LOSS

 

What exactly is a loss, by actuarial standards? A loss is defined as any amount of damage or liability that results due to a claim that is filed by an insured. A loss requires payment by the insurance company only when that loss is in accordance with the terms of a given insurance policy. For example, if you have a loss of $50, and your deductible is $500, this loss is not covered by the insurance company since it is below the deductible amount. If you have a loss of $501, and your deductible is $500, the only portion of this loss covered by the insurance company is the loss that is in excess of the deductible (in this case, the loss covered by the insurance company is $501-$500=$1). In this last case, we say that the paid loss is $1.

 

LOSS RATIO

 

Now, what exactly is a loss ratio? A loss ratio is the portion of each premium dollar used to pay for losses. That is,

 

Loss Ratio = Total Losses / Total Premium

 

A loss ratio is a key determinant of how well a specific insurance product is doing, and is indicative of its profitability in future policy periods. Then, these ratio values will be used to help actuaries determine which lines of business should grow, shrink, or stay at their current level in the future (On a side note, this is one term I heard every day while I was interning as an actuarial intern this summer).

Take Insurance products A and B. Say, product A has a loss ratio of 20 and product B has a loss ratio of .5. Which one is doing better? Well, product A has a much smaller denominator, which in turn, gives it a larger loss ratio. This means that the premium being charged is too low, since the losses are much larger than the amount of premium. This is a loss for the company and a loss ratio this large is terrible for an insurance company. One way to improve (i.e., lower) this loss ratio value is to increase the premium amount, or decrease the amount of policies that are being insured for this specific product (since fewer policies implies fewer losses). With this same logic, product B is doing much better, since its premium amount is much larger than the amount of losses, which results in a profit for the insurance company.

 

EXPOSURE

 

Insurance companies use the exposure “unit” in order to determine how much a policyholder pays for their premium. An exposure (unit) is the basic unit of risk that underlies the insurance premium. It refers to the item exposed to loss as governed by the specific insurance purchased. For example, if you purchase automobile insurance, an exposure unit for auto can be expressed in terms of how much it would cost to repair that specific car if it were damaged in an accident.

 

INDEMNITY

 

The concept of indemnity was one that I heard very frequently over the summer at my P&C actuarial internship. The principle of indemnity states that the insured will be reimbursed for a loss in the form of payment, repair or replacement. So, if you get in a car accident and your car is totaled, your insurance company will indemnify you (i.e., compensate you) for your loss, in the form of payment that you will use towards your new car. This concept of indemnity is solely designed for reimbursement and compensation. The insured should NOT gain or profit from any loss. That is, the policyholder should be restored to their prior state before the loss occurred.

 

PRICING & RESERVING

 

Two of the most common, traditional roles that actuaries do are pricing and reserving. Pricing, as it sounds like, is the act of pricing an insurance policy. This is not as easy as it sounds though. Actuaries must use past data in order to predict how much it costs to cover a given policyholder. For example, if you’re in charge of pricing an auto insurance policy for an individual, some of the things you may have to consider are:

• What is the gender of the driver? Statistically, males are proven to be more reckless drivers.

• What is the age of the driver? Auto premiums are higher for younger ages, and typically doesn’t decrease until an individual turns age 25.

• What is the type of car that they want to insure? Is it a typical sedan, or a sports car?

• What color is the car they are insuring? Some color cars (e.g., red) are statistically more likely to get in an accident than other colors.

Reserving, on the other hand, entails insurance companies setting aside money for policyholders that they are going to have to pay money to at some point in the future. Basically, when an insurance policy sells insurance to the policyholder and they receive a premium, they have to set aside a portion of that premium in order to ensure that they’re able to pay you what you deserve when you file a claim for an accident. Insurance company reserves have to include a variety of factors, such as:

• People that have had an accident, but haven’t told the insurance company yet

• This is referred to as IBNR (Incurred But Not Reported) claims. Still, this is another cost that the insurance company has to account for.

• An accident that has occurred, and has had money set aside for it already, but this amount ends up being a lot less than what the amount paid out to the claimant (the person filing the claim) has to be

• Many other reasons.

And if you figured, reserving calculates IBNR, and Actuaries are responsible for calculating the Actuarial Best Estimated IBNR.

 

UNDERWRITERS

 

One thing I learned this summer was that actuaries don’t only work with other actuaries; they also work with other insurance “specialists” within an insurance company. One of these is called underwriters. Both life insurance companies and Property&Casualty insurance companies have underwriters (CLU-Chartered Life Underwriter, CPCU-Charted Property Casualty Underwriter), and actuaries frequently work with them. Underwriters are individuals who examine potential and current policyholders, in order to determine if that individual is a high risk or a low insurance risk. Then, working with Actuaries, the underwriters classify the policyholders into specific groups in order to determine what premium to charge for each. As an example, an underwriter may say “This individual is too risky to insure, we are unable to insure them,” or “this individual is low-risk, so we will charge them $X premium.”

 

MORAL HAZARD

 

Moral hazard is the concept that a policyholder will act differently after receiving an insurance policy, that could potentially expose the insurance company to more risk than they calculated or initially assumed. For example, say you are a good driver, with no history of accidents, and you decide to get a new auto insurance policy. How does the insurance company know that you don’t just start driving recklessly, or speeding? If you have theft insurance, how does an insurance company know that, now you don’t even care if you park your car in a safe place, since you know now you will be covered? Essentially, moral hazard entails the concept that giving security will encourage more risk-taking, with a “Don’t worry, I’m insured” attitude.

With this notion, you can potentially ask an interviewer “How does your insurance company account for moral hazard when you price an insurance policy?” For example, Progressive’s “Snapshot” accounts for this moral hazard risk by implementing a device into your car that can track your driving, and give you discounts for good driving records.

 

Hopefully you found this article helpful. If you need any more help, feel free to contact the club for further questions.

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Resources:

http://www.actuarialninja.com/

https://en.wikipedia.org/wiki/Incurred_but_not_reported

https://en.wikipedia.org/wiki/Actuarial_reserves

https://www.youtube.com/watch?v=TQtUbgpnmPk

https://www.investopedia.com/ask/answers/09/moral-hazard.asp