CIA Annual MeetingAssemblée annuelle de l’ICA

June 29 & 30, 2006 Ÿ Les 29 et 30 juin 2006Ottawa, Ontario

Individual & Group Style Pricing

Presenter: Jeff Neufeld, FSA, FCIA

Assistant Vice-President, Group Valuation and Pricing

The Great-West Life Assurance Company

Living BenefitsSession GRP/IND-5

CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

Individual Style Pricingvs.

Group Style Pricing

CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

Traditional “Individual” Style Pricing

bottom-up, micro approach.

product costs are dissected.

determine assumptions for incidence, termination, offsets/co-ordination, interest, expenses, etc.

use models to put the assumptions back together and build up tables of rates.

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

Traditional “Group” Style Pricing

top-down, macro approach.

not necessarily concerned with performance of each individual assumption.

product costs are not dissected by assumption type, but may be dissected by business type.

calibrate pricing and valuation to profitability or A/E claim cost.

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

“Individual” Style Pricing

Advantages:

does not require a mature, credible block of business

easier to incorporate industry or population information

helps to differentiate prices by various factors

consistent with our actuarial training.

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

– “Individual” Style Pricing

Disadvantages:– poor response time (takes time to measure and

develop all assumptions).– difficult to confirm that nothing was missed (eg. -

lump sum settlements?)– difficult to verify that data was interpreted correctly.– difficult to find credible data for all the breakdowns

of all the required assumptions.

….cont’d.

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– “Individual” Style Pricing

Disadvantages:– difficult to get accurate exposure data (e.g. self

accounting groups)– smoothing of assumptions can compromise results

– difficult to account for correlation.– a complex model is required to re-assemble all the

assumptions.

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

“Group” Style Pricing

Advantages:

quick response time to profitability or competitive concerns.

calibrating to actual profitability or experience acts as a “catch-all” mechanism to ensure nothing is missed. (No surprises

after implementation of new rates).

studying total profitability rather than each fundamental assumption separately, reduces problem of poor data credibility

and reduces the need for smoothing.

….cont’d.

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

“Group” Style Pricing

Advantages:

exposure data precision is much less important than for bottom-up pricing.

easier to account for correlation.

easier to explain results to non-actuarial management

reduced distractions caused by differences within individual assumptions (i.e. poor LTD incidence rates in Quebec).

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

“Group” Style PricingDisadvantages:

requires a mature credible block of business.easier to overlook legitimate price differentiating factors and

simply price for the average.difficult to determine precisely why experience changes

occur.does not satisfy our actuarial instincts to measure each

assumption.

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

Product Differences

Different products are better suited for each style.

Different styles have traditionally been used for each product.

Are the best styles being used for each product?

Can we gain an improved understanding from considering different styles than we have traditionally used?

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CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

Life Insurance

Life Insurance has historically been the domain of the Individual pricing style.

Easy to price Life Insurance by determining assumptions:mortality rates

interest rates

lapse rate (if necessary)

Individual Style disadvantages are not significant.

Group style pricing offers little to improve upon the Individual style for Life Insurance.

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CI

• Critical Illness Insurance pricing is similar to Life Insurance pricing– just need assumptions for incidence, interest and lapses

to get started.– Individual Life pricing actuaries are comfortable with this

kind of pricing.– this may explain why many companies have introduced

CI even if they do not have other individual Health or Disability products.

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CI

• Similar to Life Insurance, Group Style pricing can offer little to improve upon CI pricing:– especially since CI is still too new for any company to

have credible experience upon which to base their pricing.

– at my company, the Group CI pricing depended completely on the expertise of our Individual division.

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Health & Dental

• Health & Dental Insurance has historically been the domain of Group Style pricing.

• Total claims experience is measured and compared to premium rates and to prior experience.

• New premium rates are set based on total expected future claims by policy type.

• Individual or certificate level experience is studied less frequently.

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Health & Dental

• Using pure Individual Style pricing would be futile.• Too many different assumptions required (every type of

drug, dental procedure, etc.).• Plus each assumption is a moving target due to inflation

and utilization changes.• At my company the Individual Health & Dental product is

priced and administered by the Group division.

