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Pricing of Motor Insurance in a Data-limited

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					    M/S. K.A. Pandit     Consultants and Actuaries




Pricing of Motor Insurance in a
   Data-limited Environment
The Grand Hyatt, Mumbai, September 4, 2006




     Xavier Bénarosch, FCAS, FCIA, CFA, FRM
                                          1
Summary

   Context of Indian Motor insurance market

   Keys for success

   Identify solutions for adequate pricing given limitations
    on data, or

   Raise awareness of implications of limitations on data




 M/S. K.A. Pandit                                  September 4, 2006   page 2
          Consultants and Actuaries
Context

   Rapidly growing Indian Non-life insurance market with
    annual premium increase (2005-06 over 2004-05):
      – 52% All lines for Private insurers, 62% for Motor
      – 16% All lines for All insurers, same for Motor


   Predominance of Motor insurance
      – 43% of Non-life premiums




 M/S. K.A. Pandit                                     September 4, 2006   page 3
          Consultants and Actuaries
Context

    Deregulation at year-end:
       – De-tariffing starting in 2007 for major lines of business.
         File and Use system.


    Insurers face challenges in terms of data which makes
     technical and actuarial analysis more difficult:
       – Example: ‘Code 99’ claims where only manual record of
         policy exists (2004-05 IRDA report)




 M/S. K.A. Pandit                                       September 4, 2006   page 4
          Consultants and Actuaries
Keys for success
  Sound rate level: Depends on adequacy of estimate of
   costs, expenses, return on invested capital / risk margin

  Optimal segmentation of rates:
     – Avoid adverse selection
     – Identify niche/specialty markets
         • By type of vehicle / Large city vs Mid-size city vs Rural
     – Given scarcity of data, should find balance between the
       number of rating criteria and the credibility of data

  Structure of rating variables:
     – Can be same variables as other insurers but with different
       values/categories



 M/S. K.A. Pandit                                             September 4, 2006   page 5
          Consultants and Actuaries
Keys for success
    Efficiency of operating environment

    Management responsiveness to changes and trends: Must
     establish mechanism to keep track of results and respond
     rapidly

    Adequate use of reinsurance and Financial strength of
     reinsurers

    Underwriting: Procedure for acceptance/refusal of risk should
     be clearly set out

    Data: Keys for success are all closely related or
     dependent on availability, quality, management,
     interpretation and application of data


 M/S. K.A. Pandit                                        September 4, 2006   page 6
           Consultants and Actuaries
Sound rate level
Formula for Base Premium

         Loss & loss-related expenses + Fixed expenses

      1 – % Variable expense – % Return on invested capital




  M/S. K.A. Pandit                                 September 4, 2006   page 7
           Consultants and Actuaries
Sound rate level
     Loss Cost estimates : Must account for

       – Loss development: Look for industry-based external sources or
         informed actuarial judgment
            •   Motor physical damage to vehicle vs Motor liability
            •   Litigious environment or Pre-court settlements?
            •   Long settlement delays?
            •   Reserving procedures
       – Trends: This can have a very large impact on adequacy of rates
            • Insurer’s inflation trend (Labor & parts) vs Inflation as per CPI
            • High inflation environment (ex: Jamaica)
            • Other social trends that have a loss-related impact (Court awards)
       – Change in frequency
       – Change in coverage
       – Country-specific issues: Multiple claim events
            • In Canada: Hail or Ice storm
            • In India: Earthquakes and Flooding


    M/S. K.A. Pandit                                                   September 4, 2006   page 8
                Consultants and Actuaries
Sound rate level

    Expense estimates:

      –   Made up of Acquisition expenses and General expenses
      –   Estimation usually straightforward but can be challenging when changes in
          premium volume are important


    Timing of Cash Flow: Account for timing of collection of
     premiums, payment of claims and recovery of reinsurance




    M/S. K.A. Pandit                                                   September 4, 2006   page 9
               Consultants and Actuaries
Sound rate level

    Return on invested capital / Risk margin: Should vary
     positively with uncertainty of pricing process:

      –   Lack of adequate data
      –   Exponential growth of market
      –   Deregulation of rates: new classes/products
      –   Market risk: Inflation, Investment income
      –   Possibility of general under tariffing
      –   Adverse selection: you get poor risks, competitors get good ones
      –   Concentration of exposures
      –   All indicate high risk margins for adequate return on capital




    M/S. K.A. Pandit                                                   September 4, 2006   page 10
               Consultants and Actuaries
Segmentation of rates
  In Canada, there are more risk combinations than insured
   vehicles!!!

