Estimating Future Costs for Prospective
Property/Casualty Risk Transfer and Risk Funding

Third Exposure Draft

TRANSMITTAL MEMORANDUM

December 2016

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the Actuarial Standards Board and Other Persons Interested in Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Funding

FROM: Actuarial Standards Board (ASB)

SUBJ: Proposed Actuarial Standard of Practice (ASOP), Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Funding

This document contains the third exposure draft of the proposed ASOP, Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Funding (formerly Property/Casualty Ratemaking). Please review this third exposure draft and give the ASB the benefit of your comments and suggestions. Each written response and each response sent by e-mail to the address below will be acknowledged, and all responses will receive appropriate consideration by the drafting committee in preparing the final document for approval by the ASB.

The ASB accepts comments by either electronic or conventional mail. The preferred form is e-mail, as it eases the task of grouping comments by section. However, please feel free to use either form. If you wish to use e-mail, please send a message to comments@actuary.org. You may include your comments either in the body of the message or as an attachment prepared in any commonly used word processing format. Please do not password protect any attachments. If the attachment is in the form of a PDF, please do not “copy protect” the PDF. Include the phrase “ASB COMMENTS” in the subject line of your message, as any message not containing this exact phrase in the subject line will be deleted by our system’s spam filter. Also, please indicate in the body of the e-mail if your comments are being submitted on your own behalf or on behalf of a company or organization.

If you wish to use conventional mail, please send comments to the following address:

Estimating Future Costs
Actuarial Standards Board
1850 M Street, NW, Suite 300
Washington, DC 20036

The ASB posts all signed comments received to its website to encourage transparency and dialogue. Unsigned or anonymous comments will not be considered by the ASB nor posted to the website. The comments will not be edited, amended, or truncated in any way. Comments will be posted in the order that they are received. Comments will be removed when final action on a proposed standard is taken. The ASB website is a public website, and all comments will be available to the general public. The ASB disclaims any responsibility for the content of the comments, which are solely the responsibility of those who submit them.

Deadline for receipt of responses in the ASB office: April 30, 2017

Background

Estimating future costs for prospective property/casualty risk transfer and risk funding has been a fundamental part of actuarial practice since the beginning of the profession. Estimating future costs based on sound actuarial practice is essential to the integrity of the insurance and risk financing system and is a key to fulfilling the promise embodied in the insurance contract. The board of directors of the Casualty Actuarial Society (CAS) adopted the Statement of Principles Regarding Property and Casualty Ratemaking (Statement of Principles) in May 1988 (before the ASB was established). This document featured four fundamental principles of ratemaking and also discussed additional considerations. More recently, the CAS requested that the ASB develop an actuarial standard of practice in the area of property/casualty ratemaking. In its request, the CAS noted that the Statement of Principles contained considerations that might be expanded to become the basis of an ASOP.

Ratemaking has become much more complex and sophisticated since the days of the promulgation of the CAS Statement of Principles. In crafting this proposed ASOP and responding to comments from its initial exposures, the ASB quickly realized that there are significant differences of opinion within the profession regarding certain aspects of ratemaking, including pricing, price optimization methodologies, and rate filing requirements, that would need to be reconciled before a comprehensive standard of practice on ratemaking could be developed. Therefore, in order to create a standard of practice for the core aspects of ratemaking that could be issued in a reasonable amount of time, the ASB has chosen to develop this proposed ASOP to pertain solely to the development or review of future cost estimates for prospective property/casualty risk transfer and risk funding. It should be noted, however, that upon completion of this proposed ASOP, the ASB will give consideration to the development of a standard of practice on rate filings in an attempt to address the various issues within rate regulatory discussions today (for example, price optimization, unfair discrimination, and the Principles contained in the current CAS Statement of Principles).

This draft ASOP incorporates all of the Considerations contained in the CAS Statement of Principles and addresses issues related to cost estimating for risk transfer and risk funding not currently addressed in existing ASOPs. This exposure draft also references other existing ASOPs that include relevant issues related to the estimation of future cost estimates for prospective risk transfer and risk funding.

