Risk Management Analysis for Ratemaking: Consolidating Ratemaking in its proper context.

Syed Danish Ali

This report holistically places ratemaking into its proper context and connects the diverse operations that have impact on ratemaking as well. Broadly, the risk that a line faces can be segregated into accident risk and expense risk.

Accident Risk

The likelihood of actual claims being higher than expected is a major risk to a motor line, which will be referred as “accident risk” in this section.

Generally, the Company price for taking on this risk by assuming a certain loss ratio with a margin for contingencies. If actual claims are lower than expected, the profit emerges.

In order to mitigate this risk, proper underwriting as well as reinsurance arrangements is made. The fluctuation in actual loss ratio from year to year is a major risk which leads to fluctuations in shareholders’ return.

Expense Risk

This risk can be defined as the likelihood of actual expenses being higher than the expected. If the difference (Expected vs. Actual) is positive, the company makes money.

Process Error

Process uncertainty originates from general claims uncertainty (including frequency, severity, timing, change in demand, and claims settlement process, etc.), internal sources of uncertainty (including planned or unplanned business mix changes, reserves booked other than recommended, expenses uncertainty, etc.). Uncertainty in economic, legal and operating environment and the stages of insurance cycle are also contributing factors of process uncertainties in our results and recommendations.

Parameter Error

Our results and conclusions are derived from the parameter estimates used in our actuarial and statistical models. These parameters inherit uncertainties relating to data quality, large and exceptional claims, change in reserving process and philosophy, assumptions including inflation, claim cost trend and others (including IBNR).

Our parameter estimates are deduced from past experience, our expectations of future and reasonable actuarial judgment. Since historical estimates contain distortions and random movements, past experience is not necessarily a reasonable guide to the future. Therefore, our results and recommendations in this report inherit uncertainty due to parameters’ estimates used.

Model Error

Our results and conclusions are derived from the adopted actuarial and statistical models. These statistical models are simplified versions of very complex (and unknown) underlying systems, processes and assumptions. This leads to inherent bias in our results and recommendations within this report.

The choice of the model used can also contribute to the model uncertainty. For example, the triangulation methods used to estimate the incurred-but-not-reported claims can produce different results under paid claims pattern as compared to incurred claims pattern. Based on the pricing assumptions, the company’s management should understand the insurance business as the specificity of the insurance-related-reverse production cycle (collecting premiums first, paying out claims later and accumulating assets to cover future payouts) and the requirement to control and mitigate operational risks that are generated everywhere in the insurance value chain.

Risk management is about thinking creatively of scenarios, not just following the output of a model as risk management is ultimately about sustainability and survival and not profits and losses.

For instance, different sub-products within Motor can have different features and claim trends. Regarding claim trends, bodily injury has no maximum liability limit and so can be a major source of potential loss. The Company controls this risk by an XOL reinsurance treaty without any limit for bodily injury cases. For comprehensive products, the Sum Insured are determined and known beforehand, and it is carefully monitored that change in underwriting or depreciation policies do not unduly lead to decrease in Sum Insured as this will directly lead to decrease in premium being charged as premium on comprehensive is charged as percentage of Sum Insured.

Giving another example, different sub-products within Medical can have different features and claim trends. Regarding claim trends, grievous surgeries and chronic pre-existing conditions as well as critical illnesses can be a major source of potential loss. The Company can control this risk by an XOL reinsurance treaties.

In order to calculate a final set of rates for an existing product, the company performs the following actions:

• Select an overall average premium target for the future policy period• Finalize the structure of the rating algorithm

• Derive the base rate necessary to achieve the overall average premium target• Select the final rate differentials for each of the rating variables based on the

policy characteristics, coverage type and claim history• Calculate proposed fixed & variable expenses• Make projections based on the appropriate (or realistic) set of claims and

expense assumptions

Proposed rates and rate changes should be viewed as a quantitative diagnostic tool for determining expected costs. If company does not know its true rate needs, then it cannot know if the rates dictated by the market are sufficient to produce its planned or target returns. Once future expectations are determined, informed discussions can take place as to how to respond to those expectations. If the market dictated prices are too low, the company must know what other actions (e.g. changes in underwriting rules, marketing emphasis or claims handling) are necessary in order to produce the planned results. Implementing all or part of the rate changes is just one alternative for management to consider.

