C.1 Risk Classification

Question 1

Definitions of adverse selection and favorable

selection

Answer 1

Adverse selection: Not using a risk characteristic that is used by competitors, and attracting underpriced customers as a result.

Favorable selection: Using a risk characteristic that is not
used by competitors, and attracting profitable customers as a result.

Question 2

Definition of skimming the cream

Answer 2

Identifying a lower cost group of insureds that has not been identified by the competition and recognizing that difference in underwriting or marketing instead of rating.

Question 3

Definition of risk classification

Answer 3

The grouping of risks with similar risk characteristics

(expected costs) for the purpose of setting prices.

Question 4

3 Primary Purposes of Risk Classification

Answer 4

1. Protect the insurance system’s financial soundness.
2. Enhance fairness.
3. Permit economic incentives to operate and thus encourage widespread availability of coverage.

Question 5

5 Basic Principles that achieve the 3 primary purposes

of risk classification

Answer 5

1. The system should reflect expected cost differences.
2. The system should distinguish among risks on the basis of relevant cost-related factors.
3. The system should be applied objectively.
4. The system should be practical and cost-effective.
5. The system should be acceptable to the public.

Question 6

List 4 considerations in designing a risk classification

system

Answer 6

Any 4 of:

1. Underwriting
2. Marketing
3. Program Design
4. Statistical Criteria
5. Operational Criteria
6. Hazard Reduction Incentives
7. Public Acceptability
8. Causality
9. Controllability

Question 7

3 elements of program design of a risk classification

system

Answer 7

1. Degree of choice available to the buyer
2. Experience based pricing
3. Premium Payer

Question 8

3 statistical criteria of a risk classification system

Answer 8

1. Homogeneity
2. Credibility
3. Predictive Stability

Question 9

List 4 operational criteria of a risk classification

system

Answer 9

Any 4 of:

1. Expense
2. Constancy
3. Availability of coverage
4. Avoidance of extreme discontinuities
5. Absence of ambiguity
6. Manipulation
7. Measurability

Question 10

Major public acceptability considerations for risk

classification systems

Answer 10

1. They should not differentiate unfairly among risks.
2. They should be based upon clearly relevant data.
3. They should respect personal privacy.
4. They should be structured so that the risks tend to identify naturally with their classification.

Question 11

Social criteria for rating variables

Answer 11

1. Causality
2. Controllability
3. Public Acceptability (mainly privacy)
4. Affordability