Second Exposure Draft
Proposed Actuarial Standard of Practice
TO: Members of Actuarial Organizations Governed by the Standards of Practice of the Actuarial Standards Board and Other Persons Interested in Property/Casualty Ratemaking
FROM: Actuarial Standards Board (ASB)
SUBJ: Proposed Actuarial Standard of Practice (ASOP), Property/Casualty Ratemaking
This document contains the second exposure draft of proposed ASOP, Property/Casualty Ratemaking. Please review this second 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.
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Ratemaking (Second Exposure)
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, 2016
Ratemaking has been a fundamental part of actuarial practice since the beginning of the profession. Establishing rates based on sound actuarial practice is essential to the integrity of the insurance 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 in May 1988 (before the ASB was established).
This document featured four fundamental principles of ratemaking and discussed additional
considerations. The CAS requested that the ASB develop an encompassing actuarial standard of practice in the area of property/casualty rate development (ratemaking). In its request to the
ASB, the CAS further noted that the Statement of Principles contained considerations that might
be expanded to become the basis of an ASOP.
In developing the proposed ASOP, the task force sought to develop an encompassing standard of practice. This draft ASOP addresses items in the Considerations section of the Statement of
Principles Regarding Property/Casualty Ratemaking, as well as ratemaking items not currently
addressed in existing ASOPs. To provide a complete standard on ratemaking, this second
exposure draft references existing ASOPs that include relevant considerations.
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 are
reflected in this second exposure draft. For a summary of issues contained in these comment
letters, please see appendix 2.
Changes made to the second exposure draft in response to comment letters received include the
- revising the scope of the ASOP to clarify the practice areas for which it is applicable and
the actuarial activities to which it is applicable;
- revising the reference to estimating “expected value of all future costs” to refer to “estimating all future costs”; and
- revising the guidance provided in this proposed ASOP regarding the estimating of future
costs in total as well as by underlying levels that comprise the estimate of future cost.
In redrafting the proposed standard, the reviewers focused on the following key issues:
- reaffirming that the proposed ASOP is limited to the estimation of future costs. While the
actuary may play a key role in the company’s decisions in determining the price after taking into account other considerations, such as marketing goals, competition, and legal
restrictions, this standard does not address those other considerations;
- clarifying that the proposed ASOP applies broadly to all activities related to the estimation of future costs associated with the transfer of risk in insurance or other risk-transfer
- clarifying that the proposed ASOP would apply to actuaries when performing professional services that may relate to the total rate as well as to a subset of the elements of the rate; and
- confirming that this proposed ASOP provides guidance for the estimation of future costs for insurance, reinsurance, self-insurance, risk-funding or retention mechanisms, loss portfolio transfers, or any other risk-transfer mechanism, and not just for instances where there is a regulatory requirement to file rates determined by the ratemaking activity.
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:
- Are there any conflicts between the proposed ASOP and existing practice?
- This standard is proposed to be effective for work “performed on or after” four months following the adoption of the standard. Does this language appear to create any undue burden?
- Is it clear that this ASOP does not provide any guidance on the use of what is generally
referred to as “price optimization,” which relates to the company’s decisions in determining price?
- The task force eliminated the reference to “expected” value of all future costs to eliminate
the possible confusion that the only appropriate estimate of all future costs was a mean value without any consideration of potential variability. Is this change appropriate? Does this change lead to confusion about what is being estimated?
- Is it clear within the definition of ratemaking, section 2.8, that the ASOP provides guidance regarding the estimation of future costs at more refined levels than the aggregate?
- Is it clear that this ASOP applies to elements of the rate, such as loss costs developed by
advisory organizations such as ISO, NCCI, and AAIS?
The ASB voted in December 2015 to approve this second exposure draft.
Ratemaking Task Force
Patrick B. Woods, Chairperson
J’ne E. Byckovski Claudine Modlin
Gregory L. Hayward Christopher Westermeyer
Casualty Committee of the ASB
David J. Otto, Chairperson
Caryn C. Carmean Mary Frances Miller
Thomas J. De Falco Marc B. Pearl
Larry A. Haefner Robert J. Walling III
Kenneth R. Kasner
Actuarial Standards Board
Patricia E. Matson, Chairperson
Christopher S. Carlson Thomas D. Levy
Maryellen J. Coggins Barbara L. Snyder
Beth E. Fitzgerald Frank Todisco
Darrell D. Knapp 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
STANDARD OF PRACTICE
Section 1. Purpose, Scope, Cross References, and Effective Date
This actuarial standard of practice (ASOP) provides guidance to actuaries when performing professional services with respect to property/casualty ratemaking.