The ‘Loss Ratio’ approach is very useful when there is a lack of credible claim experience. This is because this methodology is based on the idea of observing the impact on underwriting results by varying the claims cost, and the claims cost is estimated based on the available or current rates. Furthermore, when determining rates for writing new business, where no internal historical data exists, the actuary1 can still determine the indicated rate by estimating the expected pure premium and expense provisions and selecting a target profit provision (possibly based on industry statistics).

The rate variation for different risk characteristics occurs by modifying the base rate. An insurer that fails to charge the right rate for individual risks (when other insurers are doing so), is subject to adverse selection (and thus, potentially deteriorating financial results). An insurer that differentiates risks using a valid risk characteristic (when others are not) may achieve favorable selection and gain a competitive advantage.

When a company identifies a characteristic that differentiates risk that other companies are not using, the company has two options for making use of this information:

1. Implement a new rating variable.2. Use the characteristic for purpose outside of rate-making (e.g. for risk selection,

marketing, agency management)

If the company implements a new rating variable and prices it appropriately:

Its new rates will be more equitable It may write a segment of risks that were previously considered uninsurable It will attract more lower-risk insured at a profit Some of the higher-risk insured will remain and will be written at a profit

Over the long run, the company will be better positioned to profitably write a broader range of risks.1Or technical individuals involved.

We need to take into account of the adequacy of risk factors that are considered for pricing purposes. The key objective is statistical parsimony here as seeing too many risk factors in pricing tools means collinearity/multicollinearlity problems but two few risk considerations means that not an optimum pricing structure has been embarked upon.

What we often ignore is that market considerations play a larger role than risk considerations in setting of the prices of general insurance products. Pricing is inescapably linked with underwriting. We need to see different underwriting markets (soft is where prices are low and profits are low and hard is where prices are high and profits are higher). Another is underwriting itself. If we are underwriting high risks unduly then no amount of good pricing will be adequate. For instance, having third party as majority of motor portfolio will mean higher loss ratios relative to a balanced portfolio no matter how high the prices are charged for third party insurance. Such illustrating situation demands increasing comprehensive motor into the portfolio rather than increasing prices for the third party majority portfolio.

Apart from underwriting strategy, pricing is linked with business and product policy as well. Generally, if objective is revenue enhancement of market share in soft underwriting cycle, then pricing will tend to be low and underwriting less strict (higher GPW growth but higher loss ratios) and vice versa.

The Company emphasizes data capturing and management as pricing requires holistic data and not segregated in silos. IT capturing is important too especially for risk parameters. MIS platform is suited for this purpose.

One possible adjustment in deciding the ‘permissible loss ratio’ is to offset it by the ‘investment return’. Investment gains sometimes, but not always, offset underwriting losses. And certain forces significantly affect the underwriting results; inflation, regulation, competition, and investment results. When the major components of loss costs are increasing rapidly because of inflation, rates tend to increase more slowly because of competition among insurers. Competition also affects underwriting results. During periods of seemingly favorable results, insurers might try to increase their premium volume, writing business at less-than-adequate rates. Sometimes, it is possible to, based on a belief, write more commercial insurance at an underwriting loss, for which they can compensate with superior investment results. Although this practice can be effective in the short run when investment conditions are favorable, it can result in adverse operating losses.

That is why it is suggested that Underwriting decisions should be kept independent and distinct from investment decisions by the company.

Feasibility analysis for critical distribution channels like agents, brokers and bancassurance should be undertaken by the company to see how adverse market conditions can likely change the quantity and quality of business brought by these distribution channels for premium revenue.

Innovations should be adopted but cautiously. Complex forms medical and motor insurance products and add-ons, complex derivatives and investment instruments should be generally avoided as it is difficult to realize their precise consequences until it is usually too late. Pricing

should be continuously improved and enhanced but products should remain legible to all the stakeholders involved.

Lastly we would like to highlight that Insurance companies do not become insolvent due to having vulnerable balance sheets. As insurance is the business of risk taking so there are always vulnerabilities that have the potential to cascade and develop into a larger crisis. This vulnerability is kept in balance by risk management and market confidence. Ensuring that adequate premiums are charged for the commensurate risk is a part of this overall risk management.

