2012 Fall Q11 b.
Hi,
Could someone explain to me this sub-question? I have difficulty to understand the sample solution. Does someone have an idea to rephrase the idea by another way?
Thank you!
Hi,
Could someone explain to me this sub-question? I have difficulty to understand the sample solution. Does someone have an idea to rephrase the idea by another way?
Thank you!
Comments
We're given information about an industry experience rating plan, i.e. one that could be adopted by many insurers in the market place.
First we need to explain how the incorrect credibilities impact both large and small insureds. For example, too much credibility to large insureds means if a large insured has a debit mod (worse than average experience) then they are charged too much because some of that worse than average experience should have been considered random bad luck.
Secondly, and less obviously related to the Exam 8 syllabus, you're meant to know that a competitive insurance market means companies would deviate from the industry plan if they saw an opportunity. In the case of our large insureds with debit mods, individual insurers would see they are overpriced using the industry plan and offer a lower rate. The large insureds with debit mods would then move to the individual insurers which do not offer the industry experience plan.
In other words, the forces of supply and demand cause the market place to balance out and produce rates that aren't unfairly discriminatory even though the industry experience plan starting point is flawed.
Thank you! I got it now. The key word here is "industry" as you highlighted.
So the first sentence of the examiner report is a typo?
"Large risks with credit mods will have worse experience than expected" --> should be debit mods instead right?
The examiners report is correct. It's helpful to think about timing when it comes to experience rating. Remember, we are not trying to recoup past losses but instead reflect how well that past experience reflects the future loss experience that isn't already captured in the rating plan.
If we place too much credibility on a risk and we give them a credit mod then we're treating them like they are a better risk than they actually are, so in the future they would have worse than expected experience. If they have a debit mod then we're treating them like they are a worse risk than they actually are, so in the future they would have better than expected experience.
You can reverse this logic in the case where we don't apply enough credibility to the past experience.