2019.Fall Q7 (post from BR)

GrahamGraham
edited October 2021 in W-08-Indication

Why it would be incorrect to use Trended On-Leveled EP for the premium component of the Reported B-F Ultimate loss calculation per the Examiner’s Report. That would seem to contradict some of the calculations we would do for a Cape Cod or Expected Claims method (that uses historical experience to derive ECR).

In addition, why it would be incorrect to use Trended On-Leveled EP for the calculation of the Fixed Expense Ratio. I thought it was especially important to use trended On-leveled premium here since we would do that if we are trying to determine a trend factor.

Comments

  • GrahamGraham

    The reason you don't use trended OLEP in the BF method is that the premiums have to be on the same basis as the losses and the losses are not trended (at least not in that step.) After you get the BF estimate of ultimate, you then trend that estimate to bring it up to date.

    It's true that the Cape Cod method can involve trending and on-leveling of premiums when coming up with the ECR but note that the losses in that calculation would have to be trended also. In this exam problem, they made it easy for you by giving you the ECR (60%) so you just use that for all years.

    It's the same reasoning for the Fixed Expense Ratio. The given information provides EP and fixed expenses for each of 3 calendar years. If you used trended OLEP instead of what was given, you would be under-estimating the fixed expense ratio (assuming the trend and rate changes were positive) unless you somehow trended the given fixed expenses as well.

  • StudyFor5StudyFor5

    Hi Graham - This gets back to an earlier gripe I had with this question around the Fixed Expense Ratio. In the Wiki article you lay out step 3 to this problem in the following way:

    Step 3: calculate F for each CY separately (recall F = EF / Pc where EF is fixed expenses)

    I thought that was the appropriate thing to do in this problem too. But in the examiner's note they clearly say that using On-leveled EP in the base of the fixed expense ratio is incorrect. Why is that wrong here and maybe not in other places? Thanks.

  • GrahamGraham
    edited April 2022

    I wasn't careful in my original answer. I explained why they didn't use trended premiums, but I kept referring to on-leveled premiums. So here's what I think about this problem:

    • Generally, if you're given the expected claims ratio, it appears you are to assume it was calculated at historical premium levels (so it's a better match to historical or non-OLEP.) They don't say this, but for the BF method that generally seems to be the case. So if you're asked to use the BF method, just use the premiums as given, without on-leveling (or trending.)
    • For the fixed expense ratio, I think it's better to use on-leveled EP. I don't know why they listed that as a mistake. Of course, it's easier to use the non-on-leveled EP because that's directly given but since you have to calculate the OLEP anyway, it seems like OLEP would be a better match.

    I realize that's not a definitive answer but sometimes examiner's reports are not 100% correct. I think that's the case here. (They probably deducted points for something that wasn't technically wrong.)

  • StudyFor5StudyFor5

    Thanks! Feel much better about expense ratios and methods.

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