premiums are matched w/ losses). It does not utilize the most up to date data

o Accident year – All losses in a given year are captured regardless of the policy years to which they are attributable. This is preferred over policy year data

Components of loss costs

· Loss costs include:

o Paid losses – known amounts

o Outstanding losses – provision for reported but not yet paid claims which are usually referred to as estimates in claims files

o Incurred but not reported losses (I.B.N.R.) – late reported claims could significantly affect the final loss costs. Using policy year data, we have seen that such loss costs flow back to the policy year of origin. Using accident year data, actuaries must calculate the I.B.N.R. using historically demonstrated factors and add it to incurred losses. Together w/ subsequent changes in reserves for o/standing claims, this is known as the development factor – a factor for how this year’s loss costs will be affected by subsequent development

Actual loss ratio and pure premium exhibits

· The Green book (Grey book in Quebec) shows loss costs ratioed to the earned premiums in the Actual Los Ratio exhibit – this is known as the earned loss ratio. Loss costs are expressed by coverage per vehicle insured for all provinces, territories, years, classes and coverages

· Example:

Province of NS, Private Passenger, Year 19XX

Coverage – third party liability

Claim frequency per 100 vehicles 5.13

Avg cost per claim $3,704.00

Avg earned premium $155.21

Claim cost per vehicle $189.99

Earned/Incurred loss ratio 122%

Use of base rates, relativities and differentials

· Relativities are extracted from loss costs and the resulting differential is applied to the base future rate to provide premium

· Example:

o Actual $250 collision deductible loss costs $150 – this is the base rate b/c most people purchase this deductible

o Actual $100 collision deductible loss costs $165

o Actual $500 collision deductible loss costs $135

For the $100 deductible the loss costs are 10% higher than the $250 – the relativity is 1.10. For the $500 deductible the relativity is 0.90. If the future $250 deductible premium is $180 then the $100 deductible premium is $198 (180 x 1.10) and the $500 deductible premium is $162 (180 x 0.90)

· When applied to the base rates, these factors are known as differentials and appear in many rate manuals

Vehicle rate groups

· Various factors are taken into account such as damageability, reparability, and parts available

· The Highway Loss Data Institute (HLDI) in the USA provide data on loss costs per vehicle. Equivalent Canadian data is emerging from the Vehicle Information Centre of Canada (VICC) a non profit organization that supports both private and government insurers

Other factors

· IBC provides a great deal of data that is not required by law to be in the Green Book which is a public document

· Insurers have their own statistical data which they use to fine tune their rates and to justify their rates

Final premiums

· Expense loadings are added to the projected loss costs

· Premiums may be reviewed by sr. mgmt and adjusted for the market, competition and for political reasons

Investment income

· The insurer’s use of investment income to modify premiums has been subject to close scrutiny. Regulators have been interested in the overall return on equity when determining permitted rate levels

Rate control

· Some provincial governments have established rating boards to control auto insurance rates. These are:

o AB

o Man

o NB

o Nfld

o NS

o ON

· Some boards are set up under the direction of the Public Utilities Boards while others are independent or associated w/ the Superintendent of Insurance

· Types of control:

o Prior approval – companies file proposed rates and must wait for approval b4 using them

o File and use – companies file proposed rates and use them as proposed but may face enquiries by the board

o File and use following a ‘deemer’ period – companies file their proposed rates and the law allows a period of time during which the board can challenge them. Following this period the company can use the rates

o Prior setting of rates by the board w/ variations from ‘benchmark’ – the board sets the rates and these are known as the benchmark. Insurers can use the benchmark rates or vary them based on a board approved percentage

· Provinces w/out rate boards:

o BC

o Sask

o NWT

o PEI

o QC

o YT

· Superintendent of Insurance have supervisory powers and courtesy filings may be made in these provinces above

Sample Review Questions - Automobile Insurance (Part 1)

1. The major classes of automobile risks are:

- Private passenger (pleasure and business)

- Commercial vehicles (trucks and delivery autos)

- Public automobiles (buses and taxicabs)

- Recreational vehicles (motorcycles, snowmobiles, ATVs)

- Garage risks (road hazard and dealership risks)

- Non-owned automobiles

2. The 4 aspects that must be considered in rating are:

- Territory – the exposure for third party and collision losses is greater in the cities than in the country.

