Pricing in General Insurance

vii

Contents

Preface .........................................................................................................................................xxiii

Acknowledgements ................................................................................................................... xxv

Section I Introductory Concepts

1. Pricing Process: A Gentle Start ............................................................................................3

1.1 An Elementary Pricing Example ................................................................................3

1.1.1 Risk Costing (Gross) ........................................................................................5

1.1.1.1 Adjusting for ‘Incurred but Not Reported’ Claims .....................5

1.1.1.2 Adjusting for Claims Ination .......................................................6

1.1.1.3 Adjusting for Exposure Changes ...................................................7

1.1.1.4 Adjusting for Other Risk-Prole Changes ....................................9

1.1.1.5 Adjusting for ‘Incurred but Not Enough Reserved’ Claims ......9

1.1.1.6 Changes for Cover/Legislation .................................................... 10

1.1.1.7 Other Corrections ........................................................................... 10

1.1.2 Risk Costing (Ceded) ..................................................................................... 11

1.1.3 Determining the Technical Premium ......................................................... 11

1.1.3.1 Loading for Costs ........................................................................... 11

1.1.3.2 Discounting for Investment Income ............................................ 11

1.1.3.3 Loading for Capital/Prot ............................................................12

1.1.4 Commercial Considerations and the Actual Premium ............................12

1.1.5 Limitations of This Elementary Pricing Example .....................................13

1.2 High-Level Pricing Process ....................................................................................... 13

1.3 Questions ...................................................................................................................... 14

2. Insurance and Reinsurance Products ...............................................................................17

2.1 Classication of General Insurance Products: General Ideas ............................... 17

2.2 Products by Category of Cover .................................................................................18

2.2.1 Property Insurance ........................................................................................18

2.2.1.1 Legal Framework ............................................................................18

2.2.1.2 Pricing Characteristics ...................................................................19

2.2.1.3 Examples of Property Policies ...................................................... 20

2.2.2 Liability Insurance .........................................................................................20

2.2.2.1 Legal Framework ............................................................................20

2.2.2.2 Pricing Characteristics ...................................................................22

2.2.2.3 Examples of Liability Insurance...................................................22

2.2.3 Financial Loss Insurance ..............................................................................23

2.2.3.1 Examples ..........................................................................................23

2.2.3.2 Pricing Characteristics ...................................................................23

2.2.4 Fixed Benets Insurance ............................................................................... 23

2.2.4.1 Examples ..........................................................................................23

2.2.4.2 Pricing Characteristics ...................................................................23

2.2.5 ‘Packaged’ Products .......................................................................................24

viii Contents

2.3 Products by Type of Customer ..................................................................................24

2.3.1 Personal Lines ................................................................................................24

2.3.1.1 Examples ..........................................................................................24

2.3.1.2 Pricing Characteristics ...................................................................24

2.3.2 Commercial Lines ..........................................................................................25

2.3.2.1 Examples ..........................................................................................25

2.3.2.2 Pricing Characteristics ...................................................................26

2.3.3 Reinsurance ....................................................................................................26

2.3.3.1 Examples ..........................................................................................26

2.3.3.2 Pricing Characteristics ...................................................................27

2.4 Prudential Regulation Authority Classication ..................................................... 27

2.5 Other Classication Schemes .................................................................................... 38

2.6 Non-Extant Products ..................................................................................................38

2.7 Questions ......................................................................................................................38

3. The Policy Structure ............................................................................................................41

3.1 Personal Lines ..............................................................................................................41

3.1.1 Purpose of the Excess Amount ....................................................................42

3.1.2 Purpose of the Limit ......................................................................................43

3.2 Commercial Lines ....................................................................................................... 43

3.2.1 Policy Bases .....................................................................................................43

