Fall 2013 - Q10 - off-balance
What really is the purpose of an off balance factor? Why and when is it used?
I understand it's not used for determining plan performance, but then what is it used for?
What really is the purpose of an off balance factor? Why and when is it used?
I understand it's not used for determining plan performance, but then what is it used for?
Comments
Great question - it's one of those things that's rarely explicitly talked about in any text.
Let's suppose you're doing a territory relativity analysis. You go ahead and calculate the (credibility weighted) indicated relativities and make selections. To determine the impact to your policyholders you use extension of exposures to re-rate their policies using the proposed territory relativities. When you compare their current and proposed premiums you find your proposed selections result in a 2% increase in premium for the book of business.
That's great - assuming you want to increase rates, plus your product manager and/or state regulator will allow it. But what if you want to benefit from the refined segmentation (better territory relativities) but keep the overall rate level (premium) the same - i.e. make the change revenue neutral?
Here's where the off-balance factor is used. The off-balance factor adjusts the (territory in this case) relativities all by the same amount so it's equivalent to changing your base rates. You get to keep the relative positions of the territories but now the overall rate impact is chosen to be 0% (revenue neutral). Using an off-balance factor is a neat way of doing it all in one exhibit rather than having to file updated relativities plus changes to your base rates.