CS-18: THE ACTUARIAL ROLE IN THE AUDIT Brian E. Johnson, ACAS, MAAA Senior Underwriter

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3 The Deal Team Traditionally the deal team was lead by the UW or Account Exec and the Actuary was just called upon to “crunch” the numbers

4 Data/Structure Loss Cost

5 The Deal Team Only looking at the submission could lead to a misinterpretation of what is going on at the company By looking at the UW files actuaries can quite often interpolate information wrt the submission that is not evident In addition you will quite often be able to extract anecdotal evidence that may not otherwise be available in the company’s system (information not captured)

6 The Deal Team Some examples of anecdotal information that can be obtained from the UW files include: – Trends in usage of pricing components (credits/debits, IRPM mods, adjusted ILFs, a-rates, class codes, etc) – Effects of minimum premium not otherwise captured in rate change – UWs consideration of the specificities of a risk which lead to pricing decisions (or lack thereof)

7 The Deal Team The actuary should also sit in meetings with a cross section of insurance professionals i.e. UWs and claims. This will allow the actuary to hear about important changes to the company and relate them to things they may see in the data.

8 Case Study – A Tale of Two Actuaries Two actuaries (at different companies) Alpha and Beta both received a submission from Pandorum Insurance Company who is looking to buy a quota share on their umbrella business. Alpha decides that he is too busy to participate on the UW/Claims review. Instead he sends a couple of questions back to Pandorum’s actuary to confirm his understanding of the data in the submission Beta attended The Actuarial Role in the Audit at the CARe meeting and very wisely decides it is well worth his time to attend the audit. First we will look at a few aspects of the submission and then see how each actuary utilizes them in their analysis

9 Case Study – A Tale of Two Actuaries One exhibit that was of interest to both actuaries was the historical and projected limits distribution According to the submission, Pandorum had made a concerted effort to move up into higher layers (away from the lead position) to layers that they perceive to be more adequate. The exhibit is as follows:

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12 Case Study – A Tale of Two Actuaries In addition the submission has the following rate change summary

13 Case Study – A Tale of Two Actuaries Both actuaries notice that there is in fact a shifting in the attachment point to higher layers. In addition, they also notice that they are also writing higher limits. Both actuaries ask if there has been a shifting in the class of business commensurate with the shifting in the limits/attachment distribution (the old adage that people who buy higher limits need them) The response back is that they are writing the same kinds of risk and that there has been no shift in the hazard group

14 Case Study – A Tale of Two Actuaries Both actuaries also notice that the Pandorum seems to have achieved much bigger rate changes in the soft market than their competitors. They both ask to confirm that these are actual exposure adjusted rate changes and not premium increases. The response is that these rate change have been adjusted for increases and decreases in the exposure. The response also goes on to say that the rate change is calculated as part of the UW process. Details can be found in each UW file. Alpha (who is a very busy man) accepts this explanation and moves forward with his analysis. Beta makes a note to confirm the process while looking at UW files.

15 Case Study – A Tale of Two Actuaries While reviewing files Beta notes how the rate change was calculated in several files. Here is one example what he sees:

16 Case Study – A Tale of Two Actuaries Beta immediately notices that the “rate change” does not account for the expanding limit. He does a quick adjustment to reflect the difference in limit and sees for this particular account the change in rate is not +3.3% but instead a -1.7%.

17 Case Study – A Tale of Two Actuaries Beta sets up a meeting to talk to the Chief Pricing Actuary and the Senior VP of Underwriting. Beta asks about the rate change calculation in the files compared to what was in the submission. In addition he also asks about any changes going forward that may not be reflected in the data.

18 Case Study – A Tale of Two Actuaries Pandorum’s actuary confirms that the rate increase does not reflect change in limit. Since their retention ratio is in the high 90’s and historically the limits didn’t change much the system was not created with that kind of complexity. He goes on to say it is on ITs list of enhancements for their pricing/underwriting system.

19 Case Study – A Tale of Two Actuaries When asked about company changes the SVP of UW comments that due to Agent feedback they are going reduce their minimum premium per mill from $1,500 to $1,250 for 75% of their classes. Given the higher average attachment and propensity to hit minimum premiums more frequently, Beta asks if they have tried to estimate the change in rate due to the lowering of the minimum They both comment that this kind of information is not currently captured in their pricing system but that it is on IT’s list of future enhancements.

20 Case Study – A Tale of Two Actuaries Beta and his UW audit team get through 35 files. Beta is able to use the data captured in these files to make subjective adjustments to the rate change to account for the decrease in the minimum. In addition, he also uses the change in limits/attachment distribution and Pandorum’s ILF tables to adjust the rate change history. Even though the minimum premiums per million are decreasing Beta feels as though there is some additional rate lift provided by the mins. Using data from the sample of files reviewed Beta estimates the net rate lift due to minimums.

21 Case Study – A Tale of Two Actuaries He runs his adjustments by Pandorum’s actuary for ensure they are somewhat reasonable. The actuary agrees the adjustments make senses. Here is a comparison of the unadjusted and adjusted rate changes.

22 Understanding the Big Picture In addition to a better understanding of the data, the actuary may also gain additional insight to other changes at the company that should be reflected in the loss cost selection. For example, quite often companies will stop writing certain classes or lines of business that have been historically unprofitable for them. In order to determine how much “credit” can be given for these kinds of changes the actuary must have a very thorough understanding of the changes in the UW guidelines and how they are being implemented by the desk UW’s.

23 Understanding the Big Picture While understanding rate changes on renewals is an important step towards estimating loss cost, it is also important to understand the marginal effect on rate levels of writing new business. If company ABC’s average rate change on their renewal book is say -3%, the business that was non-renewed (written new by company XYZ) is written at a rate decrease bigger than -3%. By that same token, when ABC writes a new piece of business, there may be a difference in the average rate adequacy of the new business versus the renewal book.

24 Understanding the Big Picture The actuary can gather statistics from the files which will allow them to estimate the adequacy of premiums of new business versus renewed business. Things to look for and compare include: average rate level by class of business, average unit rate per vehicle, difference in discretionary mods, difference in take-up factors in the case of umbrella business While estimating the new business rate effect is not exact it should be considered especially in cases where the company is growing and there is a material amount of new business.