Sample Lognormal Loss Ratio

Distribution

Is the resulting LR distribution

reasonable?
Compare resulting distribution to historical results

Focus on level LRs, but dont completely

ignore untrended ultimate LRs.
Potential for cat or shock losses not captured
within historical experience
Degree to which trended past experience is
predictive of future results for a book
Actuary and underwriter should discuss the above
issues
If the distribution is not reasonable, adjust the CV
selection.

Process and Parameter

Uncertainty
Process Uncertainty: Random fluctuation of results around

the expected value.

Parameter Uncertainty: Do you really know the true mean
of the loss ratio distribution for the upcoming year?
Are your trend, loss development & rate change
assumptions correct?
For this book, are past results a good indication of
future results?
Changes in mix and type of business
Changes in management or philosophy
Is the book growing, shrinking or stable
Selected CV should usually be above indicated
5 to 10 years of data does not reflect full range of
possibilities

Modeling Parameter
Uncertainty: One Suggestion
Select 3 equally likely expected loss ratios
Assign weight to each loss ratio so that the weighted

average ties to your selected expected loss ratio

Example: Expected LR is 65%, assume 1/3
probability that true mean LR is 60%, 1/3 probability
that it is 65%, and 1/3 probability that it is 70%.
Simulate the true expected loss ratio (reflects
Parameter Uncertainty)
Simulate the loss ratio for the year modeled using the
lognormal based on simulated expected loss ratio
above & your selected CV (reflects Process Variance)

Example of Modeling
Parameter Uncertainty

Common Loss Sharing

Provisions for Pro-rata Treaties
Profit Commissions

Already covered
Sliding Scale Commission
Loss Ratio Corridor
Loss Ratio Cap

Sliding Scale Comm

Commission initially set at Provisional

amount
Ceding commission increases if loss ratios
are lower than expected
Ceding commission decreases if losses
are higher than expected

Sliding Scale Commission

Example
Provisional Commission: 30%
If the loss ratio is less than 65%, then the commission

increases by 1 point for each point decrease in loss

ratio up to a maximum commission of 35% at a 60%
loss ratio
If the loss ratio is greater than 65%, the commission
decreases by 0.5 for each 1 point increase in LR down
to a minimum comm. of 25% at a 75% loss ratio
If the expected loss ratio is 65% is the expected
commission 30%?