3.2.1.1 Occurrence Basis ............................................................................43

3.2.1.2 Claims-Made Basis .........................................................................43

3.2.1.3 Other Bases .....................................................................................44

3.2.2 Basic Policy Structure ....................................................................................44

3.2.2.1 Each-and-Every-Loss Deductible .................................................44

3.2.2.2 Annual Aggregate Deductible .....................................................44

3.2.2.3 Each-and-Every-Loss Limit ...........................................................45

3.2.3 Other Coverage Modiers ............................................................................49

3.2.3.1 Non-Ranking Each-and-Every-Loss Deductible ........................49

3.2.3.2 Residual Each-and-Every-Loss Deductible .................................49

3.2.3.3 Quota Share .....................................................................................49

3.2.3.4 Yet-More-Exotic Coverage Modiers ...........................................50

3.3 Reinsurance..................................................................................................................50

3.3.1 Policy Bases .....................................................................................................50

3.3.1.1 Losses Occurring During..............................................................50

3.3.1.2 Risk Attaching During .................................................................. 50

3.3.1.3 Claims Made ................................................................................... 51

3.3.2 Non-Proportional Reinsurance ....................................................................51

3.3.2.1 Risk Excess of Loss .........................................................................51

3.3.2.2 Aggregate Excess of Loss ..............................................................55

3.3.2.3 Catastrophe Excess of Loss ...........................................................55

3.3.2.4 Stop Loss Reinsurance ...................................................................57

3.3.3 Proportional Reinsurance .............................................................................58

3.3.3.1 Quota Share .....................................................................................58

3.3.3.2 Surplus Reinsurance ...................................................................... 58

3.4 Questions ......................................................................................................................59

ixContents

4. The Insurance Markets ........................................................................................................ 61

4.1 Major Participants in the Insurance Market ........................................................... 61

4.1.1 Buyers of Insurance ....................................................................................... 61

4.1.2 Insurers............................................................................................................63

4.1.2.1 Insurance and Reinsurance Companies .....................................63

4.1.2.2 Lloyd’s of London ........................................................................... 64

4.1.2.3 Captives ...........................................................................................65

4.1.2.4 Pools and Self-Retention Groups (Excluding Captives) ............67

4.1.2.5 P&I Clubs .........................................................................................67

4.1.2.6 Diversication: How Risk Is Spread in the Insurance Market ....67

4.1.3 Intermediaries ................................................................................................68

4.1.3.1 Brokers .............................................................................................69

4.1.3.2 Tied Agents .....................................................................................69

4.1.3.3 Independent Financial Advisors and Consultancy Firms ....... 70

4.2 Major Insurance Markets ........................................................................................... 70

4.2.1 London Market ...............................................................................................70

4.2.1.1 Slip System ......................................................................................71

4.2.2 Bermuda and Similar Markets .....................................................................72

4.3 How Is Insurance Sold? ..............................................................................................72

4.3.1 Personal Lines ................................................................................................72

4.3.2 Commercial Lines and Reinsurance ........................................................... 72

4.4 Underwriting Cycle ....................................................................................................73

4.4.1 How Does the Underwriting Cycle Affect Pricing? .................................75

4.5 Questions ...................................................................................................................... 76

5. Pricing in Context .................................................................................................................77

5.1 Regulatory Environment ...........................................................................................77

5.1.1 Product Restrictions ......................................................................................77

5.1.2 Premium Restrictions ....................................................................................77

5.1.3 Information Restriction .................................................................................78

5.1.4 Capital Requirements ....................................................................................78

5.2 Legal Environment .....................................................................................................78

5.2.1 Changes in the Legal Environment May Increase or Decrease the

Number and Severity of Claims .................................................................. 78

5.2.2 Court Rulings Filter Down to Out-of-Court Claims .................................79

5.2.3 Lost in Translation ......................................................................................... 79

5.2.4 Court Ination ................................................................................................80

5.2.5 General Trends in Behaviour and Awareness ........................................... 80

5.3 Larger Economy ..........................................................................................................80

5.3.1 How Does This Affect Pricing? ...................................................................81

5.4 Investment Conditions ............................................................................................... 81

5.4.1 How Does This Affect Pricing? ...................................................................81

5.5 Currency Movements .................................................................................................82

5.5.1 How Does This Affect Pricing? ...................................................................82

5.6 Natural Environment .................................................................................................83

5.6.1 Weather ............................................................................................................83