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Disability

• Disability Insurance has traditionally been priced using the Individual pricing style. Assumptions are derived for incidence, termination, interest, offsets, lapses, etc.

• Premium rates are often determined by the use of a model which re-assembles all the assumptions.

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Disability

• The Group pricing style may be under-utilized for DI/LTD even in Group Insurance.

• As a result, pricing may be slow to respond to changing morbidity levels.

• Also, without testing rates against actual total experience, one can never be certain the rates are appropriate.

• How can Group Style pricing be used for Disability Products?

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Testing DLR's (excluding PFAD's):Claim

DurationBeginning

DLR+ Val.

Int. - Paid Claims

- End DLR = Adequacy

4 1,000 50 200 900 (50)3 1,000 50 300 850 (100)2 1,000 50 400 800 (150)1 1,000 50 400 350 300

Total 4,000 200 1,300 2,900 0

CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

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– Several years of experience can be layered on top of each other to improve credibility.

– Splitting by duration is very important.• in total, the DLR looks adequate.• however, the duration results show that the

inadequacy is masked by strength in duration 1.• this block of DLR’s would ultimately produce a loss

on run-off.

CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

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• The total termination rate assumption might be correct.• However, maybe the assumption for offset changes, reopens,

or lump sum settlements was incorrect.• This test ensures that everything is accounted for.• DLR’s can be calibrated to this test.• Using this test, an accurate DLR table could be built without

ever measuring each assumption (no termination rate study). • That is, the test can tell us how much reserve is needed at the

beginning of each duration to fund claim payments and ending reserve (an iterative process).

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Determining the Required DLR (excl. PfADs)

Claim Duration

Beginning DLR

End DLR Adequacy

Chg in Req'd

End DLR

Req'd Beginning

DLR %

4 1,000 900 (50) N/A 1,050 105%3 1,000 850 (100) 43 1,143 114%2 1,000 800 (150) 114 1,264 126%1 1,000 350 300 92 792 79%

Total 4,000 2,900 0 249 4,249 106%

Assumptions should be revised to achieve the Required Beginning DLRfor each duration.

(Note this simplified example ignores the interest impact.)

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• This test can also be used to test other parameters (to assist in pricing and valuation).

• For example, the table could be split into one table for Quebec claims and one for claims outside Quebec. Quebec tends to have better termination experience but, are offset changes different, etc.?)

• Using these tests, one could confidently develop separate DLR tables for Quebec vs. outside Quebec to be used for pricing.

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• This concept can be extended to pricing once appropriate DLR & IBNR tables are developed.

Group example:

+ Risk Premium (excluding retention) – restated to current basis

- Paid Claims

- DLR

- IBNR

+ Valuation Interest

= Morbidity Gain (expect zero)

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• Splitting this table by a parameter (such as Quebec vs. other) will again indicate if the pricing differential is appropriate.

• A number of experience years can be layered together to increase credibility.

• Premium rates can be calibrated to the results of this analysis.

• This test is really an extension of the previous DLR test to include duration 0. Risk premium is used in place of beginning DLR for duration 0.

CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA

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Testing ALR’s (Individual DI) - excluding PFAD’s

+ Total Premium

- Paid Claims

- DLR

- IBNR

+ Valuation Interest (on all reserves)

- ALR

- Valuation Expenses

= ALR Adequacy (morbidity & lapse experience only)• Similar to the Group example, splitting this test by various

parameters can test the adequacy of price differentials.

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• With a credible block of business, one could theoretically use this “Group Style” to develop LTD or DI rates without ever studying incidence or termination rates.

• Experience years can be layered on top of each other to increase the credibility of these tests.

• Even without full credibility, these tests can be used to indicate areas of weakness or strength in the existing LTD or DI rates.

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• Since actuaries love to study incidence and termination rates, a more practical use of Group Style pricing methods for Disability products is as a test.

• Pricing and valuation tables can be initially developed using assumptions derived from traditional methods.

• Resulting premium rates and/or reserves can be tested using Group methods (splitting by all required parameters).

• Assumptions can be calibrated to the results of these tests.