C.1. Risk Classification

Question 1

Adverse and favorable selection

Answer 1

Adverse: not using a risk characteristic used by competitors, attracting underpriced customers as a result
Favorable: using a risk characteristic not used by competitors, attracting profitable customers

Question 2

Skimming the cream

Answer 2

Identifying lower cost group of insureds not identified by competition and recognizing difference in UW or marketing instead of rating

Question 3

3 Primary Purposes of Risk Classification

Answer 3

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

Question 4

5 basic principles that achieve 3 primary purposes of risk classification

Answer 4

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

Question 5

Considerations in designing risk classification system

Answer 5

Underwriting
Marketing
Program Design
Statistical Criteria
Operational Criteria
Hazard Reduction Incentives
Public Acceptability
Causality
Controllability

Question 6

3 elements of program design of a risk classification system

Answer 6

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

Question 7

3 statistical criteria of a risk classification system

Answer 7

1. Homogeneity
2. Credibility
3. Predictive stability

Question 8

Operational criteria of a risk classification system

Answer 8

Expense
Constancy
Availability of coverage
Avoidance of extreme discontinuities
Absence of ambiguity
Manipulation
Measurability

Question 9

Social criteria for rating variables

Answer 9

Causality
Controllability
Public Acceptability (Privacy)
Affordability

Question 10

Major public acceptability considerations for risk classification systems

Answer 10

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