Driving returns: global insurers reconsider fixed income and private assets
Final Report
1. 1
Actuarial Science Program
Integrated Project Group # 3
Pricing Tool for General Liability Insurance
May 13th
, 2016
Students: Jingwen Yuan, Wenzhao Yang
Mentors: Eric Ratti, Nicole Fong
Supervisor: Lina Xu
Pricing Tool for
General Liability Insurance
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Table of Content
Executive Summary……………………………………………………............2
Introduction………………………………………………………………………3
Data/Methodology……………………………………………………………....7
Analysis…………………………………………………………………….........9
Conclusion……………………………………………………………………...13
Appendix A: Search Function………………………………………………...14
Appendix B: Reasonability Test Function…………………………………...16
Appendix C: East Start Over Function…………………………………........18
Appendix D: VBA Code………………………………………………………..20
Appendix E: ILF, DCF and LCM……………………………………………...23
Appendix F: Historical Data…………………………………………………...26
Appendix G: Final Indicate Premium…………………………………………28
Appendix H: Weekly Meeting Agenda……………………………………….29
Appendix I: Weekly Meeting Minutes………………………………………...40
Appendix J: Statement of Intention…………………………………………..85
Appendix K: Project Charter………………………………………………….89
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1. Executive Summary
Eric and Nicole, both from a P&C insurance company, are planning to
develop a tri-state general liability insurance product for small businesses.
They need a pricing tool for underwriters to calculate the premium of this
new product. Wenzhao and Jingwen, actuarial consultants from Columbia
University, are hired to develop this pricing tool.
Driven by our dedication to excellence, we finished a thorough theoretical
research, figured out the whole ratemaking process. We meet with our
clients weekly to keep updated on any new requests and offer instant
feedback. Every progress in this project is well-documented.
Our pricing tool is designed to be accurate, convenient and flexible. Apart
from the essential formulas for calculation, we also built handy functions into
our tool, such as quick search, reasonability testing, easy start-over, etc. Our
tool is tested to be robust under various scenarios.
With the support of this pricing tool, our clients are smoothing their way to
launch new products into the market.
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2. Introduction
a) Project Description
General liability insurance is for companies to protect their business and
assets when faced with property damage claims, bodily injury claims or any
other claims that are caused by their premises or products.
In our case, we only consider businesses in three state, namely New York,
New Jersey and Connecticut.
We also limit our study to two policy types, i.e., claims-made and occurrence.
A claims-made policy provides coverage when a claim is made against it.
The claim event needs to be after the retroactive date, a date used to
determine insurance liability. On the other hand, an occurrence policy
provides coverage as long as it is active when an accident occurs. The
retroactive date is not applicable for the occurrence policy.
In addition, for expenses, we only consider commission, taxes and general
expense. Commission is a percentage set by the underwriter, that has to be
less than 30%. Taxes depends on the state we underwrite. General expense
is fixed at 20%.
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b) Core Concepts’ Explanations
• Limit is the maximum amount for which an insurance company would
be liable. This is an indispensable feature for general liability
insurance.
• Deductible is part of the limit that an insured would be responsible to
pay. For example, if the limit is $100,000, and the deductible is
$10,000, then the maximum amount that an insurer would pay for
losses is $90,000.
• Class Code is what we used to describe the business that an insured
is in.
• Loss Cost, also known as Pure Premium, is a measurement for the
average expected cost purely depends on loss.
c) Product Design
We built our pricing tool through spreadsheets in Excel. We will show the
underwriters three main pages, namely the General Information page, the
Historical Loss Date page, and the Final Indicated Premium page. We hide
all the calculation process in any other spreadsheets or the VBA code.
In the General Information page, underwriters will input basic information of
the insured and the insurance policy, as well as the class codes. This page
will show underwriters the manual premium, a premium that should be
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charged to average members of homogeneous groups based on similar
risks.
