CAS Ratemaking Seminar

Price Monitoring -

Survival Strategies for a Softening Market

March 13,14, 2006

Chris NyceSenior Manager

KPMG LLP

Brian HughesSenior Vice PresidentArch Insurance Group

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Disclaimer

•The views expressed in this presentation are those of the speakers; and

•They are not necessarily the views of the CAS, KPMG, Arch Insurance or any other sponsor of this seminar;

•Anyone who says otherwise is not only wrong, but is itching for a fight.

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Contents for the Presentation

Introductions

Why is price monitoring critical (and failures of the past)

Chris Nyce

Interactions between manual rates and prices charged

Automating approaches:

Standard commercial renewal price monitoring

Price monitoring framework Brian HughesIndustry sources of price information

Large commercial lines - Methods 1-5

Challenges and practical issues

Handling less straightforward lines of business Chris Nyce

Implementation model

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Backdrop 2006 or “Why Measure Pricing”?

•CIAB Pricing Survey shows prices are declining in the last year

•Yet III shows Industry consolidated ROE at 11% - Marginal even at the height of the cycle; below all industry average every year for past 15 years

•Conclusion: Company must be better than average to earn a return equivalent to peers in other industries

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Historical Price Changes Implied by Reported Industry Results Compared to Actual Results

General Liability Occurrence

AYEarned

PremiumInitially

Reported

Reported at 24

Months

Reported @

12/2004

Reported (Initial to

24 month)

Actual (based on

12/04)

Difference Actual to Reported

1995 11,193,735 79.4% 78.4% 75.1% xxx xxx1996 11,362,262 78.8% 77.8% 76.2% -0.5% -1.5% -1.0%1997 11,982,431 79.8% 78.4% 83.7% -2.5% -9.7% -7.2%1998 11,678,847 77.8% 77.3% 90.9% 0.8% -8.7% -9.5%1999 11,523,956 75.2% 76.5% 95.5% 2.6% -5.0% -7.6%2000 11,732,232 75.6% 77.8% 95.2% 1.3% 0.3% -0.9%2001 12,334,245 87.7% 88.9% 94.0% -12.9% 1.2% 14.1%2002 16,814,191 70.8% 70.0% 71.5% 20.4% 23.9% 3.6%2003 21,007,773 67.7% 65.4% 65.4% 3.3% 8.5% 5.2%2004 25,007,920 65.8% xxx 65.8% xxx -0.5% xxxTotal 144,637,592 xxx xxx xxx xxx xxx

0.3% -22.9% -23.2%

Loss and ALAE RatioChange in Rate

Adequacy

Subtotal 1996-1999

Note initially reported results stable from 1996-1999, but actual results deteriorated markedlyRate adequacy changes implied in reported results lag actual by 23%!

Source: AM BEST Aggregates and Averages composite Schd P.

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Historical Price Changes Implied by Reported Industry Results Compared to Actual Results

CMP

AYEarned

PremiumInitially

Reported

Reported at 24

Months

Reported @

12/2004

Reported (Initial to

24 month)

Reported @

12/2004

Difference Actual to Reported

1996 18,001,516 74.3% 74.6% 77.0% -6.2% -8.3% -2.1%1997 18,339,971 68.0% 67.8% 70.0% 8.8% 9.0% 0.2%1998 18,289,197 74.0% 74.7% 80.1% -9.2% -14.4% -5.3%1999 18,609,666 73.8% 74.9% 80.6% 1.2% -0.6% -1.8%

-6.2% -15.0% -8.8%

Workers' Compensation1996 27,124,365 71.7% 70.0% 68.3% -1.6% -5.3% -3.7%1997 25,108,476 73.2% 75.5% 78.8% -4.7% -15.4% -10.8%1998 24,586,828 77.8% 79.7% 87.8% -3.0% -11.5% -8.5%1999 22,948,284 79.6% 83.1% 93.6% 0.2% -6.6% -6.8%

