www.the-actuary.org.ukSoft marketInsurance187 Pricing process Ensuring that the data captured is accurate and complete in order to allow a technically driven price to be calculated to support the underwriting process.187 Rate monitoring process Ensuring that changes in market conditions are captured accurately in order to provide management information to mitigate the effects of the cycle.187 Pricing and rate monitoring controlsTo ensure that the pricing and rate monitoring processes are effectively controlled through appropriate mechanisms such as peer review and/or internal audit. Nicholas Thein March 2008 39is typically written on worse terms than renewal business since the business needs to be attracted from the previous insurer, usually by offering a lower price or better terms. Given this, the rate index would understate rate reductions in the softening market. If rates are actually 15% off based on all business, rather than, say, 10% based purely on renewal business, then this could add $3m to $4m to the reserve levels based on rolling forward a 70% IELR. Overall, it is not clear what constitutes best market practice as to the methods used to calculate these rate indices, and who conducts rate monitoring 8212 the underwriting or actuarial function, or a combination of both? Controls The controls around the pricing process are fairly standard throughout the market. It is common to have actuaries involved in calculating at least the expected loss cost element of the technical premium. Most insurers have a 8216four eyes8217 principle where risks are peer-reviewed, although this is often only after risks have been bound. Further to this, internal audit functions will review a sample of risks written to ensure underwriting guidelines and processes are adhered to. The controls around the rate monitoring process are generally less well embedded. The calculation of the rate index involves a fair degree of subjectivity and it can be dif64257 cult to allow for some of the factors discussed above. An added complication is how to monitor rates in binding authorities where the nature of such underwriting can make it more dif64257 cult to do so. Again, peer review may be used where underwriters oversee each other8217s judgments on rate movements but this could potentially lead to collusion where the underwriters scratch each other8217s backs.An internal audit is rarely a reliable option as those involved often lack the relevant skill-set to provide effective challenge in this area. Those insurers that recognise the value to be gained from effective monitoring of pro64257 tability are those that will succeed over the length of the underwriting cycle.The April 2008 edition of The Actuary will feature a roundtable debate on the issues surrounding the general insurance soft market.9632 Historic claim levels9632 Underlying exposure9632 Terms and conditions9632 In64258 ation9632 Level of deductible/attachment point9632 Excesses/limits.Most, if not all, (re)insurance companies and syndicates now maintain some form of rate index. The idea is to track rates from year to year for each main line or class of business written. The aim of the index would be to capture the impact of the changes listed above so, for example, using 2000 as a starting point and re-basing to, say, 100, we can track how rate levels have changed each year relative to 2000 levels (see Figure 1).Such an index is commonly used to roll forward ultimate loss ratios from prior years to give an initial expected loss ratio (IELR) for the Bornhuetter-Ferguson reserving method, to estimate ultimate claims for the most recent year or years. The importance of this rate index can be seen in terms of the level of reserves. For example, applying a 60% or 70% IELR to a $100m book of premium could lead to a difference in reserves of $10m on the most recent year of account.How is this index calculated? There is a range of sophistication evident, from a subjective view provided by underwriters, based on what they are seeing in the market, to more quantitative approaches trying to capture the impact of each of the factors outlined above. Each factor is recorded with varying levels of complexity and accuracy. Another issue to consider is whether new business is captured within the rate index or not. In practice it is easier to ignore new business because details of the previous year8217s risk may be incomplete. However, new business The challenges facing insurers in a softening market The Actuary website features an exclusive article by Paul Johnson of Antares Underwriting Services on different approaches to monitoring rate changes. Visit www.the-actuary.org.uk to read the article.Web exclusive 8211 rate monitoring038_039_Actuary_soft_0308.indd 3919/2/08 11:17:13
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