Pricing in General Insurance

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9

Setting the Claims Ination Assumptions

Experience rating – the type of pricing based on the analysis of past loss experience and

which will be the basis of much of this book – is loosely based on the idea that the past is

a good guide to the future and that you can therefore use past losses to estimate future

losses. This is what we have done, in a very simple way, in the elementary pricing example

of Chapter 1.

Even the staunchest supporter of experience rating, however, knows that loss experience

will not simply repeat itself identically and that experience must be made relevant to current

conditions. One thing that one must denitely do to be able to make past claims relevant

to today’s environment is to bring them up to the value they would have if they happened

today. This is similar to what we do when we compare prices from the past to prices today,

and we therefore call this type of ination ‘claims ination’. Claims ination is affected

bythe behaviour of many other ination indices but is not normally identical to any of them.

To deal with claims ination appropriately, one needs to be aware of what, in the wider

environment, drives increases (or reductions) in claims payouts as a function of time and

needs to be able to tap into the correct information using publicly available ination indices.

Examples of relevant indices are the consumer price index (CPI), the retail price index

(RPI), the average weekly earnings (AWE) index and a number of specialised indices for

different classes of risk.

The idea behind claims ination is to estimate the value that past claims would have if

they happened today. Let us remind ourselves of what we discussed in Chapter 2:

Obviously, a claim which occurred in 2002 would have, if it occurred again under

exactly the same conditions in 2012, a much larger payout, because of a thing called

claims ination. Claims ination is not the same as the RPI ination or the CPI ination

we have in the United Kingdom, as it depends on other factors that the CPI or the RPI

are not concerned about. For example, property claims will depend on a number of fac-

tors including cost of repair materials, cost of repair labour and others. Liability claims

will depend on wage ination and court ination, that is, the tendency on the part of the

courts to award compensations that are increasingly favourable for claimants.

Let us now look at how information can be extracted in practice. There are a number of

sources for ination gures; furthermore, we are sometimes able to extract claims ination

information from the data itself.

Figure 9.1 shows where setting the claims ination assumption ts into the overall process.

9.1 Sources of Inflation Information

Figure 9.2 shows a number of indices that can be used as proxies for claims ination for

different lines of business in the United Kingdom.