An Introduction to Underwriting Profit Models

A deterministic treatment of profit models, including taxation, cited here as an encyclopedic reference. Abstract This paper will provide an introduction to the subject of underwriting profit models in order to provide actuaries with a basic framework for further study. This paper starts with the premise that the subject of underwriting profit provisions is an area in which actuaries can be of assistance in advancing knowledge and developing methods. While this paper will concentrate on the theoretical aspects, this subject has many potential practical applications. The basic structure of the paper is to start off with an extremely simple model, and then add additional considerations. For clarity, this paper has focused on one basic method of calculating a provision for underwriting profits. There are three basic ingredients used in these models. First, via a "cashflow" analysis, one estimates the length of time an insurer will have premium dollars on hand, prior to paying losses and expenses. Second, one estimates how much investment income an insurer will earn on this cashflow and the necessary equity backing up the policies. Finally, one sets the expected return on equity equal to a target return on equity. One can then solve this equation for the underwriting profit provision.