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Maine Event 2004
Thinking about Decision Making
Rich Clement:
Underwriting Decisions
Rick Leavitt:
Actuarial Decisions
- Issues
- Simulation
- Game Theory
September 22, 2004
Maine Event 2004
Underwriting Decisions
September 22, 2004
Maine Event 2004
Difficulties In Underwriting
Limited to poor information
Quick turnaround time
Competition – Acquisition/Irrational Pricing
Multiple Products
Tenure of underwriters – size of accounts
Economic conditions
Evaluation periods are too short
Most volatile time period
September 22, 2004
Maine Event 2004
Difficulties In Underwriting
Limited Tools/Consistently Changing Tools
Changing plan designs – move to employee
contributions
New sales and underwriting territories
Aging workforce
Obesity – co-morbid conditions
Pressure on underwriting gain from poor investment
income
Limitations to Home Office Partners
September 22, 2004
Maine Event 2004
Difficulties In Underwriting
Mind space for LTD
Increasing medical costs
Churning business
Employer’s “attitude” towards employee’s
Regulatory issues
Internal meetings
Profitable Growth Goals
September 22, 2004
Maine Event 2004
Traditional U/W Response
September 22, 2004
Maine Event 2004
Traditional U/W Response
Risk Analysis
Read and Understand the RFP
Why is case out to bid?
Who is the broker?
Partner with sales on strategy.
Who is employer? – Financial Underwriting
Manual rates
SIC, OCC, Area factors
September 22, 2004
Maine Event 2004
Traditional U/W Response
Risk Analysis (continued)
Plan design features
Experience evaluation
Cause and effect
Most recent period is volatile
Credibility
Other perspectives
Claims, actuarial, similar customers
trust yourself
September 22, 2004
Maine Event 2004
New Approaches
Track Decisions
Competitive advantage
Learn from your mistakes
Evaluate # of claims
Strategic direction
Understand where you make money
Maintain underwriting discipline – mistakes sell
“Hit them were they ain’t” – Ty Cobb
September 22, 2004
Maine Event 2004
Actuarial Decisions
…. Harder than I thought
“All you need in this life is ignorance and confidence;
then success is sure”
- Mark Twain
“The greatest obstacle to discovery is not ignorance it is the illusion of knowledge”
- Daniel Boorstein
September 22, 2004
Maine Event 2004
Actuarial Decision Making
1980’s actuary: Conduct an experience
study and recommend rate modifications
21st Century Actuary: ???
“Actuaries are professionals who provide expert advice and
relevant solutions for business and societal problems that
involve economic risk” ….SOA Promotional Material
Given difficult business environment, it is not
enough just to get the pricing right.
September 22, 2004
Maine Event 2004
2004 Disability Product Strategy
*** Strategy Options ***
1. “Slow and Steady Wins the Race”
-
Develop Appropriate Pricing and Stay the Course
-
You might need investor and management education
2. “Decisive and Aggressive”
-
Identify Target Markets and Attack Aggressively
-
Fix Mistakes as you Go
September 22, 2004
Maine Event 2004
2004 Disability Product Strategy
*** Strategy Options ***
3. Market Intelligence: “Hit ‘em where they ain’t”
-Exploit Undeveloped Market Niches
4. “Execution, execution, execution”
-Improve Distribution Efficiency/UW Decision Making
-Reduce Administrative Expenses and Cost of Capital
-Risk Evaluation Tools = Smart Decision Making
September 22, 2004
Maine Event 2004
Actuarial Decisions: LTD
Why is it so hard to get the pricing right?
1. Volatility of Loss
September 22, 2004
Maine Event 2004
Loss Volatility
September 22, 2004
Maine Event 2004
Actuarial Decisions: LTD
Why is it so hard to get the pricing right?
1. Volatility of Loss – Random versus external impacts
2. Loss takes a long-time to develop
September 22, 2004
Maine Event 2004
LTD Components of Loss
September 22, 2004
Maine Event 2004
Actuarial Decisions: LTD
Why is it so hard to get the pricing right?
1. Volatility of Loss – Random versus external impacts
2. Loss takes a long-time to develop
3. Product Complexity
September 22, 2004
Maine Event 2004
LTD Product Complexity
LTD Components of Risk
Age
Gender
Occupation
Salary
Industry
Region
Case-Size
Elimination Period
Definition of Disability
Replacement Percent
Maximum Benefit
Definition of Earnings
Pre-Ex
M&N Limit
Work-Place Environment
Societal Attitudes
Health Trends
Local and National Economy
Financial Health of Employer
Risk Drivers are Correlated (Isolation of Risk is Impossible)
September 22, 2004
Maine Event 2004
Example of Risk Dependence
September 22, 2004
Maine Event 2004
Actual Manual Rates
Companies
Base Rates
Age
Gender
Elim
Benefit Dur
SS Credit
Rate 1
September 22, 2004
A
0.57
0.57
1.05
0.77
0.98
0.70
0.18
B
0.64
0.65
1.04
0.78
0.97
0.67
0.22
Max Rate /
Min Rate
C
0.64
113%
0.61
1.00
0.92
0.99
0.71
0.25
137%
Maine Event 2004
Actual Manual Rates (Cont)
Rate 1
Salary
Occupation
Industry
Area
Size Lives
Rate 2
September 22, 2004
A
0.18
0.96
1.31
0.75
0.90
1.00
0.16
B
0.22
1.00
1.25
1.16
1.00
1.00
0.32
C
0.25
1.00
1.73
0.87
1.00
1.27
0.47
Max Rate /
Min Rate
306.0%
Maine Event 2004
Actual Manual Rates (Cont)
Rate 2
Plan Provisions
Net Rate
Expenses
Final Rate
September 22, 2004
A
0.16
1.40
0.22
B
0.32
1.08
0.34
C
0.47
0.96
0.46
Max Rate /
Min Rate
210.2%
45.0% 44.0% 45.8%
0.39
0.61
0.84
213.3%
Maine Event 2004
Manual Rate Volatility
September 22, 2004
Maine Event 2004
Actuarial Decision Making
So Let’s see….