This marks the end of the main report. The below sections are not part of the main report, but indicate how diverse and seemingly disconnected aspects of operations can have its impact on pricing like underwriting, market dynamics, reinsurance and so on. These are detailed as per the following sequence:

Overview of Motor Products and Coverages Investigating Motor Insurance Dynamics Medical Pricing- Some Considerations Market overview for Commercial Lines2

Underwriting Review Reinsurance efficiency Inherent variability in pricing forecasts

2 This subsection from 7.6 to 7.11 are from: http://www.asiainsurancereview.com/News/View-NewsLetter-Article/id/36990/type/MiddleEast/UAE-Excess-insurance-capacity-pressures-commercial-lines

Overview of Motor Products and Coverages

Motor insurance is a form of non-life insurance. And pricing for non-life products is dependent on the nature of insurance coverage i.e. the subject/person covered and the causal factors necessitating coverage.

Motor products written in UAE are usually for 13 months. The premium charged is for 12 months and one month being the graced period.

Motor insurance coverage is provided to:

Individuals: Also known as Personal or Private insurance coverage. Corporate Entities: Also known as Group or Fleet insurance coverage.

Broadly, there are three common type of motor insurance policy:

Own Damage - Insured only also known as own damage Comprehensive - Insured and Third Party coverage also known as comprehensive Third Party Liability - Third party coverage only

The kinds of coverage under either ‘Comprehensive’ or ‘Third Party Liability’ can be seen in the table below (Need to see this in UAE regulation context):

Comprehensive Third Party Liability

Damage Injury to body Theft (for enhanced policies) Death

Damage Injury to body Damage to third party property Death

Comprehensive Cover

Other additional coverages are Personal Accident, Natural Calamities, Roadside Assistance and so on.

Below is a brief description of the nature of the various items covered by the insurance policy listed above:

Damage: Damages covered could either be those to the insured individuals own car or to the third party’s vehicle. Damages could occur either due to collision, fire and other such perils. In the case of damage, the insurance company pays to repair the damage. However, in the case of the damage being extremely severe it is sometimes considered to be a total loss and the company would pay to replace the car. In the case of repairs that need to be conducted, these could either be conducted in the company owned garages, or in third party workshops.

Injury to body: Again this can either be for the insured individual or for the third party. In either case, the insurance company will either pay the full amount of the medical costs, or, will pay up to a certain limit.

Theft: This naturally will refer only to the theft of the insured individual’s car. The amount reimbursed to the insured by the insurance company will be subject to a limit. However, theoretically it is possible that the insurance company, after making certain adjustments (like depreciation), could replace the stolen car.

Death: In some Muslim countries, the death by accident of the third party by the insured would require the insured to pay a sum (termed as ‘blood money’) to the affected party’s family. In case of death of the insured, it is usually provided as an additional rider, known as the Personal Accident rider, to the main policy.

The type of coverage (i.e. death, damages, etc.) is one of the risk exposures that are associated with the insurance cover. And therefore type of cover is also an important factor for evaluating the price of particular insurance cover.

Motor Insurance Policy - Regulatory requirement 3

The Unified Motor Insurance policy is mandatory by law in the UAE. The minimum insurance as stipulated by law is a Third Party Liability insurance cover. The UAE Unified motor policy is available in two product forms:

Third Party Liability only – This meets the minimum law requirement. Loss, Damage and Third Party Liability – commonly known as Comprehensive or full

insurance.  Comprehensive cover may be bought at various optional levels depending on the additional rider covers and limits.

The minimum cover requirement can be provided by the majority of insurance companies within the UAE. Various extensions to the minimum cover can also be availed at an additional premium.

Insurance policies are valid for 13 months, covering the one-month grace period the Traffic Police allow after the registration expires (registration must be renewed annually). It is not possible to renew vehicle registration without proof of insurance.

Some insurers in the UAE provide a range of options and benefits at an additional affordable premium. These may include:

Personal Accident Benefit for Driver and Passengers (Scale as per Insurance Authority Standard Wording)

Agency Repair Increasing the limit under Third Party Property Damage Road side assistance Vehicle replacement during an accident – Car Hire Off-road cover Towing following an accident

3 Arabian Gazette; Tariq Zietoun; June 2016: How to choose the right Motor insurance in UAE

Emergency Medical Expenses following accident Storm, flood, riot, strike and civil commotion

Listed below are usually the main factors that decide your motor annual insurance premium:

Cover required (Type and Level) Age of the Insured and Driving Experience Vehicle Age Body Type Vehicle Value Number of Cylinders Vehicle Make and Model Claims History Use of the vehicle (Private / Commercial)

Not all insurance policies provide off-road driving insurance cover. It may be difficult to get comprehensive cover for cars over a certain age (usually seven years old) or certain classes of sports cars. Younger drivers may also find it more difficult to find comprehensive insurance, particularly if male. When particularly poor driving results in a serious accident or death, the driver at fault can expect a large fine and even a prison sentence. This is often followed by deportation.

