Traditional Risk Classification

Question 1

classification ratemaking

Answer 1

Process of grouping risks with similar loss potential and charging different manual rates to reflect differences in loss potential among the groups

Question 2

rating variable

Answer 2

Any variable used to vary rates, even if it is based on a characteristic normally considered an underwriting characteristic

Question 3

Rate relativity

Answer 3

If a rate differential is applied multiplicatively

Question 4

Additive

Answer 4

If the rate differential is applied additively

Question 5

Goal of classification ratemaking

Answer 5

To determine a rate that is commensurate with the individual risk

Question 6

Criteria for evaluating the appropriateness of rating variables

Answer 6

1. Statistical
2. Operational
3. Social
4. Legal

Question 7

Statistical criteria for selecting a rating variable

Answer 7

1. Statistical significance
2. Homogeneity
3. Credibility

Question 8

What does “the rating variable should be a statistically significant risk differentiator” mean?

Answer 8

• The expected cost estimates should vary for the different levels of the rating variable
• The estimated differences should be within an acceptable level of statistical confidence
• The estimated difference should be relatively stable from one year to the next

Question 9

What does “the levels of a rating variable should represent distinct groups of risks with similar expected costs” mean?

Answer 9

The levels of a rating variable should represent distinct groups of risks with similar expected costs

Question 10

What does “sufficient credibility” mean?

Answer 10

The number of risks in each group should either be large enough or stable enough or both for the actuary to be able to accurately estimate the costs?

Question 11

What two objectives does the science of classification require to balance?

Answer 11

1. Grouping risks into a sufficient number of levels to ensure the risks within each group are homogeneous
2. Not to crate too many granularly defined groups that may lead to instability in the estimated costs

Question 12

Operational criteria for selecting a rating variable

Answer 12

1. Objective
2. Inexpensive to administer
3. Verifiable

Question 13

Social criteria for a selecting a rating variable (social acceptability of using a particular risk characteristic)

Answer 13

1. Affordability
2. Causality
3. Controllability
4. Privacy concerns