Disability Rates are all over the place
Trends are hard to predict and hard to track
Some Carriers are buying Market share
Some Carriers are behaving, uh, irrationally
Investors want short-term results on a long-term product
What is an actuary to do??
September 22, 2004
Maine Event 2004
One Approach: Simulation
Simulate Reality and Test Various Strategies
But….
Need to simplify may eliminate key dynamics
Be careful not to assume your outcomes
Test outcomes and relationships for “Reasonability”
(Need Reality Check)
September 22, 2004
Maine Event 2004
Example: Sales/Profit Model
Assumptions:
All Carriers have identical expertise
Average Rate = Best Estimate of Cost
Sale depends on Rate (5% Threshold)
Incumbent has rate advantage on renewal
Some Cases will take almost any rate increase
Some Cases will leave regardless of renewal action
September 22, 2004
Maine Event 2004
New Sales Price Elasticity
September 22, 2004
Maine Event 2004
Persistency Model
September 22, 2004
Maine Event 2004
Scenario 1: On Target Pricing
No Rate Increase on Renewal
September 22, 2004
Maine Event 2004
Scenario 2: Modest Acquisition:
Break-even Pricing, 10% Increase on Renewal
September 22, 2004
Maine Event 2004
Scenario 3: Aggressive Acquisition:
Priced at a Loss, 20% Increase on Renewal
September 22, 2004
Maine Event 2004
Scenario 4: Light Acquisition:
Two Renewal Increases limited to 5%
September 22, 2004
Maine Event 2004
Scenario 5: Classic Underwriting Cycle
September 22, 2004
Maine Event 2004
Scenario Outcomes
September 22, 2004
Maine Event 2004
Scenario Outcomes (Years 6-10)
September 22, 2004
Maine Event 2004
Other Approaches?
Can Game Theory Help??
The theory of games is a theory of decision
making in complex situations… when the
outcome is uncertain (chance) and there are
competing goals (other players)
1944, John Von Neumann – “Theory of Games and
Economic Behavior”
1948, John Nash – “Nash’s Equilibrium” – identifies
existence of optimal Strategy
September 22, 2004
Maine Event 2004
Game Theory
Pure Skill
Pure Luck Luck and Skill
Chess
War
Poker
Go
Chutes and Stock Market
Checkers
Ladders
LTD ??
Tic-Tac-Toe
Trivial !
Categories
Zero-Sum versus Non Zero-Sum
2 Person versus Multi-person
Cooperative versus Non-Cooperative
September 22, 2004
Maine Event 2004
Optimal Strategies??
Equilibrium Strategy
Defined as a strategy in which you will have no
regrets regardless of what the other players do
Nash Equilibrium – 1948
An equilibrium strategy exists for all two-person games
zero-sum and non-zero sum
September 22, 2004
Maine Event 2004
Prisoner’s Dilemma
Player 1
Player 2
Option 1
Option 2
Option 1
2,2
0,3
Option 2
3,0
1,1
Question: What is the equilibrium strategy?
September 22, 2004
Maine Event 2004
Prisoner’s Dilemma
You and your partner are caught leaving the scene of a
crime with no other evidence. You are placed in separate
rooms and pressured to testify. What should you do?
You
Your Partner
Keep Silent
Testify
Keep Silent
Both go Free
Testify
You go free, but your
partner goes to jail
September 22, 2004
You go to jail, but your
partner goes free
Both convicted of a
lesser charge
Maine Event 2004
Prisoner’s Dilemma
Best Possible Payoff: Keep Silent
If you keep silent and your partner testifies, you will
regret decision
If you testify:
Partner keeps silent: You go free (Good decision)
Partner Testifies: Lesser charge
(Good decision)
Both Partners testify = Nash Equilibrium
September 22, 2004
Maine Event 2004
Prisoner’s Dilemma
Player 1
Player 2
Option 1
Option 2
Option 1
2,2
0,3
Option 2
3,0
1,1
Nash Equilibrium minimizes expected payout.
Is this really the optimal strategy?
What strategy would you use over multiple games?
September 22, 2004
Maine Event 2004
Multi-player Games
Complicated by Possibility of Alliances
Start-up company offers the following bonuses
24K
Actuary
Underwriter
20K
16K
Claims
27K if all three join
Who should join? How much should each get?
September 22, 2004
Maine Event 2004
Multi player Games
Option 1: All three join and get $9K each
Option 2: Actuary and Underwriter get $12K each
… but wait,
Claims person offers the underwriter $13 (keeping $3)
Actuary offers the claims person $4 (keep $16)
Underwriter offers the claims person $5 (keeping $11)
… where will the negotiation end up?
September 22, 2004
Maine Event 2004
Multi-player Games
Any solution is unstable. There can always be an
alliance with another player that works better for one
member of the alliance.
No Optimal Solution: Too often all
parties end up with nothing
September 22, 2004
Maine Event 2004
Game Theory
Interesting, but…
N-player, non-zero sum, cooperative games are poorly
understood.
Game Theory can characterize optimal solutions, but
does not do well at identifying actual solutions
Defining player utility in real life is difficult
Games are more fun to play than they are to study…
September 22, 2004