Diya, or blood money, is a fine imposed for causing death willfully or by accident. The minimum fine imposed by the Dubai Courts is AED 200,000, and can be higher depending on the circumstances and claims of the victim's family. Bodily injury can be unlimited.

There is a zero tolerance policy for driving while intoxicated. Drinking and driving will result in arrest (and most likely jail time), fines and 24 black points on the driver's record. Driving under the influence of alcohol or drugs may also void insurance coverage in the event of an accident.

From October 2014, motor insurance companies have a shared database to determine insurance premium based on the accident history of the motorist, rather than previous general parameters such as age, nationality and driving experience. This means that if customer has bad loss history with one company, he cannot go to another insurance company without mentioning his prior history of claims.45

Moreover, 5 Insurance companies have the power granted by the Road and Transport Authority to register vehicles. This means that when a motorist goes to renew his vehicle insurance at one of the five approved insurers, he can also get his car registration renewed at the same place without visiting vehicle licensing departments or Tasjeel centers. The five insurance companies approved by the RTA for carrying out car registration are Royal and Sun Alliance Insurance, Fujairah Insurance, Oman Insurance, AXA Insurance and Noor Takaful Insurance.6

4 The National UAE; Aug 2015: Motor Insurance in Dubai.5 The National UAE; Oct 2014: UAE insurers can now use single database for drivers’ data 6 Gulf News; Aug 2016: Five Dubai Companies given power to register cars

The motorist, however, has to get the vehicle tested and get the vehicle pass test report from Tasjeel or other authorized vehicle test centers. However, a vehicle test report is not required any more for vehicles up to three years old.

Investigating Motor Insurance DynamicsFollowing are the selected extracts from relevant research report by Alfaki and Enaji7 for Investigating

Motor Insurance Dynamics entitled “Effect of Motor Insurance Premiums on Driver Behavior and Road Safety” Published in 2014 in Journal of Ergonomics.

Overview

“The intension is to shed some details into high risk groups in the UAE driver’s population who are involved in traffic accidents and consequently uncover possible links between motor insurance claims and the likelihood of involvement in traffic accidents.

It is worthy to note that 73% of traffic accidents in the UAE are caused by inappropriate driving behavior, in fact, more than 50% are attributed to either excessive speeding or careless driving.8 According to Abu Dhabi Emirate Road Code 2011, careless driving is perceived to include many aspects of breach of road code, such as tailgating, lane hogging, running red lights, failure to yield the right of way to other road users, etc.

Data Generation, Characteristics and Modeling

Published and sample surveyed data were used to investigate the country’s Road Travel Accidents (RTAs) experience and possible links between insurance premiums/claims and drivers’ behavior and road safety. Drivers’ risk profile and other relevant factors obtained from Abu-Dhabi Emirate vehicle drivers’ survey were used to probe into determinants of the number of motor insurance claims and to discuss characteristics of high risk drivers, those who are more likely to cause road accidents.

Over 80% of the 718 surveyed drivers were males; females represented about 16% of the sample, with average ages of 32.9 and 31.0 years, respectively. Almost two-thirds of the respondents were married. Emirati respondents represented one third of the sample, enjoying higher levels of education (13.5 years of education on average) compared to Non-Emiratis (12.8 average years of education). However, Emirati respondents have lower driving experience (on average 9.2 years since obtained UAE driving license) compared to Non-Emiratis who on average have 10.2 years of driving experience. According to the sample, Emirati nationals reported an average of 2.5 traffic accidents, compared to 1.9 for non-Emiratis.

