2007 Annual Meeting ● VancouverIP 40 LTD & STD Pricing ● Andrew Ryan

2007 Annual Meeting ● VancouverIP 40 LTD & STD Pricing ● Andrew Ryan

Canadian Institute

of Actuaries

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

L’Institut canadien desactuaires

LTD Pricing

• Purpose of this presentation: illustrate inefficiencies in standard LTD pricing methodology– Is LTD pricing efficient?– What are the causes of inefficiency?– What can be done to fix inefficiencies? – Consequences of quick fixes

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LTD Pricing – Is it Efficient?

• observed industry quotes on a variety of representative cases – I have selected a random assortment of 6 cases

from the Fraser 2006 Market View survey– 15 insurers participated in Market View – I deleted 4 insurers who did not quote on all 6

cases

• Market View is a proprietary and confidential study. Fraser Group has released the data used in this presentation.

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LTD Pricing – Is it Efficient?

• Assumption: all Canadian insurers have similar cost structures (contracts, adjudication practices, expense structure, profit requirements etc.)

• Under this assumption, efficient pricing would lead to a very narrow range of quoted rates by all competing insurers– true cost of a case is a random variable with a common

expected mean amongst all insurers

• Relaxing the assumption would widen the expected range somewhat– true cost of a case is a random variable, but the expected

mean varies amongst insurers – insurers with the competitive advantage should always

have the lower cost

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LTD Pricing – Is it Efficient?

• The following charts illustrate the quoted rate for each of the 11 insurers– Quoted rate shown as a percentage of

the sold rate for each case – more later on how I have defined the

“sold rate”; for now, assume that the industry avg sold rate contains a 10% profit margin

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LTD Pricing – Is it Efficient?LTD Pricing – Is it Efficient?20

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LTD Pricing – Is it Efficient?LTD Pricing – Is it Efficient?20

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LTD Pricing – Is it Efficient?LTD Pricing – Is it Efficient?20

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LTD Pricing – Is it Efficient?LTD Pricing – Is it Efficient?20

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LTD Pricing – Is it Efficient?LTD Pricing – Is it Efficient?20

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LTD Pricing – Is it Efficient?

• Observations:– Maximum rate is often double the minimum rate– No clear consensus on the true cost of a case

(high variance around the mean)– The lowest quote on any given case is generally

below cost (as indicated by red-dotted line)– No insurers are consistently high or low (which

indicates that the variance is not due to different cost structures by insurer)

• Conclusion:– Group insurers cannot accurately price a given

case within a reasonably narrow range i.e. LTD pricing is inefficient

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LTD Pricing: Causes of Inefficiency

• Rating factors vary from insurer to insurer– Slope of base rates by age– Range and slope of industry and occ factors– Miscellaneous adjustment factors (CPP offsets,

elim period, replacement ratio etc.)

• Interpretation of rating factors internally within any given insurer– Classification of industry– Classification of employee occs20

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LTD Pricing: Fixing Inefficiency

• Reduce rate basis components that are too conservative, and increase components that are too aggressive– Review industry and occ factors for reasonability– ensure base rates are consistent with recent

experience

• Easier said than done, as group actuaries generally don’t get:– Objective competitive rate feedback– Case-level demographic data upon which to

evaluate every component of the rate basis

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LTD Pricing: Fixing Inefficiency

• Suggestions for future industry research– More frequent industry incidence and

termination rate studies– Termination and incidence experience by

broad industry and/or occ classification

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LTD Pricing: Quick Fixes• Consequences of “across the board” x% increases or

decreases to the rate basis– Where original rate was above the pack, no impact as neither

original rate nor new rate will be sold (eg. #1 or #5)– Where original rate was mid-pack, rate reductions will increase

sales at lower margins, whereas rate increases will reduce sales at higher margins (eg. #6 or #11)

– Where original rate was a market leader, rate reductions will not change sales but will reduce margins, whereas rate increases may not reduce sales but will increase margins (eg. #2 or #7)

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LTD Pricing: Quick Fixes

• Estimating the impact of a “quick fix” basis change requires a demand curve assumption

• The industry avg sold rate is based upon the distribution of quoted rates, weighted per the above market share assumption

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LTD Pricing: Quick Fixes

• Assume that the average sold rate contains a 10% profit margin – breakeven rate is 90% of the average sold rate– An insurer’s expected profit margin is based on

its quoted rate relative to the breakeven rate, weighted by expected sales volume given the ranking of the quoted rate

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LTD Pricing: Quick Fixes

• What would happen if each insurer, independently, changed rates by plus or minus 5%– Assume that a 5% rate increase increases profit margin by

5%– Assume that a 5% rate reduction reduces profit margin by

5%

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LTD Pricing: Quick Fixes

• Observations:– Optimal strategy (in terms of maximizing

dollar profit) varies from company to company

• Generally, a quick fix rate increase is more effective for insurers with lower profit margins, whereas a quick fix rate reduction is more effective for insurers with higher profit margins

– Any quick fix change is suboptimal relative to fixing the components of the rate basis

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LTD Pricing: Summary

• LTD pricing appears to be inefficient– Opportunities for improvements in actuarial

research at both the insurer level and industry level

• Group actuaries should not give the impression to Senior Management that case rates are more accurate than they really are– Recognize that case rates are potentially biased

estimators with a wide range of uncertainty

• Do not allow Sales to dictate rating based on the lowest common denominator– Chasing the lowest quote on any given case will

generally lead to pricing below cost

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