Basic Ratemaking
Basic Ratemaking
Basic Ratemaking tests whether you can convert loss experience, expenses, and target profit into a prospective rate per exposure, then adjust for trend, development, credibility, classification, limits, and deductibles. CAS questions emphasize the loss-ratio and pure-premium methods, on-leveling, expense treatment, and how those pieces interact.
Core rules
- A rate is prospective: expected loss and LAE per exposure plus fixed and variable expenses plus underwriting profit or contingency, with risk load and catastrophe loads where needed.
- Express everything on a common exposure and rate-level basis. On-level historical premium with a parallelogram or current-rate-level factor before comparing losses.
- Trend losses to the average date of the policy period; develop losses to ultimate; apply LAE as a ratio to losses unless the expense is premium-based.
- Fixed expenses are dollar amounts per exposure; variable expenses and profit are percentages of premium. This gives required premium = (loss + LAE + fixed) / (1 - variable% - profit%).
- Credibility weights class experience with related experience when data are thin; the complement is often a broader loss ratio or pure premium.
- Classification ratemaking uses GLMs or minimum-bias methods; increased limits factors and deductible credits adjust for coverage changes.
Worked example
Current earned premium is 10,000,000. The on-level factor is 1.05, so on-level premium is 10,500,000. Losses are 6,300,000 and LAE is 15% of losses, so loss + LAE = 7,245,000. Fixed underwriting expense is 600,000, variable expense is 18% of premium, and target UW profit is 6%. Trend and development are already reflected.
Required premium = (7,245,000 + 600,000) / (1 - 0.18 - 0.06) = 7,845,000 / 0.76 = 10,322,368. Indicated change = 10,322,368 / 10,500,000 - 1 = -1.7%. The negative sign means current rates are slightly redundant after expenses and profit.
Traps
- On-leveling is not trending: on-leveling restates premium to current rates; trending projects losses to the future cost level.
- Do not apply trend to premium or forget to trend LAE with losses.
- Mixing written and earned premium, or using incurred losses without developing them, changes the indication.
- Double-counting fixed expenses or treating profit as a dollar amount instead of a percentage of premium.
- Ignoring credibility, catastrophe loads, reinsurance costs, or risk load in lines where they are material.
- Applying increased-limit or deductible adjustments after the indicated rate change instead of to losses.