Thus, the data might lead to the conclusion that splits UAE drivers at fault of causing Road Traffic Accidents (RTAs) due to behavioral mistakes into two groups. The first one is the group of middle age non-Emirati nationals who drive low value and low insurance premium

7 Alfaki IMA, Enaji M (2014) Effect of Motor Insurance Premiums on Driver Behavior and Road Safety. J Ergonomics S3: 007. doi:10.4172/2165-7556.S3-007 8 Bener A, Crundall D (2005) Road traffic accidents in the United Arab Emirates compared to Western countries. Advances in Transportation Studies an international Journal Section A 6

vehicles. The second group is the group of young Emirati nationals who drive high value and high insurance premium vehicles.

Generalized Linear model was applied with Negative Binomial providing the best fit to the claim count data. Different risk profiles of vehicles’ drivers obtained from Abu- Dhabi Emirate drivers’ survey were used to investigate predictors of the number of motor insurance claims. The fitted statistical models revealed a significant positive relationship between drivers of other vehicles and the increase in the number of claims compared to car drivers. The analysis further suggests that drivers with comprehensive motor insurance liability make more claims compared to those holding third-party motor insurance policies.

Results

According to our sample data, the driver’s age, gender or years of driving experience seem to have no significant impact on the number of motor insurance claims made in the UAE.

Based on the standard Poisson and other subsequent models, it was found that the age and the gender variables confirm the expected direction of the relationship reported by Abdalla9 that males and young age drivers are more responsible for causing RTAs compared to females and old age drivers. However, the model coefficients were not statistically significant; therefore, the two variables were removed from the model. It is worthy to note that Abdalla analysis used official Dubai Police data, whereas the current study is based on sample survey data. As police data in the UAE are considered more complete, inability to confirm statistical significance of age and gender in this study could be attributed to the limited scope of the conducted survey.

The study has identified two groups of UAE drivers who are more likely to be at fault of causing RTAs due to behavioral factors; viz careless driving or speeding. The first one is the group of middle age non-Emirati nationals who drive low value and low insurance premium vehicles, and the second one is the group of young Emirati nationals who drive high value and high insurance premium vehicles. At fault drivers in the lower premium pay level (less than 1000 AED) who caused RTAs due to behavioral mistakes were generally involved in more accidents than those in the higher premium pay level (5000 AED or more).

Results suggest that the proportion of drivers at fault in road traffic accidents decreases with the increase in the value of motor insurance premiums. Moreover, drivers who make more motor insurance claims are more likely to be guilty of causing traffic accidents. The nationality of the driver and the number of motor insurance claims made are two important predictors of high risk drivers.

Research evidence suggests that the nationality of the driver, marital status and the number of motor insurance claims made were significant predictors of the number of RTAs that are the driver’s fault. Emirati nationals have higher rate of causing traffic accidents compared to non-Emiratis. Interestingly, married individuals were found to cause more traffic accidents

9 Abdalla IM (2002) Fatality risk assessment and modeling of drivers’ responsibility for causing traffic accidents in Dubai. J Safety Res 33: 483-496.

compared to unmarried. Moreover, the analysis results apparently suggest that those who make more motor insurance claims are more likely to be guilty of causing the traffic accident.”

Medical Pricing- Some ConsiderationsIt is obviously plan now that data is of no use to us in our analysis. The question that arises is how are we able to arrive at strategic decision to conclude that medical pricing is adequate and meets the requirements of the law.

Medical inflation and expense structure needs to be kept in constant check and balance. What is the current pricing policy followed by the company? How is experience rating implemented currently in the company? How does the new health insurance law affect the current pricing policy of the company?

What is the current reserving policy for IBNR? Reserves are likely to increase as a whole multitude of pool of policyholders has been generated due to the new law. The question is ‘to what extent reserves will increase under different reserving policies.

Riders or additional benefits provided such as dental and optics should be evaluated.

Reinsurance Arrangements and Treaty Rates should be assessed on the basis of profitability and security provided to the company. The following Risk Factors should necessarily be monitored and appraised by the underwriting management of the company while deciding on the reasonability of the medical insurance product.

