First, one needs to ask whether the premium credit offered is really
"adequate" from an economic perspective. If it is based simply on the
difference in average annual expected loss cost without an adjustment for
risk load, I believe the credit is inadequate. In theory, the risk load for
$500 deductible hurricane cover should be higher than for 2% deductible,
since the capital required to cover the loss will be higher. Since few of
our actuarial papers provide clear guidance on this and since even fewer
regulators are likely to accept finely tuned risk loads, I expect that
relative deductible prices (in theory) will not reflect the true economic
utility of the additional deductible. In other words, the credit for
increasing the deductible is probably too low.
Second, If you accept basic utility theory, you would expect risk averse
consumers to always select the lowest deductible if the price credit is set
at the difference in average annual loss. Again, the lack of a risk
load/consumer utility adjusted price will not be sufficient to convince a
risk averse consumer to accept a higher deductible of $2,000 or more in
exchange for a $20 credit.
For these reasons, I disagree with those who expect that consumers will
always take the lowest price and highest deductible. My experience has seen
quite the opposite.
I think this discussion illustrates the need for more actuarial research
into consumer perceptions of utility and ratemaking techniques to properly
reflect risk load on a classification level.
Rade Thomas Musulin
Vice President - Actuary
Florida Farm Bureau Insurance Companies
P.O. Box 147030
Gainesville, Florida 32614-7030
Phone: (352) 374-1539 FAX (352) 374-1514
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