I'm not sure I understand why the participation ratio is calculated using NON ceded EE. Wouldn't it make more sense to pay more if you participate more?
Hope you're doing well this morning! I see where you're coming from about non-ceded versus ceded EE, but here's the reason the PR (Participation Ratio) formula uses non-ceded EE:
If the formula used ceded EE, then a company could make its PR = 0 simply by not ceding any policies.
They could be a giant company that accounts for a significant portion of the market so it wouldn't be fair for them to be able to avoid participation in the RSP.
Note that the way the formula is written, using non-ceded policies, they could never make their PR equal to 0 because there are normally transfer limits on ceding policies to the RSP.
At the same time, why would it be unfair for the giant company to avoid participation in the RSP? In general, the idea behind insurance is for everyone to pay their fair share. I guess RSP is different in that regard? I just don't get why it makes sense that the participation ratio goes down the more a company cedes.
Ok, I see what you mean about the PR going down the more they cede. I suppose it does seem counter-intuitive. If we were to take a step back and think about the best way to set up the RSP, there is probably no single way of doing it that is demonstrably better than any other way.
The overall idea with the RSP is to allow companies to share bad risks and spread them more evenly across the whole market. Every company that participates and profits within the market should have to share the cost so there has to be some sort of formula that determines how the sharing is done. It seems generally reasonable that bigger companies should pay more because they potentially profit more from operating in the market.
I suppose the given PR definition is essentially arbitrary and there may be other equally valid ways of defining it that meet the overall goals of the RSP. For example, you could use the total ceded PLUS non-ceded EEs in the numerator. That would ensure that the biggest companies pay the biggest share, regardless of how much they cede or don't cede. (Note that an effect of the RSP is that good risks subsidize bad risks. If each insured was charged an actuarially sound rate, then rates would be unaffordable for some and that may be considered socially undesirable.)
Anyway, this is a long way of saying there likely isn't a perfect reason for defining the PR the way they do.
If the company's participation ratio is based on non-ceded EE, doesn't this contradict page 4 of the text where the five classes of business are listed? There, it states that a member's participation is determined by "Business transferred to a risk sharing pool", i.e. ceded risks? Is there an inconsistency here?
Or is it saying that the classes of business are the separate pools that need to be allocated among the members, and the way that is done is by taking the market share of non-ceded exposures?
I guess what's confusing me is that the paper says the classes of business determine a member's participation, when what I think they're trying to say is that the classes are used to determine the composition of the individual pools of losses (which then have to be allocated using non-ceded exposures)? Am I correct in this interpretation?
For the first point:
I do not think it is inconsistent here. In a way, the more risks you cede the lower your non-ceded exposures. That's my way of interpreting what the paper is trying to say. And Graham needs to tie this into the calculation question for this paper and thus it would make sense to define it this way. More business transferred to a risk sharing pool = less non-ceded EE.
For the second point:
Yes that is how I would interpret it too. And subsequently you would allocate these losses using non-ceded exposures for each class of business (i.e. you'd have a different participation ratio for FARM, RSP, etc.)
Hi, for Graham's comment:
"For example, you could use the total ceded PLUS non-ceded EEs in the numerator. That would ensure that the biggest companies pay the biggest share, regardless of how much they cede or don't cede."
Is there any disadvantage in this approach?
If there's no clear flaws in this approach comparing to using non-ceded EE (where the main flaw is that "the more company cedes the less its PR") then why would FA to use non-ceded EE to determine PR?
One more question, based Facility Association Bulletin F2020-050:
"Members should also be aware that no change is proposed at this time to the Ontario Risk Sharing Pool sharing formula, which will retain its current structure of loss sharing based 50% on market share, and 50% on pool usage."
As i interpret it that we should use some kind of combination of ceded and non-ceded losses and premiums to determine PR for ON specifically, am i correct?
For your first question: I personally think using total Earned Exposures would make the most sense as Graham alluded to in his explanation. Perhaps using non-ceded EE is a way to ensure everyone cedes the maximum amount possible at all times (i.e. 5% ) regardless of their loss ratio vs the industry and there would be less room for gamification of the system.
For your second question I kind of interpreted it as 50% on premium volume (market share) and 50% on ceded EE (pool usage)
For second question, do you think we should expect PR calculation question based on this 50/50 rule? Because it will be different from the one used in 2015.Fall #7
I think generally you should expect that - For this sitting, the majority of past year questions are no longer relevant with the scale of changes implemented.