1) Product Name2) Product Type3) Insured Age4) Occupation5) White Collar/Blue Collar6) Health status (so we know if it’s high risk or low risk; pre-existing conditions, chronic

diseases, complications, number of admission to hospitals in a year etc will all impact the health status of the insured)

7) Gender8) Treatment at panel hospital Vs Non panel hospital.9) Third party/Fronting Vs insured by the company itself.10) Marriage status: Single/Married (as pregnancy can increase claim costs)11) Size of family dependents (Number of spouse and children and domestic workers)12) Smoker/Non-Smoker13) In patient Vs outpatient14) Health service provision; only consulted General Practitioner Vs Specialists15) New product features added as per the relevant Law like provision of prevention

services, cannot deny due to preexisting conditions etc and their estimated costs.16) Size of group being insured (so that we can gauge if economies of scale is actually

occurring in terms of larger volumes generating more capacity for the insurer or not)17) Insured Nationality18) Insured geographic presence (like residence and office)19) Deductibles and Co-Insurance proportions. 20) Registration Place21) Corporate or individual

22) Number of years of No Claim Discount23) Agent/broker; type of distribution channel24) Class of business (Private or Commercial)25) Pre-authorized claims and emergency claims26) Emergency provision of dental and optics Vs no dental and optics provided (this is

because dental and optics cannot be now excluded in cases of emergencies and these items are very costly)

These Risk factors should be properly reviewed by the underwriting management in case there are some patterns or abnormalities in the experience of the company. For instance, Blue Collar workers leading to a lot of claims, one occupation like laborers in engineering leading to exceptionally adverse experience and so on.

Hospitals are generally treating for more complex diagnoses and health problems. Complex treatments increase the requirement for IBNER generally. The more complex treatments that the hospital undertakes in majority of claims paid is:

Additional Cardio Limit Additional Accidental Limit M.R.I / C.T Scan Hospitalization Dread Disease

Whereas, the generally simpler treatments referred to clients are:

Outpatient Investigation Funeral Executive Checkup C. Inpatient Maternity C-Sec Maternity Normal C. Outpatient

There can also be significant cross-over effects at work here; for instance, for outpatient clients if health worsens, they get referred to hospitalization or dread disease or MRI/CT scan.

Clients are paid lower proportion of billed amount relative to hospitals. This might be due to lower documentation from clients or unstructured procedure for handling the situation leading to lower proportion being paid than hospitals with professional teams.

Market overview for Commercial Lines10

There is an observation in the GCC market that There is a risk of excess insurance capacity servicing commercial lines of business that are unlikely to experience high growth this year, given the competition in the market, thereby restricting bottom-line growth for insurers.

Regarding commercial lines, the increasingly complex nature of clients’ business exposure is making the process of risk analysis more difficult, as time is needed to adapt risk assessment techniques to changes in business fundamentals. Technological advancement, climate change and uncertain political and economic conditions are among other key factors making risk assessment and pricing more complex in these lines of business.

On the bright side, changing market dynamics bring new risks, which corporate clients would like to hedge while keeping associated costs at acceptable levels. To achieve this, clients demand insurance partners that are able to not only manage their risks effectively and efficiently but also have the resources and expertise to develop appropriate solutions that allow them to optimize business opportunities. This demand for increased expertise and adaptability is likely to give rise to unique differentiators among insurers.

Considering the current period of slow economic growth, most customers expect premium cuts, wide coverage and increased limits. While these expectations are challenging to meet, some underwriters are able to work more closely with clients to reduce their risks through additional services such as periodic risk inspections and recommendation of suitable risk management techniques. This not only improves the overall performance of risk management for clients but also allows insurers to share resulting benefits with customers in terms of pricing, profit sharing, etc. Insurers that are able to show such adaptability and breadth of expertise are likely to extract the best market share over the next few years.

Operational adaptability and underwriting discipline apart, there are also some silver linings on the product front. There are few insurers currently capable of investing in product innovation given high margin pressure. Consequently, non-conventional products are under less competitive pressure and have the potential to offer significant market share. Credit insurance and cyber liability are examples of non-conventional products that could offer stable returns over the next few years. In fact, cyber risk is an increasingly relevant phenomenon in the region requiring businesses to be insured. It is a typical example of changing market dynamics creating new risks and thereby new opportunities for product innovation.

Apart from cyber liability, other lines that can be expected to grow are sabotage and terrorism and political violence covers, due to the uncertain political and economic situation in some markets within the region.

