Plastic Card Fraud Coverage and Its Actuarial Challenges: A Case Study

Fall 2006 MWAFSeptember 29, 2006

Case Study Format

• Describe a coverage that CMG writes.

• Present two specific actuarial challenges.

• Ask the audience to brain storm possible solutions or avenues of research for the two challenges.

This morning, we will…

Remember…

• When we “brain storm”, there are no bad or dumb ideas.

• This session really depends on your

participation.

• We have 50 minutes.

The Plastic Card Coverage

• Reimburses the insured for losses resulting from an Unauthorized Transaction occurring in the insured’s Card Programs.

• Unauthorized Transactions: stolen cards, counterfeited card, “card not present” internet purchases.

• Card Programs: Credit, Debit and ATM.

Structure of the Plastic Card Coverage

• “Account Number” deductibles and limits (AKA “per card deductibles and limits”). Example: $100 deductible and a $15,000 limit

• Annual aggregate deductibles and annual aggregate limits. Example: $25,000 AAD and a $1m AAL

Example of Adjusting a Plastic Card Loss

• $100 per card deductible and a $15,000 per card limit.

• $25,000 AAD and a $1m AAL.

(1) (2) (3) (4)Losses Col. (1) Less Col. (2) Col. (3) Total

Per Card Ded. Of Capped at in XS ofAccount $100 $15,000 $25,000

$16,000 $15,900 $15,00010,000 9,900 9,9005,000 4,900 4,9002,000 1,900 1,900

50 0 0$33,050 $32,600 $31,700 $6,700

Scale of CMG’s Plastic Card Program

• CMG insures approximately 5,500 credit unions for Plastic Card.

• Credit union card programs range from a few hundred to 700,000 cards.

• ~1,000 credit unions exceed their AAD each year.

• ~90,000 card accounts will sustain losses on policies written in 2006.

• The annual aggregate deductible

• Frequency of Plastic Card losses

We will see that the two actuarialchallenges are related to…

Looking for Analogies

• Has anyone worked with a coverage that uses an annual aggregate deductible?

Possible analogies:

• Excess Aggregate WC Policy• Excess Reinsurance with AAD• Medical Policies with Family AAD

The Loss Reserving Challenge

• How does the Reserving Actuary reserve for the Plastic Coverage, a high loss frequency coverage that uses an AAD ? The answer to this question probably depends on the answers to…

• How does the Reserving Actuary count claims and assign loss dates?

A Plastic Card Loss Scenario

ABC Credit Union

Policy Efective Date of 7/1/2005Per Card Deductible of $0; Per Card Limit of $15,000AAD of $25,000; AAL of $1,000,000

Loss Scenario

Card 1 Card 2 Card 3 Card 4 Card 5 Card 6

DOCL* => 7/5/05 9/25/05 11/2/05 1/15/06 2/27/06 6/27/06Loss => $10,000 $5,000 $8,000 $7,000 $3,000 $6,000

Eliminated by AAD of $25,000

* Date of Card Loss

Loss Reserving Challenge: Approach #1

• What loss date do we use?• Do we change the loss date if a loss at the

cardholder level changes?• Reserve using AY or PY histories?• Is there is an appropriate matching of

revenues and losses?

Suppose we use the convention that we will count and record claims at the policy level, that is, if the AAD is exceeded, we record a single claim.

Loss Reserving Challenge: Approach #2

• What loss date do we use?• What do we do with the AAD? Allocate a

portion of it to each cardholder loss? Does the allocation change with additional cardholder losses?

• Reserve using AY or PY histories?• Is there is an appropriate matching of

revenues and losses?

Suppose we use the convention that we will count and record claims at the cardholder level.

Pricing Challenges

• For this complex coverage and rapidly changing loss environment – What exposure base should the Pricing

Actuary use?– What combination of Pricing Plans

(manual, experience and schedule rating) is best

– Structuring manual rating for both - Per Event Limit and Deductibles, and- Aggregate Limit and Deductibles

Pricing the Aggregate Deductible

Is it sufficient to …• Design a table of Excess Loss Factors

by Deductible Amount?

AAD Factor

25,000 0.900

50,000 0.800

100,000 0.650

(Too much variation by size of account)

Pricing the Aggregate Deductible

Is it sufficient to …• Design a table of Excess Loss Factors

by ratio to pure premium (“Entry Ratio”)?

AAD / E(L) Factor

0.800 0.900

1.000 0.800

1.500 0.650

(Better, but still too much variationby size of account)

Sidebar: Entry Ratio is not sufficient

Are the following equivalent? • 1 policy of 10,000 cards at AAD = 1.0 * E(L)• 100 policies of 100 cards at AAD = 1.0 * E(L)

LargePolicy

SmallPolicy

100 SmallPolicies

Cards 10,000 100 10,000

E(L) 20,000 200 20,000

AAD 20,000 200 20,000

No: Excess loss on 100 small policies will be much higher than on a single large policy

Avg Loss /AAD

5% 500%

Pricing the Aggregate Deductible

Is it sufficient to …• Design a table of Excess Loss Factors

by Entry Ratio and size grouping?

?• How many columns do we need?• Creates issues related to column “transitions”• Model interaction with Per Event limitations?

AAD / E(L) Size Group 1 Size Group 2 etc …

0.800 0.900 0.720

1.000 0.800 0.640

1.500 0.650 0.520

Recent Plastic Card Experience

• Beginning with the 4Q 2004, Plastic Card Losses Have Sky-Rocketed Because of..– Increased Credit Card Counterfeiting

Related to File Intrusion at Merchants.– Increased Debit/ATM Card Fraud

Related to “Phishing”.• “Ground Up” Losses Have More Than

Tripled.