Actuarial Considerations Regarding Risk and Return in Property-Casualty Insurance Pricing
Chapter 4
The Myers-Cohn Net Present Value model and NCCI’s IRR model are the two leading cash flow models used in ratemaking. This paper presents simple parameter and structural changes which demonstrate their equivalency. The “fair” premium produced by both models is shown to be identical given rational and consistent rules for setting parameter values, control of the flow of surplus, and discounting.
A byproduct of the structural changes proposed in the models is a rate of return that measures operating profítability. This “Operating Rate of Return” measures the insurance risk charge implicit in the ratemaking process in the form of a rate of return, yet it avoids the need to allocate surplus to lines of business. It is suggested as a replacement for the Return on Premium statistic.
Finally, ratemaking implications are discussed involving comparison of the liability beta and the equity beta, key parameters used in the Myers-Cohn and IRR models, respectively, which lead to determination of premium levels.