In the Historical Loss Data page, underwriters will input historical loss
information of the specific insured for the latest three years. They will also
input individual claims information for all the large losses that is greater than
the deductible. This page is used to calculate the Experience Modifier, an
important factor applied to calculate the final premium.
In the Final Indicated Premium page, no extra data input is needed. This
page will present underwriters the value of the Experience Modifier, the
Schedule Modifier, and the Final Indicated Premium. Also, aggregate losses
within or greater than the deductible will be accumulated and shown by year.
d) Flexible Functions
Search Function is used when an underwriter cannot memorize the class
codes he should input. This function will show all the descriptions that
contain the keyword he typed in. Similar to the Google Search, it is case
insensitive. Once a certain description is selected, the related class code will
pop-up. (Appendix A)
Reasonability Testing Function catches mistakes made by underwriters and
gives a warning message. For example, Connecticut doesn’t have territory
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502.
If an underwriter types in 502 and chooses “CT” in the state column, a
warning message will appear on the screen saying “Territory 502 doesn’t
exist in State CT. Please select a right one.” This function is also applied to
check the accuracy of the commission value, the loss information, and the
retroactive date. (Appendix B)
Easy Start-Over Function offers a small button on the General Information
page and the Historical Loss Data page for underwriters to click on when
they need to clear up all the data they have input. This function can largely
save their time. (Appendix C)
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3. Data/Methodology
a) Data Resource and Reference
All the tables we used during the calculation process are provided by the
Insurance Services Office and randomized by our mentors to preserve
proprietary information.
We followed the rules in ISO Commercial General Liability Experience and
Schedule Rating Plan, 2006.
The book we referred to is called Basic Ratemaking, written by Geoff
Werner and Claudine Modlin.
b) Methodology
The whole calculation process can be split into three parts.
The first part is to calculate the manual premium, an average premium we
would get for homogenous groups with similar risks. The three main factors
we use in this part are the Increased Limit Factor (ILF), the Deductible Credit
Factor (DCF) and the Loss Cost Multiplier (LCM), which depend on the limits,
the deductible and the expenses respectively. (Appendix E)
The second part is to calculate the experience modifier. For General Liability
Insurance, manual ratemaking is not enough because individual risk
experience can be expected to vary widely around the average group rate.
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Thus, we make appropriate adjustments to the manual premium on the
historical experience of insured individuals. This part is crucial for some past
claims that are sufficiently large. The latest three years of historical loss data
are used. (Appendix F)
The third part is to calculate the final indicated premium using the results
from the two parts above. (Appendix G)
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4. Analysis
a) Policy Type Analysis
As we mentioned in section 2.1, there are two different policy types in
general liability insurance: claim-made policy and occurrence policy. In this
section, we will explain the differences between these two policy types and
the purpose of using them in general liability insurance.
During the 1960s and 1970s, because of high economic and social inflation,
loss trend for many liability lines increased dramatically causes high
increases in claim frequency. However, almost all liability insurance polices
were written on occurrence policy form. Hence, once a claim occurred, the
insurer became perpetually obligated to indemnify the insured. As a result,
in the 1970, insurers writing liability insurance experienced a dramatic
upswing in late-reported claims as well as increases in the average cost of
claims due to the high inflation. Therefore, the industry developed an
alternative to occurrence coverage that help to minimizes the time between
the coverage inception and claim settlement: Claims-made policy.
The major difference between claims-made policy and occurrence policy is
that for claims-made policy, we have an additional date except effective date
and expiration date: retroactive date. Retroactive date must be earlier than
effective date, and any claims occur between retroactive date and expiration
date are covered by insurer. In most liability insurance, the maximum
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number of years between retroactive date and expiration date is less than 4
years. As a consequence, there are some additional factors are considered
during the pricing process for claims-made policy: claims-made factor and
two policy adjustment factor.