I am still very confused by how the participation ratio was determined.
I understand from the post above that the ratio was determined by the non-ceded EE.
but why did points (3) and (4) in page 4 said "Business transferred to a risk sharing pool ....."
it sounds the the more the companies ceded, the more they need to participate.
I don't think it implies that at all. It just means your participation is determined by your business transferred to the pool which is true. The more business you transfer, the smaller your non-ceded EE and the less your participation
@ThrowGrow Sample answers are often candidate answers and sometimes candidates have correct knowledge about a topic that is not in the source.
As @adipelino mentioned about the bulletin in relation to the post from @rlohoida: (But note that the bulletin was not part of the syllabus until 2022-Fall and this 50-50 rule has not changed. That means an exam question should not have required you to know that prior to 2022-Fall even though that would have technically been the correct method to use.)
I'm really not sure what the expectations would be on the exam regarding calculating the PR (Participation Ratio) but I suspect you would still get credit even if you did it the "old way".
I was surprised too at first to see it was based on the non-ceded premium, but when thinking about this more thoroughly, it really makes sense. Actually, I feel like the pool works only because it is based on the non-ceded premium (unless the regulator made the ceding mandatory).
I feel like this is a good example of a Nash Equilibrium (think of the Prisoner's dilemma).
Insurer have two options: to cede or not to cede. For the industry (not the society), the best solution would be that no one ever accept high risk insureds, therefore ceding nothing. If there was collusion between insurers, they could have such an agreement.
However, assuming that no other insurer is ceding, an individual company has an advantage to cede risks to the pool because it will benefit from subsidization without having to pay for the others. But obviously, in the end all insurers know that so they will break their agreement and cede to the pool too.
So in the end, all insurers will write and cede high-risk policies and while this is the "worst scenario" for the insurers, this is clearly the best one for the society and exactly what the Facility Association wants. Such an evil scheme ahah
Of course, I'm over-simplifying things, there are probably other mechanism not accounted for, but that's the reasoning I see to justify the use of Non-Ceded premiums.
Comments
Hey @jptardif2,
Hope you're doing well this morning! I see where you're coming from about non-ceded versus ceded EE, but here's the reason the PR (Participation Ratio) formula uses non-ceded EE:
They could be a giant company that accounts for a significant portion of the market so it wouldn't be fair for them to be able to avoid participation in the RSP.
Note that the way the formula is written, using non-ceded policies, they could never make their PR equal to 0 because there are normally transfer limits on ceding policies to the RSP.
Hi Graham,
At the same time, why would it be unfair for the giant company to avoid participation in the RSP? In general, the idea behind insurance is for everyone to pay their fair share. I guess RSP is different in that regard? I just don't get why it makes sense that the participation ratio goes down the more a company cedes.
Thanks so much,
Ok, I see what you mean about the PR going down the more they cede. I suppose it does seem counter-intuitive. If we were to take a step back and think about the best way to set up the RSP, there is probably no single way of doing it that is demonstrably better than any other way.
The overall idea with the RSP is to allow companies to share bad risks and spread them more evenly across the whole market. Every company that participates and profits within the market should have to share the cost so there has to be some sort of formula that determines how the sharing is done. It seems generally reasonable that bigger companies should pay more because they potentially profit more from operating in the market.
I suppose the given PR definition is essentially arbitrary and there may be other equally valid ways of defining it that meet the overall goals of the RSP. For example, you could use the total ceded PLUS non-ceded EEs in the numerator. That would ensure that the biggest companies pay the biggest share, regardless of how much they cede or don't cede. (Note that an effect of the RSP is that good risks subsidize bad risks. If each insured was charged an actuarially sound rate, then rates would be unaffordable for some and that may be considered socially undesirable.)
Anyway, this is a long way of saying there likely isn't a perfect reason for defining the PR the way they do.
If the company's participation ratio is based on non-ceded EE, doesn't this contradict page 4 of the text where the five classes of business are listed? There, it states that a member's participation is determined by "Business transferred to a risk sharing pool", i.e. ceded risks? Is there an inconsistency here?
Or is it saying that the classes of business are the separate pools that need to be allocated among the members, and the way that is done is by taking the market share of non-ceded exposures?
I guess what's confusing me is that the paper says the classes of business determine a member's participation, when what I think they're trying to say is that the classes are used to determine the composition of the individual pools of losses (which then have to be allocated using non-ceded exposures)? Am I correct in this interpretation?
