Actuarial pricing, capital modelling and reserving

Pricing Squad


Issue 20 -- November 2017

Welcome back to Pricing Squad!

Pricing Squad is a newsletter for fellow pricing practitioners and actuaries in general insurance.

Today's issue is about actuaries who build houses.


If actuaries were builders

My family has recently moved house. The new flat needs rewiring, fitting two new radiators and redecorating.

Imagine if personal lines pricing actuaries were in the business of refurbishing houses.

First, the pricing actuary would decide that the best plan is to build a completely new and better house and superimpose it on the existing one. He would recommend that the new house be built from steel using the Great Layered Method (GLM).

Each room would be designed separately and by a different actuary. Division of labour ensures that maximum attention is paid to all details. In fact, the living room will even be split between two actuaries - one doing the floor and the other doing walls and ceiling.

- Sounds fine, please go ahead - say naïve I.

Presently, I would find out that the Great Layered Method requires that all rooms be perfectly square steel boxes. If I want a rectangle or other shape then multiple smaller square rooms must be welded together to achieve this. This is called "interacting".

Also, there will be no bathroom appliances because GLM can only do things which are square. Do I want a square toilet? No thank you, I will sort this out later.

There will be no staircase too. Or glazing. Or plumbing. Do I want square pipes?

Then the actuaries would go away and build all the rooms and floors and ceilings out of sight.

Three months later 16 lorries arrive at my driveway. Each lorry carrying a big steel container.

- Sorry we are late, there was a problem with your steel delivery. Some of it turned out to actually be aluminium and plastic.
- But can GLM handle aluminium and plastic?
- Technically not, but we stitched it together all the same.
- OK.
- Your rooms are on the lorries, please inspect and approve them before final welding.

I would inspect the rooms and notice that while each room is OK, they all have different height. Also, the doors seem to be fixed in different places so the rooms will not connect.
- Yes, but at least each room is perfect by itself. Do not worry, we will blow torch new doors after installation.
- But my land is actually too small for all these containers. In fact each container is wider than my current house!
- That's not a problem. We will stack all the rooms on top of your house and then we will drill through them from the top room all the way to the ground with this drilling rig.
- I am not sure that's a good idea... - I would say finally coming to my senses.

Learnings

  • The best way to improve rates is rarely to rebuild your GLMs
  • Do not split modelling by peril it it can be avoided
  • Use non-linear predictive models which align with the insurance product, not the other way round

That is all for today. Thank you for reading!


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