First Exposure Draft

In September 2014, the ASB approved a first exposure draft with a comment deadline of January 31, 2015. Twenty-two comment letters were received and considered in making changes that were reflected in the second exposure draft.

Second Exposure Draft

In December 2015, the ASB approved a second exposure draft with a comment deadline of April 30, 2016. Eighteen comment letters were received and considered in making changes that are reflected in this third exposure draft. For a summary of issues contained in these comment letters, please see appendix 2.

Key Issues

In redrafting the proposed standard, the reviewers focused on the following key issues:

1. Clarifying the scope of the proposed ASOP to estimating future costs for prospective property/casualty risk transfer and risk funding and not the preparation of rate filings and the issues related to the interactions between ratemaking, pricing decisions, and rate regulation;

2. Adding  a section requiring the actuary to determine and disclose the intended measure for the estimation of all future costs based on the intent or purpose of the future cost estimates; and

3. Adding additional disclosures in section 4 to be consistent with the guidance in section 3.

Request for Comments

The ASB appreciates comments on all areas of this proposed ASOP and would like to draw the reader’s attention to the following questions:

1. Does the proposed ASOP provide sufficient and appropriate guidance to actuaries estimating future costs for prospective property/casualty risk transfer and risk funding?

2. The proposed ASOP has added reference to “intended measure” for the estimation of all future costs to eliminate any implication that the only appropriate estimate of all future costs was an expected value without any consideration of potential variability. Is it clear what is meant by “intended measure”?

3. Are the definitions of “risk transfer” and “risk funding” in the proposed ASOP complete from the perspective of all activities in which an actuary is involved when estimating future costs for prospective property/casualty risk transfer and risk funding?

4. Is it clear that this proposed ASOP provides guidance only for the estimation of future costs for prospective property/casualty risk transfer and risk funding? Is it clear that the scope does not include items such as the balancing and interaction of potentially competing objectives related to regulation, business objectives, and actuarial cost estimates?

5. When the role of the actuary is reviewing the estimate of future costs developed by another actuary, is the guidance provided in the proposed ASOP sufficient and clear?

6. Is the level of disclosure required in the proposed ASOP sufficient and appropriate? If the response is no, what are the issues?

The ASB voted in December 2016 to approve this third exposure draft.

Ratemaking Task Force
Patrick B. Woods, Chairperson
J’ne E. Byckovski Claudine Modlin
Gregory L. Hayward Christopher J. Westermeyer
Casualty Committee of the ASB
Kenneth R. Kasner, Chairperson
Caryn C. Carmean Heather D. Lake
Benjamin W. Clark Mary Frances Miller
Thomas J. De Falco Alan K. Putney
Gordon K. Hay Robert J. Walling III
Actuarial Standards Board
Maryellen J. Coggins, Chairperson
Christopher S. Carlson Barbara L. Snyder
Beth E. Fitzgerald Kathleen A. Riley
Darrell D. Knapp Frank Todisco
Cande J. Olsen Ross A. Winkelman

The Actuarial Standards Board (ASB) sets standards for appropriate actuarial practice in the United States through the development and promulgation of Actuarial Standards of Practice (ASOPs). These ASOPs describe the procedures an actuary should follow when performing actuarial services and identify what the actuary should disclose when communicating the results of those services.

PROPOSED ACTUARIAL STANDARD OF PRACTICE

ESTIMATING FUTURE COSTS FOR PROSPECTIVE PROPERTY/CASUALTY RISK TRANSFER AND RISK FUNDING

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose

This actuarial standard of practice (ASOP) provides guidance to actuaries when performing actuarial services with respect to developing or reviewing future cost estimates for prospective property/casualty risk transfer and risk funding. This includes cost estimations for insurance, reinsurance, self-insurance, risk-funding or retention mechanisms, loss portfolio transfers, or any other risk-transfer mechanism.

1.2 Scope

This standard applies to actuaries when performing actuarial services with respect to developing or reviewing future cost estimates (often known as actuarial indications) for prospective property/casualty risk transfer and risk funding. For example, this standard applies when actuaries are developing future cost estimates underlying product prices, estimating funding requirements for self-insured programs and captives, and developing reinsurance contract prices.

