AAA - Risk classification SOP Flashcards Preview

CAS Exam 8B > AAA - Risk classification SOP > Flashcards

Flashcards in AAA - Risk classification SOP Deck (10):
1

How and why individual risk rating affects the needed level of refinement in a classification system.

To the extent that prices are adjusted based on risk's actual experience, less refined risk classification systems are needed.
Experience rating refunds, premium adjustments or dividends, ultimately produce a refined risk classification system.

2

List four operational considerations and how each contributes to the success of a classification system.

1. Expense - cost of collecting data and pricing classes should not exceed the benefits achieved
2. Absence of ambiguity - classes should be collectively exhaustive and mutually exclusive
3. Minimize abilities to manipulate system
4. Measurability - class variables (age, sex, occupation) should be reliably measurable.

3

5 Basic principles to achieve the primary purposes.

1. reflect expected cost differences
2. based on relevant cost-related factors
3. applied objectively
4. practical and cost efficient
5. accepted by public

4

three primary purpose of risk classification system

1. protect insurance systems financial soundness
- risk classification is a primary mean to control instability caused by adverse selection
2. be fair
- prices are not unfairly discriminatory
- reflect expected cost differences
- no redistribution or subsidy among classes
3. encourage coverage availability through economic incentive
- motivate insurer to refine their risk classification system to better serve both high and low cost risks.

5

List three methods for determining price and one deficiency for each method

1. rely on wisdom, insights, and good judgment
- valuable information is lost when a risk's actual loss experience is not reviewed.
2. Observation of the risk's actual loss experience over an extended period of time
- gradual changes in hazard may render past information useless
3. Observation of losses from groups of individual risks with similar characteristics
- identification of similar risk characteristics before the observation period is problematic

6

Briefly describe adverse selection

adverse selection arises when buyers are free to select among different sellers, and when sellers react by offering a similar product at a price where the seller has not matched price to cost.

7

Two methods for controlling adverse selection.

1. risk classification in a voluntary market
- charges each risk an appropriate rate through proper risk classification
- balances the economic forces governing buyer and sellers
2. Compulsory insurance with limited choice
- restriction of buyer freedom prevents adverse selection

8

What are the three statistical considerations

1. Homogeneity
- Individual risks within a class should have reasonably similar expected cost

Credibility
- number of claims should be voluminous to warrant credibility

Predictive Stability
- responsive to changes in the nature of insurance loss
- yet stable in avoid unwarranted abrupt changes

Homogeneity and credibility are in conflict:
making a class more homogeneous by eliminating risks comes at the expense of credibility. There may not end up being enough risks in the class to make it credible.

9

Discuss advantages and disadvantages of using controllability as a consideration for in
identifying rating variables

Advantage:
- Its close association with an effort to reduce hazard
- general acceptability by the public

Disadvantage -
- Susceptibility to manipulation
- it's irrelevance to predictability of future costs

10

Three elements of programs design and briefly describe the impact of each on risk classification

1. Degree of buyer choice:
compulsory system: little choice, less refined risk classification system maybe used without the issue of adverse selection
2. Degree of experience based pricing: to the extent that premium is modified based on individual risk's actual experience, less refined risk classification system may be used
3. Premium payer - if someone other than the insured is the premium payer, premium is of less concern to the insured. less refined risk classification system may be used.