The UAE is on the top of the list of countries worldwide when it comes to fire safety, in spite of a spate of high-rise blazes in recent years, international statistics show. Following a spate of high-

10 This subsection from 7.6 to 7.11 are from: http://www.asiainsurancereview.com/News/View-NewsLetter-Article/id/36990/type/MiddleEast/UAE-Excess-insurance-capacity-pressures-commercial-lines

rise blazes in Dubai, attention is focused on the issue of fire safety in tall buildings. An amended UAE Fire and Life Safety Code, expected to be released this year, will include fines levied on building consultants should faulty fire safety material be discovered by civil defense inspectors. Manufacturers who sell building materials not approved by authorities will for the first time face prosecution under new provisions in the updated fire safety code. At the same time, nearly 80% of expatriates in the UAE are not insured against fire damage.11

11 http://www.asiainsurancereview.com/News/View-NewsLetter-Article/id/37134/type/MiddleEast/UAE-Emirates-beats-several-developed-nations-in-fire-safety

Underwriting ReviewAssessing Risk Exposures

Insurance products are designed to minimize the financial or economic consequences of an undesired event. Therefore, any condition or situation that presents a possibility of loss, regardless of whether the loss actually occurs, is described as ‘loss exposure’. The components of loss exposure12 are:

Assets exposed to loss Cause of loss Financial consequences of loss

A very basic approach to underwrite any insurance product is to thoroughly identify all potential loss exposures and to investigate, using various techniques, characteristics of the loss exposure that have been identified. Identification and classification of loss exposure is the first step in the assessment of (potential) costs associated with the insurance product.

Underwriters must ensure that each loss exposure is properly classified so that it is properly rated. A very broad description for assessment purposes is provided in Annexure-A.

For group/fleet policies the risk is assessed collectively, usually based on the number of vehicles, type of vehicle and business, vehicle values and the financial position of the corporate/group.

Insurance claim-costs are typically based on an elaborate classification system in which similar loss exposures are combined into the same rating classification. Combining loss exposures into rating classification enables the insurer to appropriately match potential loss costs with an applicant’s particular loss exposures. Consequently, the insurer can develop an adequate premium to pay losses and operating expenses and to produce a profit.

In case of Group/Fleet insurance the insurer is better able to generalize about the probabilities of loss within large groups of similar risks and to formulate rates that reflect the average probabilities of loss for business within these groups. Therefore, a ‘class rating’ approach that uses rates reflecting the average probability of loss for business within large groups of similar risks is preferred.

Accurate classification ensures a pooling of loss exposures whose expected loss frequency and loss severity are similar. Misclassification can produce adverse results which include having insufficient premiums to cover losses and expenses or the inability to sell policies because prices are higher than competitors’ prices.

12 The term “exposure” sometimes is used to refer to the state of being subject to loss. It is also used to refer to the rating units on which insurance premium is based or to the units by which the probability and size of loss are measured.

Characteristics of Claims and Claims Handling

The claims arising from motor insurance fall into two categories mainly:

1. Property Damage2. Bodily injury (including death)

When analyzing motor experience, it is necessary to look at these two types of claims separately, because they are quite different in many ways. Furthermore, own damage and third party liability claims should also be looked into separately.

For claim cost estimation it is necessary to understand:

The reporting pattern- i.e. when claims are reported after the incident took place The recording process – i.e. how initial claim cost is estimated and when it is booked

as reserve The claim settlement – i.e. how long usually it takes in settling claims

Each of the points mentioned above is also dependent on whether an insurer has its own department for claims handling or a third party claim management arrangement is in place for that purpose, i.e. agency repair, workshops etc.

Claim cost for pricing purposes is estimated using incurred claims, where incurred claims include both paid claims and outstanding claims reserves. The process that is followed for estimating outstanding claims reserves for known reported claims and the estimation of claim that are not reported is important from the perspective of claims cost estimation.

Claim reporting and settlement delays are the major factors that are involved in the estimation of unreported claims. Claim settlement delays usually takes place for cases that go into legal disputes, and therefore should be analyzed separately.

Estimation of Claims Related Expenses

Usually claims related expenses are divided into two categories - allocated and unallocated expenses.

Allocated expenses are those costs that can easily be related to individual claims. Legal fees to defend against a specific claim, or costs incurred by a claim adjuster assigned to one claim are allocated claims related expenses. Since these are recorded separately with claim, therefore they are estimated as a part of claim cost.

Unallocated claims related expenses are those that are more difficult to assign to particular claims - such as claim department salaries. Also, these are more difficult to incorporate into the loss projection process.

