In 1997, our case study company introduced a super-preferred nontobacco class and modified the criteria for Preferred class. The pricing actuary (after consulting with the chief underwriter) made assumptions as to the distribution of risks among the classes as well as the relative mortality that each class should experience.
The relative mortality assumption was keyed on a starting point equal to 100 percent of all nontobacco risks combined. Based on input from the marketing department, the actuary concluded that there would be a difference between the number of applicants that would qualify for standard class and those that would actually purchase a policy at standard rates. This skewed the distribution of placed risks toward the preferred classes.
Note that the weighted average mortality based on the qualifying percentages is 100, while it is only 96, based upon the placed percentages. The actuary correctly used the qualifying percentages in determining mortality assumptions.
|Underwriting Class||Qualifying Percentage||Placed Percentage||Relative
|Super-Pref||35 %||40 %||75.0 %|
|Preferred||40 %||45 %||105 .0 %|
|Standard||25 %||15 %||127 .5
Table 1 - Pricing Assumption
Now we can compare the pricing assumption to our experience. Recall from Part II of this series that the original study was for policies issued from 1992- 2001 with claims observed from 1996-2001. In order to analyze class experience over a consistent underwriting period, we have reduced both issue and observation years to 1997-2001 to coincide with the introduction of the super-preferred class.
Also recall that the company experienced a few large claims in 1997 that distorted the mortality trends. We have solved that problem by looking at the experience net of excess retention reinsurance. Here is our revised view of the experience:
- Policies issued from calendar years 1997 to 2001
- Claims observed during calendar years 1997 to 2001
- Expected mortality based on the SOA 1975-80 Select and Ultimate Tables
- Fully underwritten term insurance only
- Study based on face amount of insurance, net of excess retention reinsurance
- Nontobacco classes only
The first item that the actuary should review is the distribution of risks among classes, using the exposed amount as a proxy for issued amount. This is a reasonable assumption if the issue year period is not too long. Otherwise, lapses, deaths and variances in annual production volumes may distort the distribution.
In our case study, the distribution of exposures matches well with the actuary’s pricing assumption (40, 44 and 16 percent experience vs. 40, 45 and 15 percent pricing). It appears that the skewing effect anticipated by marketing is taking place.
|Underwriting Class||Exposure ($millions)||Claim Count ($thousands)||Actual
Amount ($thousands)||Expected Amount||Actual A/E Ratio||Relative A/E Ratio|
|Super-Pref||104 ,612||687||41,656||151 ,164||27.6 %||77.6 %|
|Preferred||116 ,991||1,077||59,861||161 ,455||37.1 %||104 .4 %|
|Standard||43,116||815||38,484||81,598||47.2 %||132 .8 %|
|Grand Total||264 ,720||2,579||140 ,000||394 ,218||35.5 %||100
Table 2 - Experience Data Net of Reinsurance Ceded
Next for review are the relative mortality A/E ratios. In general, overall experience by class appears to validate the theoretical pricing assumptions. However, the actuary may want to take a closer look at the super-preferred class (77.6 percent experience vs. 75 percent pricing) and the standard class (132.8 percent experience vs. 127.5 percent pricing).
For the super-preferred class, the actuary may want to investigate that (1) the 77.6 percent experience may actually be the correct mortality discount for that class, and simply the methodology used to calculate the 75 percent pricing assumption needs to be refined, or (2) experience mortality may be higher than expectation because the underwriting shop is not strictly following the criteria defining the class. In other words, some preferred risks have been given a super preferred policy. However, because our class distribution matches and the preferred class A/E ratio is within expectations, it seems more likely that the initial 75 percent may have been aggressive.
For the standard class, the higher than expected A/E ratio may be due to insureds who have selected against the company. Applicants who just missed qualifying for preferred class may not have taken the company’s standard rate. The skewing effect noted before confirms this suspicion. Since “healthier” standards did not accept a standard policy, only “unhealthier” standards remain. The result is deterioration in standard class mortality; the actuary may want to increase the assumption to account for this possibility.
Understanding exactly what mortality studies say about a company’s experience can be challenging for even the most seasoned actuary. I hope this series of articles has provided some keys to unlocking the secrets hidden within the data.