April 2021, Q2 (iii)

[toco851]

I am having a lot of conceptual difficulty understanding part of the solution to this question.

• Outline factors to consider when determining how much credibility to give to premium rate changes in a reserving exercise.

Rate is defined as premium charged per unit of exposure.

Premium itself is a function of expected losses, we wouldn't charge £1 million premium for a contract with £1,000 expected annual losses. There are other soft factors that determine a premium, but a key component is the expected claims that will be incurred.

Therefore, by definition, this will account for claims inflation, as the expected losses year-on-year will increase (or decrease) with claims inflation.

As a result of the above, rate change, as is confirmed by Lloyd's in their PMDR guidance, must be net of claims inflation.

One of the acceptable solutions for this question in the Examiner's report states:

• Is it including or excluding claims inflation?

How can we have rate change that excludes claims inflation? I am very confused by this.

 

[Busy_Bee4422]

Hi
The question is more or less asking how you would investigate how much you can rely on a rate in a reserving process for example if you want to set the loss ratio for the BF method. This will determine what adjustments you need to make to get a reliable rate. In your example, you are overlooking issues such as the underwriting cycle, the balance of bargaining power, portfolio growth strategies etc. This would mean that ideally, the rate should include adequate inflation but in reality, it may not.