As estimates are often made for separate elements of the cost of risk transfer and risk funding (for example, loss and loss adjustment expenses, operational and administrative expenses, and the cost of capital) and subsequently summed to a total cost estimate, this standard applies to the separate elements as well as the total. If the actuary’s role relates to any of the elements of the future cost estimate, the guidance in this standard applies only to the actuarial services related to those elements. If the actuary’s actuarial services involve reviewing future cost estimates developed by another party, the actuary should use the guidance in section 3 as is practicable. This standard also applies to developing or reviewing the future cost estimates by class within a risk classification system.

Actuarial services involved in developing or reviewing estimates of future costs may include actuarial communications, expert testimony, regulatory activities, legislative activities, or statements concerning public policy to the extent these activities involve providing an opinion on property/casualty future cost estimates.

If the actuary departs from the guidance set forth in this standard in order to comply with applicable law (statutes, regulations, and other legally binding authority), or for any other reason the actuary deems appropriate, the actuary should refer to section 4.

1.3 Cross References

When this standard refers to the provisions of other documents, the reference includes the referenced documents as they may be amended or restated in the future, and any successor to them, by whatever name called. If any amended or restated document differs materially from the originally referenced document, the actuary should consider the guidance in the referenced standard as amended or restated to the extent it is applicable and appropriate.

1.4 Effective Date

This standard is effective for work performed on or after six months following adoption by the Actuarial Standards Board.

Section 2. Definitions

The terms below are defined for use in this standard.

2.1 Coverage

The terms and conditions of a plan or contract, or the requirements of applicable law, that create an obligation to pay benefits, expenses, or claims associated with contingent events.

2.2 Exposure Base

A basic unit that is used to measure the future risk-transfer and risk-funding cost. This unit can vary by element of cost.

2.3 Method

A systematic procedure for developing, reviewing, or revising future cost estimates or elements thereof.

2.4 Model

A simplified representation of relationships among real world variables, entities, or events using statistical, financial, economic, mathematical, or scientific concepts and equations.

2.5 Risk Funding

A mechanism for the assessment, management, and financing of exposure to loss.

2.6 Risk Transfer

A risk management and control strategy that involves the contractual shifting of financial exposure to loss from one party to another. Examples of risk transfer are seen in the purchase of insurance, reinsurance, loss portfolio transfers, or any other mechanism by which a specified exposure to loss is shifted from one party to another party.

Section 3. Analysis of Issues and Recommended Practices

3.1 Future Cost Estimate

The actuary should determine the elements that are appropriate to include in the future cost estimate. Such elements may include, but are not limited to, loss and loss adjustment expenses, operational and administrative expenses, and the cost of capital.

3.2 Intended Measure

The actuary should determine the intended measure based on the intent or purpose of the future cost estimate. This intent will be affected by the desires or needs of the principal, legal requirements, and the regulatory environments in which the future cost estimate will be used.

Examples of intended measures include, but are not limited to, the mean, the mean plus risk margin, a range of reasonable outcomes, or a specified percentile of the distribution of possible outcomes. For example, a common intended measure is the mean. There are instances in which other measures may be appropriate based upon the intent or purpose of the estimate.

The actuary should disclose the intended measure used in accordance with section 4.2.

3.3 Organization of Data


If appropriate data is available, the actuary should determine how data will be organized to develop or review the future cost estimate or any element of the future cost estimate.

For each element, the actuary should select the data aggregation that is appropriate for the type of analysis being performed. Examples of data aggregation may include, but are not limited to, aggregating by accident period, calendar period, policy period, and report period. The nature of the insurance coverage, the element of the future cost being estimated, and the type of analysis being conducted will influence the selection of the data aggregation.

The actuary also should consider the level of granularity of data needed for the type of analysis being performed. For example, one level of aggregated data may be appropriate for estimating the overall future cost, whereas more refined data may be appropriate for estimating future costs by class within a risk classification system.

