The Price Is Right(A.K.A. Optimal

Pricing)

Chet Szczepanski

Chief Actuary

Pennsylvania Insurance Department

The Price Is Right(A.K.A. Optimal Pricing)

An

Actuarial

Perspective!

The Price Is Right(A.K.A. Optimal Pricing)

CAS: Principles Regarding P&C Ratemaking

A rate is an estimate of the expected value of future costs.

A rate provides for all costs associated with the transfer of risk.

A rate provides for the costs associated with an individual transfer of risk.

The Price Is Right(A.K.A. Optimal Pricing), cont’d.

A rate is reasonable and not excessive, inadequate or unfairly discriminatory if it is an actuarially sound estimate of the expected value of all future costs associated with an individual transfer of risk.

The Price Is Right(A.K.A. Optimal Pricing)

The beginning of conflicting views?

The Price Is Right(A.K.A. Optimal Pricing)

AAA: Risk Classification Statement of PrinciplesThree Primary Purposes:

Protect program’s financial soundness

Economic incentive

Enhance fairness

The Price Is Right(A.K.A. Optimal Pricing)

Who decides what is fair?

Who establishes criteria to guage fairness?

The Price Is Right(A.K.A. Optimal Pricing)

More conflicting views?

The Price Is Right(A.K.A. Optimal Pricing)

AAA: Risk Classification Statement of PrinciplesDesign considerations:

UnderwritingMarketingProgram designStatistical considerationsOperational considerationsHazard reduction incentivePublic acceptabilityCausalityControllability

The Price Is Right(A.K.A. Optimal Pricing)

A

Regulatory

Perspective!

The Price Is Right(A.K.A. Optimal Pricing)

What the law says!

Rates shall be neither:

Excessive,

Inadequate,

Unfairly Discriminatory.

The Price Is Right(A.K.A. Optimal Pricing)

The law tells us what rates can not be.

The law does not tell us what rates should be.

The law does not tell us how to determine rates.

The Price Is Right(A.K.A. Optimal Pricing)

The law gives the Commissioner considerable discretion!

The Price Is Right(A.K.A. Optimal Pricing)

In Pennsylvania, we rely on competition and competitive markets as much as possible.

The Price Is Right(A.K.A. Optimal Pricing)

Competitive markets require, among other things:

Many buyers and sellers

Freedom of entry and exit for both buyers and sellers

No one buyer or seller sufficiently large to affect the price

The Price Is Right(A.K.A. Optimal Pricing)

The government HAS interfered in the personal auto market!

The government mandates coverage, barring exit from the market for consumers.

The Price Is Right(A.K.A. Optimal Pricing)

The government often adds problematic constraints:

Limited Tort

Mandatory discounts for specific devices

Limits on merit rating charges

The Price Is Right(A.K.A. Optimal Pricing)

Consequently, the government will serve its constituency by investigating such innovations and regulating their application!

The Price Is Right(A.K.A. Optimal Pricing)

Where do we go from here?

What can we conclude?

The Price Is Right(A.K.A. Optimal Pricing)

Conclusions:Innovation is necessary for a healthy market

The government issues mandates as a result of public consensus

There exists a tension between the government and innovators in mandated markets!