This standard applies to all actuaries when performing professional services with respect to developing or reviewing property/casualty insurance rates, or elements thereof. If the actuary’s role relates to a subset of the elements of the rate, the guidance in this standard applies only to the professional services related to that subset. If the actuary’s role involves reviewing rates developed by another party, the actuary should use the guidance in section 3 as is practicable.
The scope includes the evaluation of future costs for insurance, reinsurance, self-insurance,
risk-funding or retention mechanisms, loss portfolio transfers, or any other risk-transfer mechanism. Such professional services may consist of expert testimony, regulatory activities, legislative activities, or statements concerning public policy to the extent these activities involve providing an opinion on property/casualty insurance rates.
This standard is limited to the estimation of future costs. While the actuary may play a key role in the company’s decisions in determining the price charged after taking into account other considerations, such as marketing goals, competition, and legal restrictions, this standard does not address the other considerations.
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 four months following adoption by the Actuarial Standards Board.
Section 2. Definitions
The terms below are defined for use in this standard.
The terms and conditions of a plan or contract, or the requirements of applicable law, that create an obligation for claim payment associated with contingent events.
2.2 Experience Rating
A rate modification technique that involves evaluating the individual or entity’s actual experience relative to the average experience of similarly classified entities to derive a rate unique to that individual or entity.
2.3 Exposure Base
The basic unit that is used to measure the future risk-transfer cost.
A systematic procedure for developing, reviewing, or changing rates or elements thereof.
A mathematical or empirical representation of a specified phenomenon.
The final price charged for the transfer of risk.
An estimate of all future costs per exposure unit associated with an individual risk transfer.
The process of estimating future costs associated with the transfer of risk in insurance or other risk-transfer mechanisms. This includes estimation of future costs in total as well as by the underlying levels that comprise the estimate of future cost.
2.9 Retrospective Rating
A rating technique that adjusts the insured’s premium for a policy period based on the insured’s loss experience during that same period.
2.10 Schedule Rating
A rate modification technique that considers the individual risk characteristics that are expected to affect the future loss and expense experience but are not otherwise reflected in the rating process.
Section 3. Analysis of Issues and Recommended Practices
The actuary should identify and consider the costs associated with the elements that make up the rate. Such elements should include, but are not limited to, loss and loss adjustment expenses, operational and administrative expenses, and the cost of capital.
3.2 Organization of Data
The actuary should determine how data will be organized to estimate the rate or portion of the rate.
There are several acceptable aggregation methods including, but not limited to,
aggregating by accident period, calendar period, policy period, and report period. The
nature of the insurance coverage and the type of ratemaking analysis will influence the
selection of the data aggregation method. For each element, the actuary should select the
type of aggregation that is appropriate for the type of ratemaking analysis being
The actuary also should consider the level of granularity of data needed for the type of
ratemaking analysis being performed. For example, one level of aggregated data may be
appropriate for estimating the overall rate, whereas more refined data may be appropriate
for estimating the underlying levels that comprise the overall rate within a risk
3.3 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 ratemaking.
3.4 Methods, Models, and Assumptions
The actuary should select appropriate methods and models for estimating the rate or portion of the rate. The actuary should use reasonable assumptions (including parameters) appropriate to each method and model. Assumptions may be implicit or explicit and may involve interpreting past data or projecting future trends. The actuary should use methods, models, and assumptions that, in the actuary’s professional judgment, have no known significant bias to underestimation or
overestimation and are not internally inconsistent.
3.5 Exposure Base
If selecting a new exposure base or changing the existing exposure base, the actuary should take into account various practical requirements, such that the exposure base bears a strong relationship to the risk-transfer cost, as well as being 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 for the ratemaking exercise.
Some complex risks have multiple exposure bases for each aspect of coverage provided (for example, sales revenue for general liability, property value for commercial property).
In undertaking ratemaking analyses for these risks, 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.
3.6 Risk Classification System
Risk classification systems are an integral part of the development of rates. 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 for ratemaking.
3.7 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.
The actuary should adjust the historical exposure and premium data to reflect a consistent rate and exposure level. This adjustment should consider exposure changes and the effective dates
of the various rate changes during and after the historical period. The actuary should consider any modifications applied to rate changes that affect the premium charged. The adjustment can be completed at an aggregate level (for example, on-level factors) or at an individual risk level (for example, extension of exposure). The method of adjustment is often dictated by the nature of the data collected and the purpose of the analysis.