-8.9% -33.8% -24.9%

Casualty Reinsurance1996 7,892,289 77.6% 78.4% 77.2% -2.1% -9.8% -7.7%1997 7,869,256 76.1% 74.9% 90.8% 2.9% -17.5% -20.4%1998 7,337,873 80.4% 81.9% 120.2% -7.3% -32.5% -25.1%1999 8,428,709 79.6% 78.7% 121.2% 2.9% -0.8% -3.7%

-4.0% -50.1% -46.2%

Loss and ALAE Ratio Change in Rate

Subtotal 1996-1999

Subtotal 1996-1999

Subtotal 1996-1999

Similarly for other commercial casualty lines, rate adequacy changes implied by reported results lagged actual adequacy declines by:

CMP - 8.8%Workers’ Comp - 24.9%Casualty Re - 46.2%

Source: AM BEST Aggregates and Averages composite Schd P.

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While Actuarial Approaches Need Improvement - Need Focus also on

Integrating Price Monitoring into a Comprehensive Underwriting Program

Possible Problem Manifestation

Manual rates may not fully reflect loss potential of each class of risks

Underwriters and Agents will be incented to write the inadequately priced classes

Loss potential of new business may not reflect the average in class of the manual rate

Can result when Underwriters and Agents push rate but relax underwriting quality

Data on which measurements are based may not be accurate

Price management can be defeated if manipulated in field (example, underestimate or miscode exposures)

Planned price changes may not be communicated or implemented in the field

Prices are determined at underwriters desk, so clarity at that level is needed

Even if manual rate adequacy is right by class, charged rates may not be

An “off-balance” can be created by the credits, e.g. some classes written at manual, and some well off of manual

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What Can be Done - Considerations

•No rate plan is bulletproof

•Active implementation of that rate plan is key

•Manual rates can be nearly irrelevant

•Market rates are key, and manual plans need to include flexibility to achieve clearly articulated targets

•Underwriters reacting to the market can defeat any rate plan, and often do

•Achieving profits in a soft market is not easy, it’s hard

•Average profit levels of insurers, even over a cycle, are below shareholders acceptable levels

•Generic solutions don’t always work for specialty or excess large lines

•But there is a way

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Risk Quality by Class

•Best solution: Equal rate adequacy in each class

– But even if manual rates are equally adequate, charged rates may not be

– Regulation, or filing difficulties may prevent achieving the perfect rate plan

•Segmentation and tracking price by segment may be necessary

•Need to consider existing off balances

– Departures of charged rate from manual (think new vs. renewal)

•Need to consider emerging threats

– Mold, CD, Waste, for example

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Quality of Risk Within Class

•Standard underwriting execution is key

– Reasonable authorities and delegations

– Data and risk validation

– Field audit schedules

– Self audit and management reviews

– Strong field and home office referral processes

•Underwriting Audits should include data quality

– Exposure information, coverage additions if not considered in the price monitor

•Rating plan refinements may be needed

– Any recognition of variation of loss cost within a rating segment is candidate for new rating variable

– If no manual rating differential, needs to be segmented and tracked

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Discussion of a General Approach for Standard Commercial Lines

Today we will discuss general renewal monitoring

New business (to benchmark) can be generalized in an analogous manner

Note also that Actuaries are critical to the business management process:

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Standardized Formula for Small Commercial Business - Basic PropertyState the Rate Change at Expiring or Renewing Coverages

Expiring Coverages Renewing Coverages

AOP Extension

OrdinanceAnd Law

Sprinkler Leakage

PackageExtension

Group I&II Coverage 100K

Wind Deductible

Deductible Buy-down to $250

Sprinkler Leakage

PackageExtension

Group I&II Coverage 100K

No Buydown

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Standardized Formula for Small Commercial Business - Basic PropertyState the Rate Change at Expiring or Renewing Coverages

Expiring Coverages Renewing Coverages

AOP Extension

OrdinanceAnd Law

Sprinkler Leakage

PackageExtension

Group I&II Coverage 100K

Wind Deductible

Deductible Buy-down to $250

Sprinkler Leakage

PackageExtension

Group I&II Coverage 100K

Deductible Buy-down to $250

Option I: Rerate to Expiring coverages

Benefit: Not “makingup” expiring premiumand then measuringchange from fictionalpremium.

