1. Rick Leavitt, Smith Group Steve Rulis, Munich American Re Session 103F: Group Disability Forum Anaheim Spring Meeting May 21, 2004 Modeling Alternative Pricing Strategies

2. OutlineOutline Rationale for Model Rationale for Model Model Construction Model Construction New Sale DynamicsNew Sale Dynamics Renewal DynamicsRenewal Dynamics Model Output Model Output Questions and Discussion Questions and Discussion

3. LTD Pricing Issues Manual Rate Variance Manual Rate Variance Carriers Buying Market Share Carriers Buying Market Share Underwriting Cycle Underwriting Cycle Short Term versus Long Term Strategies Short Term versus Long Term Strategies Pricing Slow to Respond to Risk Dynamics Pricing Slow to Respond to Risk Dynamics

4. Manual Rate Variance

5. Pricing Model Assumptions 7 to 10 Carriers on Every Quote 7 to 10 Carriers on Every Quote All Manual Rates are Equally Valid All Manual Rates are Equally Valid Level of discounts determined by other quotes Level of discounts determined by other quotes All Sales Reps are equally proficient All Sales Reps are equally proficient

6. New Case Assumptions Carriers more than 25% above the lowest rate have no chance for sale Carriers more than 25% above the lowest rate have no chance for sale All Carriers within 5% of the lowest rate have equal chance for sale All Carriers within 5% of the lowest rate have equal chance for sale Carriers between 5% and 25% above the lowest rate have a diminishing chance of sale Carriers between 5% and 25% above the lowest rate have a diminishing chance of sale Carrier Rates are distinguished by three parameters Aggregate level Variance of Rate Maximum Discount Allowed

7. New Sale: Price Elasticity

11. Renewal Model Some Cases will take almost any rate increase Some Cases will leave regardless of renewal action Incumbent has a rate advantage at time of sale Assumptions: 95% Attrition95% Attrition Cases not shopped if increase is less than 5%Cases not shopped if increase is less than 5% 25% cases are not shopped at any increase25% cases are not shopped at any increase Incumbent has 20% rate advantageIncumbent has 20% rate advantage

12. Renewal Model

13. 10-Year Simulation Fixed General Assumptions: Consider Start-up BlockConsider Start-up Block No Change in Risk Dynamics over TimeNo Change in Risk Dynamics over Time 2% Annual Growth in Available Employers2% Annual Growth in Available Employers Other Carriers follow a Stable Pricing PhilosophyOther Carriers follow a Stable Pricing Philosophy Test Assumptions: Manual Rate MarginManual Rate Margin Manual Rate VarianceManual Rate Variance Maximum DiscountMaximum Discount Target Increase on RenewalTarget Increase on Renewal Rate GuaranteesRate Guarantees Maximum Number of Rate IncreasesMaximum Number of Rate Increases

14. Scenario 1: On Target Pricing No Rate Increase on Renewal Scenario 1: On Target Pricing No Rate Increase on Renewal

15. Scenario 2: Modest Acquisition – Breakeven Pricing, 10% increase on renewals (Max of 3)

16. Model Variance: 1000 simulations

17. Scenario 3: Aggressive Acquisition – Priced at a Loss, 20% increase on renewals (Max of 2)

18. Scenario 4: Moderate Acquisition Pricing – Two rate increases limited to 5%

19. Scenario 5: Classic Underwriting Cycle

20. Scenario Comparison

21. Scenario Comparison: Results from Years 6-10

22. Impact of Rate Guarantee

23. ObservationsObservations Caveat: Model is simple and may not reflect actual marketplace dynamics Adequate stable pricing produces better long-term results Acquisition Pricing: Lower persistency keeps long-term premium growth low, especially after more than one increase Best results from slightly low prices followed by modest increases (if early below-target profit can be afforded!)

24. Discussion Points Model Assumptions vs. Todays LTD Marketplace Model Assumptions vs. Todays LTD Marketplace How Best To Operate In This Environment? How Best To Operate In This Environment?

25. Discussion Points -- Marketplace Start-Up Blocks vs. Ongoing Blocks Start-Up Blocks vs. Ongoing Blocks Expense Ratios Expense Ratios Growth Targets Growth Targets Current Year Results vs. Rolling Averages Current Year Results vs. Rolling Averages Trends in Results Trends in Results

26. Discussion Points -- Marketplace Constant Risk Dynamics vs. Constant Risk Dynamics vs. Trends in Claim Costs Trends in Claim Costs Aging Population Aging Population Leveraging of Social Security Offsets Leveraging of Social Security Offsets Obesity Obesity Economic Factors Economic Factors

27. Discussion Points -- Marketplace Other Carriers Philosophies Other Carriers Philosophies Stable and Rational? Stable and Rational? Throw in a New Entrant? Throw in a New Entrant? Aggressive Growth Goals? Aggressive Growth Goals?

28. Discussion Points -- Execution New Business Pricing Process New Business Pricing Process Underwriter Discretion Underwriter Discretion Sales Office Pricing Pools Sales Office Pricing Pools Updating Manual Rate Basis Updating Manual Rate Basis Grey Areas in Manual Rates Grey Areas in Manual Rates Credibility and Experience Rating Credibility and Experience Rating

29. Discussion Points -- Execution Implementing Rate Increases Implementing Rate Increases Developing the Renewal Strategy Developing the Renewal Strategy Rate Increases Targeted at Block Level or Case Level? Rate Increases Targeted at Block Level or Case Level? Segmenting the Business Segmenting the Business Differences By Case Size?Differences By Case Size? SIC Categories?SIC Categories? Voluntary vs. Non-Contributory?Voluntary vs. Non-Contributory? What to do with Rate Decreases? What to do with Rate Decreases?

30. Discussion Points -- Execution Aligning The Organization Aligning The Organization Underwriting Underwriting Objectives at Department or Employee Level?Objectives at Department or Employee Level? Which Metrics to Use?Which Metrics to Use? Sales Sales Compensated Based on Persistency?Compensated Based on Persistency? Compensated Based on Profitability?Compensated Based on Profitability? Actuarial Actuarial

31. Discussion Points -- Execution Measuring The Results Measuring The Results What Types of Experience Reports? What Types of Experience Reports? Beware of the Vanishing Rate Increase! Beware of the Vanishing Rate Increase! What if Rate Increases Achieved But Earnings Objectives Not Met? What if Rate Increases Achieved But Earnings Objectives Not Met?