Claims-made factor is used when we calculate the manual premium and it
must be less or equal to 1. For instance, if the number of years between
retroactive date and effective date is 1, then we will use “1st
year claims-
made” factor which equals to 0.45. Claims-made factor increases as number
of years between retroactive date and expiration date increases. In the final
calculation of manual premium, we multiply claims-made factor for get the
manual premium for claims-made policy. Moreover, claims-made factor
equals to 1 for occurrence policy or if number of years between retroactive
date and effective date is greater than 4.
Additionally, there are two policy adjustment factors related to claims-made
policy when we calculate experience modifier. One policy adjustment factor
applies when the policy being rated is a claims-mode policy and take
premium up to an occurrence level. The other policy adjustment factor
applies only when a particular policy of the experience period is a claims-
made policy and take the occurrence premium back down to the appropriate
claims-made level.
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In summary, claims-made policy has replaced occurrence policy as the most
common type of policy offered by liability insurance. And the premium for
claims-made policy is less than occurrence policy under the same insurance
contract.
b) Class Code
In this section, we will discuss purpose and application of class code.
General liability insurance protects a business’s property and assets. But a
business may have various activities and operations, and each of them may
associate with different exposure. Thus a gym, for example, which is
measured by the square footage of the space occupied by the gym.
Therefore, area multiple loss cost per square feet can give us the pure
premium (expected loss cost).
The exposure may include in terms of area, sales, number of employees, or
other relevant unit, and all of these liability exposures are given a code
number and brief description, and ordered alphabetically in the company’s
manual. Each class code contains five numbers and underwriter can type in
class code to find the corresponding description, exposure type and
exposure base.
Using the correct class code is extremely important in order to price a policy.
Because incorrect class code will delivery wrong exposure information which
will cause a big gap between expected premium and calculated premium.
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c) Admitted vs Not Admitted
Admitted business is highly regulated by the state insurance departments
while not admitted is not. Therefore, the difference between admitted
business and not admitted business while we are pricing general liability
insurances is state tax rate will be included for admitted business.
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5. Conclusion
This pricing tool is an important connection between underwriters and
actuaries. We created this pricing tool for underwriters to use and help them
understand the pricing process of general liability insurance. A pricing
actuary’s job is to calculate the price of general liability insurance by taking
account all information that underwriter collects from our client. Hence, the
communication between underwriter and actuary is extremely important in
order to calculate a reasonable premium for different clients. Therefore,
design of pricing tool need to be user-friendly and make complexities into
simple terms. All references and tables we have used in our pricing tool are
following the requirements of company’s instruction and ISO (insurance
service office) manual.
It has been a pleasure working on integrated project with Eric and Nicole
during the past three months. We have been successfully following our
project plan since we first started our project. Whenever we encounter a
difficult situation, our mentors always help us to find great solutions without
any hesitation. This is a great project for us to learn about P&C insurance
industry and general liability insurance. Both of us find the materials of our
project are very appealing and really help us to launch a career as Property
and Casualty Actuaries.
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Appendix A:
Search Function
1. When the cell A13 is selected, the search function is activated. A blank
textbox and a list box containing all the descriptions will be presented.
2. After the underwriter types in a key word, the list box will then present
descriptions that contain this keyword, regardless of upper case or
lower case.
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3. One certain description will show in the textbox after the underwriter
has double clicked on it. Also, the corresponding Class Code will
appear on the right.
4. Click on the button ‘Input’, then this class code will be put into the
column below automatically. This process can be repeated and the
class codes will be input in sequence.
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Appendix B:
Reasonability Testing Function
1. If the commission input is larger than 30%, our tool can catch it.
2. If the territory and the state combination is wrong, our tool can catch
it.
3. If the historical total loss for one year is smaller than the sum of
individual claims of that year, our tool can catch it.
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Appendix C:
Easy Start-Over Function
1. We set this ‘Clear All Data’ button in both the General Information
page and the Historical Loss Data page.
2. If the button is clicked on, a message box will appear, asking for
confirmation.
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3. If ‘No’ is selected, nothing will happen. If “Yes” is selected, all the data
will be cleared and the underwriter can start over easily.
