CMP & risk classification

Question 1

coverage trigger

Answer 1

event that must occur in order for an insurance policy to apply to a claim

Question 2

2 primary types of coverage triggers in insurance:

Answer 2

1. occurrence: policies cover claims that occur during the effective policy period regardless of when claim is reported to insurer; trigger = occurrence of accident
2. claims-made: cover claims that are reported to insurer during effective policy period regardless of when claim occurred; trigger=reporting of claim
   - claim occurrence date is generally restricted to start of CMP term via retroactive date
   - professional liability incl MedMel are often CMPs

Question 3

CMPs were created in effort to

Answer 3

• CMPs were created in effort to reduce pricing risk by minimizing the time between when policies are priced and losses are reported
• only need to price for claims that are reporting during that term

Question 4

Understanding CMPs and relative pricing

Answer 4

• when policy is first purchased by insured, it will be first-yr CMP
• only cover claims that occur after retroactive date and are reporting during policy term
• at renewal, insured will obtain 2nd-yr CMP
• covers that are reported during 2nd policy term but could have occurred any time after retroactive date of 1st-yr CMP
• since each consecutive CMP effectively provides more coverages than prior policy, expected costs and thus premium increase with each policy term
• typically calc using step factors in rating algorithm

Question 5

Switching policy types

Answer 5

• when professional switches from OP to CMP, no gap in coverage so long as retroactive date for new CMP coincides with expiration date of OP
• when professional switches from CMP to OP, gap in coverages for claims that occurred during a CMP term but are reported after CMP expired
• when professional retires, tail coverage can be purchased to provide coverage for claims that occurred during CMP term but are reported after CMP expires

Question 6

report year diagrams

Answer 6

CMP: row

OP: diagonal

Question 7

Claims-made RM principles (1-3)

Answer 7

1. CMP should always cost less than OP as long as claim costs are increasing
   - if claim costs are increasing, further in future that claims are settled, more time claims will have to increase
   - OP: report and settlement lag
   - CMP: settlement lag
2. if there is sudden, unpredictable change in underlying trends, CMP priced based on prior trend will be closer to correct price than an OP based on prior trend
   - since OP cover claims reported in future years, more time for trends to impact cost of those claims than for CMP -> change in trends will have more impact on OP than CMP
3. if there is sudden, unexpected shift in reporting pattern, cost of mature CMP will often be affected relatively little, if at all, relative to OP
   - increase in report lag will allow for more time for loss trends to impact claims on OP since they can be reported in future years -> increase in report lag will increase price OP if claim costs incr.
   - for CMP, decreasing in reporting of new claims occurring during policy term will be offset by extra claims now being reported late than usual from early CMP terms

Question 8

Claims-made RM principles (4-5)

Answer 8

4. CMP incur no liability for pure IBNR so risk of reserve inadequacy is greatly reduced
   - CMP only cover claims that are reported by end of policy term, do not have any pure IBNR, but do have IBNER
5. investment income earned from CMP is substantially less than under OP
   - since CMP have no report lag beyond end of policy term, less time than with OP for prem collected to be invested before claims are paid

Question 9

adverse selection

Answer 9

not using risk characteristic that competitors are using and attracting underpriced customers as a result

Question 10

favorable selection

Answer 10

using risk char that competitors are not using and attracting profitable customers as result

Question 11

‘skimming the cream’

Answer 11

identifying lower cost group of insured that has not been identified by competition and recognizing that difference in UW or marketing instead of rating

Question 12

risk classification and challenge

Answer 12

• Risk classification = grouping of risks with similar risk char (expected costs) for purpose of setting prices
• challenge: identifying appropriate risk characteristics upon which to classify risks

Question 13

4 criteria for evaluation RV

Answer 13

1. statistical
2. operational
3. social
4. legal

Question 14

statistical criteria

Answer 14

• stat significance: expected costs should vary by class with an acceptable level of stat confidence and should be fairly consistent over time
• homogeneity: expected costs for each ind risk within class should be reasonably similar with no clearly identifiable subclasses with significantly different loss potential
• credibility: classes should be large enough or stable enough to allow credible stat predictions but class need not be fully credible on its own

Question 15

operational criteria

Answer 15

• objective: classes should be measurable and clearly identified - exhaustive and mutually exclusive
• inexpensive to administer: cost of obtaining and maintaining data to establish classes should not be too high
• verifiable: levels of rating variable should be easily verifiable and minimize ability for intentional misclassification

Question 16

social criteria

Answer 16

• affordability: especially desirable for compulsory insurance programs
• causality: if cause and effect relationship can be shown or seems intuitive, it will increase public acceptability of classification
• controllability: encourages insureds to reduce hazards
• privacy: insures should feel that their privacy is not being infringed upon

Question 17

legal criteria

Answer 17

-RVs must be in compliance with applicable laws and regulations in which business is written