3.7.2 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 that, in the actuary’s professional judgment, reflect the potential for future development of loss and loss adjustment expense, the coverage being evaluated, the intended application (such as overall rate level analysis or risk classification analysis), the historical period and conditions in which the claims occurred, and the underlying claims adjustment process.
The actuary should consider whether the analysis of loss data requires different methods or models than the analysis of loss adjustment expense data. Additionally, different coverages within a line of business may require different methods or models.
3.7.3 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 future period when the rates will be in effect. These adjustments 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 that impact expenses;
f. accounting changes; and
g. reinsurance changes.
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 components that make up the rate.
3.8 Expense Provisions
The actuary should refer to ASOP No. 29, Expense Provisions in Property/Casualty Insurance Ratemaking, and ASOP No. 13 for guidance in the consideration of the expense provisions for ratemaking.
3.9 Ratemaking for 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:
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 3.9(c).
The actuary should refer to ASOP No. 25, Credibility Procedures, for guidance in considering the credibility given to a particular set of data for ratemaking.
The actuary should refer to [proposed ASOP on modeling,] for guidance in the consideration of models used for ratemaking. ( Note: May need revision depending on final version of proposed modeling ASOP.)
3.12 Catastrophe Provisions
The actuary should refer to ASOP No. 38, Using Models Outside the Actuary’s Area of Expertise (Property and Casualty) [Note: revision pending] and ASOP No. 39, Treatment of Catastrophe Losses in Property/Casualty Insurance Ratemaking, for guidance in the consideration of the catastrophe provisions for ratemaking.
3.13 Treatment of Unusual Events
The actuary should refer to ASOP No. 23 and ASOP No. 39 for guidance in the consideration of other unusual events, such as large individual losses.
3.14 Reinsurance Provisions
When reinsurance provisions are reflected in ratemaking, the actuary should select appropriate methods or models for estimating the cost associated with reinsurance arrangements expected to exist during the future period when the rates will be in effect. If the cost of reinsurance is treated as an expense, the actuary should refer to ASOP No. 29 for additional guidance.
3.15 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, for guidance in the consideration of the profit and contingency provisions and the cost of capital for ratemaking.
3.16 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 take into account additional sources of funding and their allocation and timing when establishing rates.
3.17 Impact of Individual Risk Rating
An individual or entity may have sufficiently credible experience so that its historical experience or risk characteristics can be used in whole or in part to derive a rate unique to that individual or entity, using techniques such as experience rating, retrospective rating, or schedule rating. The actuary should reflect the impact of individual risk-rating plans on the overall rate level.
Section 4. Communications and Disclosures
4.1 Actuarial Communications
When issuing actuarial communications under this standard, the actuary should refer to ASOP No. 41, Actuarial Communications.
The actuary should also include the following, as applicable, in an actuarial communication:
a. the disclosure in ASOP No. 41, section 4.2, if any material assumption or method was prescribed by applicable law;
b. 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
c. 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.
Background and Current Practices
Note: This appendix is provided for informational purposes and is not part of the standard of practice.
Ratemaking has been a fundamental part of actuarial practice since the beginning of the profession. 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 source of information regarding ratemaking, providing both principles and considerations. Several actuarial standards of practice (ASOPs) issued by the Actuarial Standards Board also pertain to ratemaking, 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
- ASOP No. 41, Actuarial Communications; and
- ASOP No. XX, Modeling (Note: Pending final approval).
Over the years, a multitude of ratemaking methods and models 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 ratemaking practices. While these may provide useful educational guidance to practicing actuaries, none is an actuarial standard of practice.
Each of the 50 states and the District of Columbia has executive departments established to
regulate the business of insurance, including insurance rates. Each of the 50 states and the
District of Columbia also has statutory and regulatory requirements for property/casualty rates. Contested rate cases have resulted in a large number of judicial and regulatory decisions. Actuarial principles and standards of practice have been very helpful to actuaries, legislators, regulators, and the courts when disputes about rates occur.
Advances in availability of data, technology, tools, techniques, and learnings from other disciplines have resulted in continued evolution of ratemaking methods and models. Innovation and use of new data and technologies will continue.
Comments on the Exposure Draft and Responses
Click here to view Appendix 2 in its entirety.
Click here to view comments in their entirety.