  Common rating criteria between India & Canada:
    – Territory
    – Vehicle type and age
    – Driving record

  Additional Canadian rating criteria:
    – Age, Gender, Marital status
    – Use of vehicle

  Use of Deductibles / Policy limits

  Discounts and surcharges

  M/S. K.A. Pandit                                  September 4, 2006   page 11
            Consultants and Actuaries
Segmentation of rates
 External sources of data:
   – Vehicle crashworthiness:
       • Vehicle Information Center of Canada
       • Highway Loss Data Institute
   – Territory:
       • Average revenue statistics (Direct relation with quality of risks)
   – IRDA industry-wide statistics
   – Use of models:
       • For impact of deductibles / limits
       • For estimation of impact of multiple claim events
   – A-priori judgmental estimate / Informed actuarial judgment




  M/S. K.A. Pandit                                                       September 4, 2006   page 12
              Consultants and Actuaries
Segmentation of rates
 Credibility (Z) weighting formula
 (To determine relativities to apply to base premium)


 Z * Indication derived from own data
                      +
 (1 – Z) * Credibility complement

 - Credibility complement is usually a group or industry estimate, an
 external estimate or an a-priori judgmental estimate
 - Z is between 0 and 1 and varies with availability and variability of
 company’s data


 M/S. K.A. Pandit                                         September 4, 2006   page 13
            Consultants and Actuaries
Efficiency

Estimation of expenses

 Need adequate information on future level of operating
  costs under different growth scenarios

 Changes in Distribution model
    – Broker vs Agent vs Internet




 M/S. K.A. Pandit                              September 4, 2006   page 14
          Consultants and Actuaries
Responsiveness
    Information systems and speed of response of
     management:
      – Need monthly reports on evolution of statistics for adequate
        monitoring: Key indicators
      – Must reduce backlog in recording of transactions, if any
      – Build formal process of management action with timeline


    Quick implementation of rate changes

    Responsiveness is a critical aspect, even more so when
     data quality and availability is limited




 M/S. K.A. Pandit                                            September 4, 2006   page 15
            Consultants and Actuaries
Reinsurance
 Use of reinsurance increases flexibility of underwriting and
  limits variability of results

 Quota Share to alleviate impact of volume increase and
  associated capital requirement

 Non-proportional reinsurance to reduce impact of large losses
  on results

 Reinsurers and Reinsurance brokers are often great sources
  of data



   M/S. K.A. Pandit                                 September 4, 2006   page 16
            Consultants and Actuaries
Underwriting
 Must establish and adhere to sound and strict underwriting
  practices

 Quality of underwriting will often make the difference between a
  successful and a non-succesful insurer

 Relies on the underwriter’s ability to interpret and validate
  available premium and loss data




   M/S. K.A. Pandit                                   September 4, 2006   page 17
             Consultants and Actuaries
Data Data Data
    Critical data to collect for adequate pricing:
      – Written / Earned premiums but also Exposures (policy and
        vehicle count)
      – Paid losses, Case reserves and IBNR
      – Broken down by rating criteria


    Important for the insurance company but also for the
     industry as a whole (Mandatory statistical plan imposed
     by regulators operated by Insurance Bureau of Canada)

    Adequate database must correct past shortcomings but
     must also see far into the future




 M/S. K.A. Pandit                                         September 4, 2006   page 18
           Consultants and Actuaries
M/S. K.A. Pandit
         Consultants and Actuaries




 Thank You


       www.ka-pandit.com
       www.eckler-int.com
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