For the first point:
I do not think it is inconsistent here. In a way, the more risks you cede the lower your non-ceded exposures. That's my way of interpreting what the paper is trying to say. And Graham needs to tie this into the calculation question for this paper and thus it would make sense to define it this way. More business transferred to a risk sharing pool = less non-ceded EE.
For the second point:
Yes that is how I would interpret it too. And subsequently you would allocate these losses using non-ceded exposures for each class of business (i.e. you'd have a different participation ratio for FARM, RSP, etc.)
Hi, for Graham's comment:
"For example, you could use the total ceded PLUS non-ceded EEs in the numerator. That would ensure that the biggest companies pay the biggest share, regardless of how much they cede or don't cede."
Is there any disadvantage in this approach?
If there's no clear flaws in this approach comparing to using non-ceded EE (where the main flaw is that "the more company cedes the less its PR") then why would FA to use non-ceded EE to determine PR?
One more question, based Facility Association Bulletin F2020-050:
"Members should also be aware that no change is proposed at this time to the Ontario Risk Sharing Pool sharing formula, which will retain its current structure of loss sharing based 50% on market share, and 50% on pool usage."
As i interpret it that we should use some kind of combination of ceded and non-ceded losses and premiums to determine PR for ON specifically, am i correct?
Hi,
For your first question: I personally think using total Earned Exposures would make the most sense as Graham alluded to in his explanation. Perhaps using non-ceded EE is a way to ensure everyone cedes the maximum amount possible at all times (i.e. 5% ) regardless of their loss ratio vs the industry and there would be less room for gamification of the system.
For your second question I kind of interpreted it as 50% on premium volume (market share) and 50% on ceded EE (pool usage)
Thank you!
For second question, do you think we should expect PR calculation question based on this 50/50 rule? Because it will be different from the one used in 2015.Fall #7
I think generally you should expect that - For this sitting, the majority of past year questions are no longer relevant with the scale of changes implemented.
I am still very confused by how the participation ratio was determined.
I understand from the post above that the ratio was determined by the non-ceded EE.
but why did points (3) and (4) in page 4 said "Business transferred to a risk sharing pool ....."
it sounds the the more the companies ceded, the more they need to participate.
I don't think it implies that at all. It just means your participation is determined by your business transferred to the pool which is true. The more business you transfer, the smaller your non-ceded EE and the less your participation
In 2018F-Q10, the sample answer listed one difference between Ontarios and Alberta RSP is that
exposure not ceded to pool.
I am not able to find any support from the source. Is it still valid that ON and Alberta's participation rate are determined differently? Thanks!
It only says in the source that the basis of determination of the participation ratio varies by jurisdiction. Thoughts @graham
the 50/50 for participation is in the bulletin only.
@ThrowGrow Sample answers are often candidate answers and sometimes candidates have correct knowledge about a topic that is not in the source.
As @adipelino mentioned about the bulletin in relation to the post from @rlohoida: (But note that the bulletin was not part of the syllabus until 2022-Fall and this 50-50 rule has not changed. That means an exam question should not have required you to know that prior to 2022-Fall even though that would have technically been the correct method to use.)
I'm really not sure what the expectations would be on the exam regarding calculating the PR (Participation Ratio) but I suspect you would still get credit even if you did it the "old way".
Oh, I forgot to check the bulletin for that. Thanks all of you for the reply!
I was surprised too at first to see it was based on the non-ceded premium, but when thinking about this more thoroughly, it really makes sense. Actually, I feel like the pool works only because it is based on the non-ceded premium (unless the regulator made the ceding mandatory).
I feel like this is a good example of a Nash Equilibrium (think of the Prisoner's dilemma).
Insurer have two options: to cede or not to cede. For the industry (not the society), the best solution would be that no one ever accept high risk insureds, therefore ceding nothing. If there was collusion between insurers, they could have such an agreement.
However, assuming that no other insurer is ceding, an individual company has an advantage to cede risks to the pool because it will benefit from subsidization without having to pay for the others. But obviously, in the end all insurers know that so they will break their agreement and cede to the pool too.
So in the end, all insurers will write and cede high-risk policies and while this is the "worst scenario" for the insurers, this is clearly the best one for the society and exactly what the Facility Association wants. Such an evil scheme ahah
Of course, I'm over-simplifying things, there are probably other mechanism not accounted for, but that's the reasoning I see to justify the use of Non-Ceded premiums.
I think this is a great reasoning - I have never thought of it by thinking through the prisoner's dilemma. This makes a lot of sense to me