Red coverages are rerated, or “normalized”

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Standardized Formula for Small Commercial Business-Basic PropertyState the Rate Change at Expiring or Renewing Coverages

Expiring CoveragesRenewing Coverages

AOP Extension

OrdinanceAnd Law

Sprinkler Leakage

PackageExtension

Group I&II Coverage 100K

Wind Deductible

Deductible Buy-down to $250

Sprinkler Leakage

PackageExtension

Group I&II Coverage 100K

No Buydown

Option II: Rerate to Renewal coverages

Benefit: Capturing all renewal coverages, but at the cost of adding fictional coverages to the expiring

Red coverages are rerated, or “normalized”

Wind Deductible

AOP Extension

OrdinanceAnd Law

Purple coverages are deleted

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Balancing Capture of Complete Information with Accuracy of MeasurementLine of Business and Coverage - Basic Property Example

Perform calculations at the coverage level so you can include or exclude coverages depending on renewal status:

“Property Coverage”

Instead of one coverage :

Consider whether to treat each coverage at each locationas separate calculation, or alternatively “normalize”

“Basic Group I-Building”“Basic Group II-Building”“AOP-Building”

“Earth Movement”

“Money and Securities

“Packaged Extension”“Brands and Labels”

“Accounts Receivable”

“Off Premises Power”

“Basic Group I-Contents”“Basic Group II-Contents”“AOP-Contents”

“Ordinance and Law”

“Debris Removal” And so forth…….

“Fire Dept Charges”

“Sprinkler Leakage”

“Off Premises Contents”

“Adjacent Structures”

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Balancing Capture of Complete Information with Accuracy of MeasurementRating Factors to Normalize - Basic Property Example

Which coverage factors should be normalized? Examine the rating algorithm and classify each factor:

Generally normalize those that give or take real coverage, such as:

Increased limits factors, Deductibles, Wind Exclusions, Exposures

Not those that reflect real exposure to loss characteristic of the risk, such as:

Territory, Class

Not those that are used to achieve target pricing, such as:

IRPM, Schedule Rating

Then make a decision on the gray areas:

Mold/Lead/Terrorism exclusions, Dispersion credits, Experience rating, Expense reduction, Commission contribution, Loss free discount

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Calculating a Normalized Renewal Rate Change - Basic Formula

Assume the “expiring coverage” approach (and decide to normalize based on expiring or current rates)

Define a “normalizing factor” for each coverage

Expiring factor/Renewal factor (example: Expiring ILF/Renewal ILF)

A robust and automated approach to renewal price change is then:

Normalized Renewal Rate/Expiring Rate =

(Normalized Renewal Premium/Renewal Exposure) (Expiring Premium/Expiring Exposure)

Normalized Renewal Premium=Charged Renewal Premium × Normalizing Factor

Where:

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Price Monitoring and the Quote/Issuance Renewal Cycle

Step in the process Practical Opportunity to ActOn Price Monitoring

Business is quoted by

underwriter (not issued)

Monthly quotesare issued to

agents/insureds

Quarterly reviews of business performed

Can influence underwriters to change quotes before

issuance

Prices Measured When?

