Asset Share Pricing for Property-Casualty Insurers

Asset share pricing models are used extensively in life and health insurance premium determination. Property-Casualty rate making procedures consider only a single period of coverage. This is true for both traditional methods, such as loss ratio and pure premium rate making and financial models, such as discounted cash flow or internal rate of return models. This paper provides a full discussion of Property-Casualty insurance asset share pricing procedures. Section I compares life insurance to casualty insurance pricing. It notes why asset share pricing is so important for the former and how it applies to the latter as well. Section II describes the considerations essential for an asset share pricing model. Premiums, claim frequency, claim severity, expenses, and persistency rates must be examined by time since inception of the policy. Appropriate discount rates must be selected for (a) present values of the contract cash flows during each policy year and for (b) the present value of future earnings at the inception date of the policy. Sections III through VII present four illustrations of asset share pricing: - Section III is a general introduction. - Section IV illustrates pricing considerations for an expanding book of business. Since both loss costs and expense costs are higher for new business than for renewal business, traditional loss ratio or pure premium pricing methods show misleading rate indications. - Section V discusses classification relativities. Since persistency rates and coverage combinations differ by classification, the traditional relativity analyses may be erroneous. - Section VI presents a competitive strategy illustration. Premium discounts and surcharges affect retention rates, particularly among policyholders who can obtain coverage elsewhere. - Section VII shows how underwriting cycle movements can be incorporated into pricing strategy. Expected future profits vary with the stage of cycle; these future earnings and losses must be considered when setting premium rates. Section VIII discusses several types of profitability measures: returns on premium, returns on surplus or equity, internal rates of return, and the number of years until the policy becomes profitable. Traditional financial pricing models examine a single contract period and multiple loss payment periods. For asset-share pricing, these models are expanded to consider multiple contract periods. For instance, the "return on premium" is the present value of future expected profits divided by the present value of future expected premium, not the single period undiscounted amounts used for operating ratios. Asset share models determine the long-run profitability of the insurance operations, the true task of the pricing actuary. Auto Liability, Class Rating, Expenses