2013 April Q1 (ii)

[XChen]

In this part the question asked why 92.5% combined ratio is in appropriate...

The solutions has given formula of combined ratio and explained that due to difference in denominators, the target ratio is likely to be distorted by difference between two. In the case of question because

(1) some premiums are earned in old basis, thereby reducing the earned premium amount... (I don't get how this mechanics works. I thought the UPR is determined by written premium and time that policies are written. Does change in basis impact the earned proportion?)

(2) The volume of business written may not remain constant. (Again how does it affect the combined ratio?)

Thanks

 

[Darren Michaels]

Hi XChen

I think you are referring to the ASET as opposed to the Examiners Report.

The first bullet point in the ASET solution actually says "some of the premium which will be earned will have been written on the old premium rates, thereby reducing the earned premium amount".

The formula for the combined ratio is the expense ratio plus the loss ratio. The denominator of the loss ratio is the earned premium.
In this case not all of the earned premium will benefit from the 20% rise in premium rates on 1 September (as some it will have been written before the increase) so the combined ratio will not fall to precisely 92.5%.

If the volume of business does not remain constant, then because some of the fixed expenses may not also reduce in line, the expense ratio and hence the operating ratio may actually increase.