3.4 Data Quality

The actuary should refer to ASOP No. 23, Data Quality, for guidance in the consideration of the choice and use of data for estimating future costs.

3.5 Methods, Models, and Assumptions

The actuary should select appropriate methods or models consistent with the intended measure for estimating the future costs  or  each element of the future cost. The actuary should use reasonable assumptions (including parameters) appropriate to each method or model. Assumptions may be implicit or explicit and may involve interpreting past data or projecting future trends. The actuary should use methods or models, along with reasonable assumptions, that, in the actuary’s professional judgment, have no known significant bias relative to the intended measure. When using models, the actuary should refer to ASOP No. 38, Using Models Outside the Actuary’s Area of Expertise (Property and Casualty) [Note: revision pending], and any ASOP on modeling that is adopted by the ASB.

3.6 Exposure Base

If selecting a new exposure base or changing an existing exposure base, the actuary should take into account various practical requirements. For example, the exposure base should bear a strong relationship to the risk-transfer cost or risk-funding cost, as well as be objectively measurable and easily verifiable. To the extent these criteria are in conflict, the actuary should use professional judgment to select an appropriate exposure base.

Some risk-transfer and risk-funding plans may have multiple exposure bases, with different exposure bases applying to different aspects of coverage provided (for example, sales revenue for general liability, amount of insurance for commercial property). In undertaking analyses for these plans, it may be appropriate to designate one exposure base, referred to as the composite exposure base, to act as a proxy for the more refined coverage-by-coverage exposure bases.

3.7 Risk Classification System

Risk classification systems are an integral part of the development of future cost estimates for prospective property/casualty risk transfer and risk funding. The actuary should refer to ASOP No. 12, Risk Classification (for All Practice Areas), for guidance in the design, review, or change of the classification plan.

3.8 Use of Historical Data

The actuary should determine the extent to which historical data are available and applicable for estimating future costs. For example, the data should be consistent with insurance policy provisions or risk-management provisions of the applicable self-insurance, risk-funding or retention mechanisms, or any other risk-transfer mechanism.

3.8.1 Use of Historical Exposure and Premium Data

If the actuary is using historical exposure and premium data, the actuary should consider adjusting the data to reflect a consistent exposure and rate level, if applicable. These considerations include adjusting historical data to a common exposure level and adjusting premium data for historical changes in how premium charges are calculated, including both changes to manual rates and the impact of any individual risk rating plans. These adjustments should consider changes during and after the historical period. The actuary should select an appropriate method for adjustments that is consistent with the nature of the available data, the intended measure, and the purpose of the analysis.

3.8.2 Use of Historical Loss and Loss Adjustment Expenses

The actuary should determine the extent to which historical loss and loss adjustment expenses are available and applicable as a basis for estimating future costs. In determining the future costs related to loss and loss adjustment expenses, the actuary should consider adjusting historical data using methods or models, along with reasonable assumptions, that, in the actuary’s professional judgment, reflect the ultimate value of the loss and loss adjustment expenses. The actuary should also consider the coverage being evaluated, the type of analysis (such as overall future cost level analysis or risk classification analysis), the historical period and conditions in which the claims occurred, and the underlying claim adjustment and reserving process.

The actuary should consider whether the analysis of loss adjustment expense data requires different methods, models, or assumptions than the analysis of loss data. Additionally, different coverages within a line of business may require different methods, models, or assumptions.

3.8.3 Additional Adjustments to Historical Data

The actuary should consider additional adjustments to the historical data needed to reflect the environment expected to exist in the period for which the future costs are being estimated. These adjustments may include, but are not limited to, the following:

a. judicial, legislative, or regulatory changes;

b. mix of business changes;

c. policy contract changes;

d. claim practice or reserving changes;

e. operational changes;

f. accounting changes; and

g. reinsurance changes.

3.8.4 Trends

The actuary should consider past and prospective changes in claim costs, claim frequencies, exposures, and premiums. The actuary should refer to ASOP No. 13, Trending Procedures in Property/Casualty Insurance, for guidance in the selection of trends for estimating future values of costs associated with the elements that make up the future cost estimate.