At any time, a claims department may be working on settling claims that arise from events occurring during many historical time periods and pertaining to many lines of business. Because of this, companies need to allocate these in a sensible way. A simple method for allocating this cost is based on the assumption that unallocated cost expenditures track with claims and allocated expense consistently over time, both in terms of rate of payment and in proportion to the number of claims paid.

Estimation of General and Administration Expenses

Other than the claims cost, rates should also incorporate the cost of doing business - i.e. underwriting expenses. Underwriting expenses are broadly broken down into:

Acquisition expense Administrative expense

Acquisition expenses normally vary with the premium size and the type of business. These expenses are, by definition, assumed to be a constant percentage of the premium. For example, commissions may be 10% of premium.

Inflation also causes expenses to increase over time. Since historical expense ratios and other information are used to select a percentage that is to apply to the premium from policies written during the time the rates will be in effect, the variable expenses will automatically change as the premium changes. Thus, there is no need to trend the variable expense ratio.

Not all costs for acquiring and processing business vary with the premium size of the policy. Many expenses are the same for every policy regardless of the premium size. These costs are referred to as fixed expenses and are assumed to be the same for each risk, regardless of premium size. Typically, overhead costs associated with the office administration are considered a fixed expense. Since fixed expenses are assumed to be a constant amount therefore it will require adjustments for the effect of inflation.

The magnitude and distribution of underwriting expenses vary significantly for different businesses in different industries. For example, commissions tend to be much higher in businesses that require a comprehensive inspection at the onset of the policy than for those that do not involve such activity. The expenses can also vary significantly by company within a given industry. It follows, then, that expense estimation requires proper examination and analysis and the most recent years’ expenses would probably be more suitable than expenses over the last two, three or more year’s period. Furthermore, serious consideration should also be given to future changes which would affect expenses.

Reinsurance efficiencyThe MENA (Middle East and North Africa) reinsurance market is expected to harden over the next 12 months as per the ‘2016 MENA Reinsurance Barometer’ report. This hardening of rates and capacity can mean that reinsurance efficiency portray a very different picture within the next coming year than in this underwriting review report.13

This hardening of the reinsurance market will likely be due to a series of major insured losses which affected the region over the course of the past 12 months and the subsequent retrenchment of some leading market reinsurers. Many reinsurers operating in the region have recently suffered significant losses, especially in the property line of business, and view current pricing levels as technically insufficient.

On average, domestic insurers in the MENA region cede 29% of their premium income to reinsurers, almost four times the global average. This strong reliance on reinsurance is expected to decrease: following the most recent spate of major loss events, reinsurers have stepped up their pressure on cedants to keep more ‘skin in the game’, on top of similar requirements from regulators and rating agencies by increasing their retentions.

13 Point 7.35 to 7.37 refer to: http://www.asiainsurancereview.com/News/View-NewsLetter Article/id/37216/Type/MiddleEast/MENA-Region-s-reinsurance-rates-are-expected-to-rise-over-next-12-months

Inherent Variability in Pricing Forecasts

Differences between pricing projections and actual amounts are contingent to the extent to which future experience conforms to the assumptions made for this analysis. It is quite certain that actual experience will not conform precisely to the assumptions used in this analysis. Actual amounts in all reasonability will deviate from projected amounts to the extent that actual experience differs from expected experience.

The burning costs, premiums and other projections contained in this report represent our actuarial best estimates of ultimate claim costs based on available data. Nonetheless, in reviewing these results and analyses, it is vital to highlight and recognize the uncertainty and variability of loss reserve estimates. The causes of this variability are the unpredictable external factors which affect future inflation rates, litigation trends benefit changes, social and judicial attitudes, and economic factors amongst others.

The Company can and does experience internal changes and this can affect claim settlement patterns, claim reserving and pricing patterns, and cost control efforts.

Key variables that can lead to different experience than forecasted include the selections of loss development factors, expected loss ratios, change in underwriting cycles, change in business conditions and regulatory landscape in addition to change in trend and tail factors. The overall estimates are potentially sensitive to any of these and reasonable alternative selections can change the estimates in either direction.

Overall, we believe that actual results could differ significantly, and in either direction, from the estimates projected in this analysis. Nevertheless, the pricing estimates presented herein reflect our best professional judgment.

Inherent Uncertainty in Pricing Forecasts