Page 44 - Insurance Times June 2023

so, they must price accurately, and the pricing of basis how much it should be setting aside in reserves in
insurance is called rate making. order to handle claims arising from incidents that have
already occurred, but for which it does not yet know the
To evaluate if the ratemaking is optimal, measurements
full extent of its liability. Claims arising from incidents
like loss ratios are used.
which have already occurred but which have not been
The most basic ones are
reported to the insurer are termed IBNR (incurred but
not reported) claims. Claims which have been reported
loss adjust expenses
Loss ratio = but for which a final settlement has not been determined
Earned premium are called Outstanding. Claims reserving is a challenging
exercise in general insurance, and one should never
This measures how much of the premiums received are
underestimate the knowledge and intuition that an
used for settling claims
experienced claims adjuster uses in establishing reserves
underwriting expenses and estimating ultimate losses. However mathematical
Expenses Ratio = models and techniques can also be very useful, and give
Earned premium the added advantage of laying a basis for simulation.

This calculates how much of the premiums received are
used for issuing new policies Problems Faced by Insurers:
Combined loss and expenses ratio = Probabilities may change through time
Policy holders may alter probabilities (moral hazard)
Loss ratio plus expenses ratio
Policy holders may not be representative of population
The sum of the two helps an insurance company gauge
from which probabilities were derived
its actual cost of writing new policies and covering losses
for a given period. The lower it is indicates more profits Insurance Company's portfolio faces risk.
for the company. However, there is not one ideal loss
Probability of Ruin is the percentile of the probability
ratio. Depending on industry subsidies and company
distribution corresponding to the point at which capital
objectives, companies' target loss ratios vary greatly
is exhausted. Typically, a minimum acceptable probability
from 40% to sometimes over 100%.
of ruin is specified, and economic capital is derived
When the actual loss ratio differs from the expected loss therefrom.
ratio, a rate change is needed to correct the difference.
Though a simple percentage surcharge or discount can Conclusion:
be applied to the overall premiums, a rate change usually The general insurance actuary needs to know the essentials
involves evaluating the entire ratemaking algorithm and of decision and game theory in the market of general
revising individual rating variables. This process requires insurance. An understanding of probability and statistical
actuarial skills and can take weeks or months of time. distributions is necessary to absorb and evaluate risk and ruin
when balancing claims, reserves and premiums. In introducing
Concepts of Rating;
and developing new products, credibility theory and statistics
In general insurance, claims due to physical damage (to
play a role in evaluating sample and collateral information.
a vehicle or building) or theft are often reported and
Generalised methods are essential tools in finding risk factors
settled reasonably quickly. However in other areas of
for premiums calculations. Time series methods are used in
general insurance, there may be considerable delay
various ways to predict trends, and simulation methods are
between the time of a claim inducing event and the
crucial to understanding the many models considered for
determination of the actual amount the company will
anything from new products to revisions in rating schemes. Is
have to pay in settlement. When an incident leading to a
it no wonder that the general insurance actuary must be a
claim occurs, it may not be reported for some time. In
practicing statistician.
employer liability insurance, the exposure of an employee
to a dangerous or toxic substance may not be discovered
Any actuary must keep abreast of investment and economic
for a considerable amount of time. In the case of an
trends, and therefore should be familiar and comfortable with
accident the incident may be quickly reported, but it
the basic concepts of univariate time series including
may be a considerable amount of time before it is
stationarity. A knowledge of the basic theory of random walks
determined actually who is liable and to what extent.
and co-integration of times series is also essential together
Clearly an insurance company needs to know on a regular with an ability to apply these concepts to investment models.
40 June 2023 The Insurance Times