Can react to influence next months quotes

Can react a quarter in arrears to influence prices

or just use to set ELR’s

BatchOption

Real TimeOption

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Break for Brian’s PresentationIntroducing Brian Hughes,

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Price Monitoring in Situations that are not Straightforward - Examples

•Example 1: Excess Casualty (Re)insurance

– Use benchmark approach

– Establish pricing model, with pricing parameters such as LDF’s, excess factors, even manual rating built in

– Measure new and renewal business as a percentage of manual

•Example 2: Excess Property (Re)insurance

– Examine CAT models to determine expected loss

– Measure price to expected loss benchmark

– Don’t forget risk margin

• Inland Marine or Other Judgment Rated Risks

– Measure benchmarks to schedule of ELP’s

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Driving Price by Segment

1. Analyze book

of business by

overall rate

need and

by meaningful

segment

3. Get agreement on the price need by larger segments

2. Divide the book into a manageable

number of segments (stratify

into A,B,C, for example)

4. Set up segmentation

model to drive price achievement by segment, and

communicate to all underwriters

5. Monitor, Measure, Report Deviations

Drive Underwriting Quality Throughout the Process

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Segmentation Approaches – Understand the Business

•Understand internal experience

•Understand market experience

– Suggest at collected level, not manual

– If performing Premium on Level, must account for discretionary price changes

•Understand market rate adequacy

– Again at collected premiums, not manual

– Rating Bureaus can be a decent source for this information

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How are the Segments Defined?

•Meaningful segments that company/underwriters manage

•Common Examples

–NAICS code

–Class code

–Program

–Geographical region

–Size of risk

–Combination of the above

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Business Drivers – Set Specific Targets

Price change on renewals

Price on new business to benchmarks

Renewal retention desired

Underwriting approach

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A B C TotalClasses Classes Classes Book

Starting Position.(1) Proportion of the book 29.0% 46.0% 25.0% 100.0%(2) Loss and ALAE Ratio with no rate change 52.0% 69.0% 119.0% 76.6%

(3) Rate change on renewals 10.0% 25.0% 50.0% 20.8%(4)

51.8% 59.2% 82.7% 56.1%(5) Net loss/exposure trend 1.5% 1.5% 1.5% 1.5%(6) Assumed unit count retention ratio 90.0% 70.0% 20.0% 63.3%(7) Resulting premium retention 99.0% 87.5% 30.0% 76.5%(8) New business as percent of expiring premium 40.0% 35.0% 0.0% 27.7%

Position after one year.(9) Resulting premium growth 39.0% 22.5% -70.0% 4.2%

(10) Resulting distribution of business 38.7% 54.1% 7.2% 100.0%(11) Resulting loss and ALAE ratio on renewals 48.0% 56.0% 80.5% 54.7%(12) Resulting overall loss and ALAE ratio 49.1% 56.9% 80.5% 55.1%

(13) Renewal experience if rate change alone were applied= 64.3%(14) Renewal Loss and ALAE ratio better due to segmentation strategy by 9.7%

Loss and ALAE ratio on new business (drive same price as renewal, but assume loss ratio is 5% worse)

Basic Implementation Model for Segmented Pricing Targets

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Sample Action Grid for Underwriters and/or Agents

Underwriters Targets for XXX Line of Business

Class Group A B C

Retention 90% 70% 20%

Renewal Price Change

+10% +25% +50%

New Business Appetite

Aggressively Seek

Open None

Target % of Manual Rate

90% 100% 125%

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Class Group Line of Business I

Line of Business II Line of Business III

Offices A or B or C A or B or C A or B or C

Services A or B or C A or B or C A or B or C

BuildingOwners A or B or C A or B or C A or B or C

Light Manufacturing A or B or C A or B or C A or B or C

Contracting A or B or C A or B or C A or B or C

Wholesalers-Durable Goods A or B or C A or B or C A or B or C

Office Condo A or B or C A or B or C A or B or C

Residential Condos A or B or C A or B or C A or B or C

Shopping Centers A or B or C A or B or C A or B or C

Churches A or B or C A or B or C A or B or C

Clubs A or B or C A or B or C A or B or C

Hotels A or B or C A or B or C A or B or C

Restaurants A or B or C A or B or C A or B or C

Retail-not separately listed A or B or C A or B or C A or B or C

Listed Retail Classes A or B or C A or B or C A or B or C

Auto Services A or B or C A or B or C A or B or C

Sample Appetite Guide