Extended Warranty Ratemaking

The warranty business is a relatively new line of insurance in the property-casualty market. For the most part insurance coverage for warranties, extended warranties and service contract reimbursement policies has been introduced over the last thirty years. There is great opportunity in this line of business for the pricing actuary. It is an area where one can use his imagination and creativity in developing actuarially sound models to price and evaluate warranty business. This paper starts with auto extended warranty ratemaking, where there is usually plenty of data to use the traditional actuarial approaches to ratemaking. From there the paper discusses a non-traditional rate-making approach when historical experience is not available. This "back-to- basics" approach focuses on developing the pure premium by independently deriving frequency and severity. The next topic is the inclusion of unallocated loss adjustment expense (ULAE) into the pricing equation. In this line of business, because of the long-term commitments, ULAE must be carefully analyzed and provided for. Lastly, the paper discusses a number of pricing pitfalls to avoid. Some of these errors have been made by the author, and it is in the hopes of exposing these pitfalls that they can be avoided by others.