- Class of automobile use – there is a wide variation in third party rates t/w automobiles used for private pleasure/business use and one used as a taxicab.

- Drivers – certain classes of drivers have more accidents. Young drivers will pay more while experienced and senior drivers pay less.

- The automobile itself – rates for automobiles are now based on: the list price (for physical damage coverage), the use of the auto, the age of the drivers, and their accident records (for liability coverage). Under the CLEAR, the premium for the physical damage coverage is based on its likelihood of being involved in claims and what it will typically cost to settle each claim.

3. Insurance rate is different from the price of another commodity b/c the ratemaker has to fix the selling price b4 all costs are known – a large part of the insurer’s future costs are losses. Other commodities, the merchant starts w/ the cost price of the article and adds the expenses of the business as well as a reasonable percentage for profit.

4. The 2 components of an automobile rate are:

- Pure premium – the amount required to pay only the anticipated losses

- Expense loading – added to the pure premium and includes:

i. Acquisition costs – commission and cost of the insurer’s sales structure

ii. Processing and servicing costs – administration

iii. Taxes – federal, provincial, municipal

iv. Contingencies – catastrophes, extra large losses and reinsurance costs

v. Profit

5. The data used in auto ratemaking come from all private auto insurers as they must record and file auto experience data in accordance w/ the requirements of the auto statistical plans prescribed by the Superintendent of Insurance. The Superintendents of Insurance have authorized this work to be undertaken by the Insurance Bureau of Canada and the cost is shared among the insurers.

6. Data exhibited per policy year – the experience of all policies w/ policy effective dates w/in the year is grouped together. All claims arising from these policies are taken into account regardless of when they occur (late reported claims are included to match premiums with losses)

Data exhibited per accident year – all losses in a given year are captured regardless of the policy year to which they are attributed. The loss costs so demonstrated are the most recent indicators of what future loss costs may be.

7. The components of loss costs are:

- Paid losses – known amounts

- Outstanding losses – provision for reported but not yet paid claims which are usually referred to as estimates in claims files

- Incurred but not reported losses (I.B.N.R.) – late reported claims can significantly affect the final loss costs for the period under review

8. I.B.N.R. losses – late reported claims can significantly affect the final loss costs for the period under review. Using policy year data, we have seen that such loss costs flow back to the policy year of origin. Using accident year data, I.B.N.R is calculated using historically demonstrated factors and add it to incurred losses. Together w/ subsequent changes in reserves for outstanding claims this is known as the development factor.

9. Trending – forecast the trend of increase/decrease in loss costs for the period for which premium are calculated.

10. Different types of auto can affect the different coverages under a policy b/c of their damageability, reparability and parts available. For example, a Mercedes may pay a higher collision premium than a Hyundai but the occupants of a Mercedes may be much safer than in a small lighter auto which would be reflected in AB premiums.

11. Investment income affects auto rates b/c insurers use them to modify premiums. Regulators have been interested in the overall return on equity when determining permitted rate levels.

12. Earned loss ratio – loss costs ratioed to the earned premiums.

13. The types of control that exist on auto insurance rates are:

- Prior approval – companies file their proposed rates and must wait for approval b4 using them.

- File and use – companies file and use them but may face inquiries by the board

- File and use following a ‘deemer’ period – companies file and the law allows a period of time during which the board can challenge them. Following this period the company can use the unchallenged rates as they are deemed to be approved

- Prior setting of rates by the board with variations from ‘benchmark’ – the board sets the rates and these are known as the benchmark. Insurers can use the benchmark rates or vary them based on a board approved percentage.

14. Green book – provides industry-wide statistics, automobile experience data, for analysis by regulators and ratemakers.

15. VICC (Vehicle Information Centre of Canada) – provide data on loss costs per vehicle taking into account various factors; damageability, reparability, parts availability. A non-profit organization supported by both private and government insurers.

CIP Study Guide

Automobile Insurance C14