3.9 Expenses

The actuary should refer to ASOP No. 29, Expense Provisions in Property/Casualty Insurance Ratemaking, and ASOP No. 13 for guidance in estimating future expenses.

3.10 New Coverages or Exposures

If the actuary is estimating the future cost for a coverage or exposure, and the historical loss and loss adjustment expenses are either unavailable, limited, or not fully representative of the coverage or exposure, the actuary should consider the following in selecting data and developing methods, models, or assumptions for use in estimating the future costs:

a. data from coverages or exposures that are similar to the new coverage or exposure;

b. data on the phenomenon or events that are contemplated by the new coverage or exposure;

c. differences between coverages or exposures with available relevant data and the new coverage or exposure; and

d. appropriate adjustments to the available relevant data to reflect expected differences identified in section 3.10(c).

3.11 Credibility

The actuary should refer to ASOP No. 25, Credibility Procedures, for guidance in considering the credibility given to a particular set of data and the selection of the relevant experience used to supplement the data, which is often referred to as the complement of credibility.

3.12 Modeling

The actuary should refer to any ASOP on modeling that is adopted by the ASB for guidance in the consideration of models used for estimating future costs.

3.13 Treatment of Catastrophes

The actuary should refer to ASOP No. 38 [Note: revision pending] and ASOP No. 39, Treatment of Catastrophe Losses in Property/Casualty Insurance Ratemaking, for guidance in the consideration of catastrophes.

3.14 Treatment of Unusual Events

The actuary should refer to ASOP Nos. 23, 25, 38, and 39 for guidance in the consideration of other unusual events, such as large individual losses.

3.15 Reinsurance

When reinsurance is reflected in future cost estimates, the actuary should select appropriate methods or models, along with reasonable assumptions, for estimating the cost associated with reinsurance arrangements expected to exist during the period for which the future costs are being estimated. If the cost of reinsurance is treated as an expense, the actuary should refer to ASOP No. 29 for additional guidance.

3.16 Profit and Contingency Provisions and the Cost of Capital

The actuary should refer to ASOP No. 30, Treatment of Profit and Contingency Provisions and the Cost of Capital in Property/Casualty Insurance Ratemaking, for guidance in the consideration of the profit and contingency provisions and the cost of capital.

3.17 Additional Funding Sources

In some risk-transfer systems, income may come from other sources, such as assessments to policyholders or other parties including insurers, a larger group of insurance purchasers, or taxpayers. The actuary should consider additional sources of funding and their allocation and timing when estimating future costs.

Section 4. Communications and Disclosures

4.1 Actuarial Communications

When issuing actuarial communications under this standard, the actuary should refer to ASOP Nos. 12, 13, 23, 25, 29, 30, 38, 39, and 41, Actuarial Communications.  In addition, the actuary should disclose the following in an appropriate actuarial communication:

a. the elements included in the future cost estimates (see section 3.1);

b. the intended measure used in developing or reviewing the future cost estimates (see section 3.2);

c. the methods or models used in developing or reviewing the future cost estimates (see section 3.5); and

d. the assumptions used in developing or reviewing the future cost estimates (see section 3.5).

4.2 Disclosures

The actuary should also include the following in an actuarial communication, if and when applicable:

a. if appropriate data is available for the analysis, the actuary should disclose the data organization used for each element (see section 3.3);

b. if the actuary selects a new exposure base or changes an existing exposure base, the actuary should disclose the new or revised exposure base (see section 3.6);

c. if the actuary uses historical data, the actuary should disclose any adjustments made to the historical data (see section 3.8);

d. if the actuary estimates future costs for a coverage or exposure with unavailable, limited, or not fully representative historical data, the actuary should disclose the data used and any appropriate adjustments made to the data (see section 3.10);

e. when reinsurance is reflected in future cost estimates, the actuary should disclose the methods or models, along with the assumptions, used in estimating the costs of reinsurance (see section 3.15);

f. if the actuary considers additional sources of funding, the actuary should disclose how the funding was reflected in estimating the future cost (see section 3.17);

g. the disclosure in ASOP No. 41, section 4.2, if any material assumption or method was prescribed by applicable law;

h. the disclosure in ASOP No. 41, section 4.3, if the actuary states reliance on other sources and thereby disclaims responsibility for any material assumption or method selected by a party other than the actuary; and

i. the disclosure in ASOP No. 41, section 4.4, if, in the actuary’s professional judgment, the actuary has otherwise deviated materially from the guidance of this ASOP.

Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes and is not part of the standard of practice.

Background

Cost estimation, ratemaking, and risk funding have been a fundamental part of actuarial practice since the beginning of the profession. A critical piece of these professional activities is the estimation of future costs.

Ratemaking principles and standards of practice are important to protect the soundness of the system, permit economic incentives to operate, and thereby encourage widespread availability of coverage. The board of directors of the Casualty Actuarial Society (CAS) adopted the Statement of Principles Regarding Property and Casualty Ratemaking in May 1988. The Statement of Principles has served as a foundational source of information regarding future cost estimation and ratemaking, providing both principles and considerations. Several actuarial standards of practice (ASOPs) issued by the Actuarial Standards Board are also important in future cost estimation, including the following:

  • ASOP No. 12, Risk Classification (for All Practice Areas);
  • ASOP No. 13, Trending Procedures in Property/Casualty Insurance;
  • ASOP No. 23, Data Quality;
  • ASOP No. 25, Credibility Procedures;
  • ASOP No. 29, Expense Provisions in Property/Casualty Insurance Ratemaking;
  • ASOP No. 30, Treatment of Profit and Contingency Provisions and the Cost of Capital in Property/Casualty Insurance Ratemaking;
  • ASOP No. 38, Using Models Outside the Actuary’s Area of Expertise (Property and Casualty) [Note: Revision pending];
  • ASOP No. 39, Treatment of Catastrophe Losses in Property/Casualty Insurance Ratemaking;
  • ASOP No. 41, Actuarial Communications; and
  • Proposed ASOP on modeling

Current Practices

Over the years, a multitude of methods and models for the estimation of future costs have been designed, put into use, and modified as a result of experience. Materials and publications of the CAS such as the Syllabus of Basic Education (formerly the Syllabus of Examinations), Variance, Proceedings (discontinued in 2014), Foundations of Casualty Actuarial Science, Ratemaking and Ratemaking/Product Management Seminar archives, and others provide discussions of current practices. While these may provide useful educational guidance to practicing actuaries, none is an actuarial standard of practice.

Throughout our history as a profession, actuarial future cost estimates have not always been the sole basis for rates and prices in risk-transfer or risk-funding transactions. For example, important other influences may include regulatory requirements and business objectives. Such other influences may support or compete with actuarial future cost estimates in deciding upon final rates and prices.

The increased availability of data and advances in technology, tools, techniques, and learnings from other disciplines have resulted in continued evolution of methods and models for the estimation of future costs. Innovation and use of new data and technologies will continue.

Appendix 2

Comments on the Exposure Draft and Responses

The second exposure draft of this proposed ASOP, Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Funding (previously Property/Casualty Ratemaking), was issued in December 2015 with a comment deadline of April 30, 2016. Eighteen comment letters were received, some of which were submitted on behalf of multiple commentators, such as by firms or committees. For purposes of this appendix, the term “commentator” may refer to more than one person associated with a particular comment letter. The Ratemaking Task Force carefully considered all comments received, reviewed the exposure draft, and proposed changes. The Casualty Committee and the ASB reviewed the proposed changes and made modifications where appropriate.

Summarized below are the significant issues and questions contained in the comment letters and responses.

The term “reviewers” in appendix 2 includes the Ratemaking Task Force, the Casualty Committee, and the ASB. Also, unless otherwise noted, the section numbers and titles used in appendix 2 refer to those in the second exposure draft.

Click here to view comments in their entirety (second exposure draft).

Comments

Click here to view comments in their entirety (third exposure draft).

Print Friendly
LinkedInTwitterFacebookMore...