Pricing for Profit share in group

business – a simple model

7th GCA
Delhi
February 2005

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 What is profit share?

 A mechanism whereby an insurer allows a group scheme to

share in any positive financial result of the insurance in a
predefined way.

 Example profit share formula:

Profit = 50% * ( 90% Premiums – Claims)

 Premiums must be earned and claims incurred

 Losses generally not carried forward

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 Expenses + Margin protection

 Insurer must be sure that in the event of a profit refund,

sufficient margin exists to meet the expenses and capital costs
of the insurer, in particular:
– net premium expenses
- i.e expenses proportionate to risk cost
– per mille expenses
- i.e. expenses/capital charges based on sum@risk
- eg solvency margin
– gross premium expenses, e.g. commissions

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 Profit commission

 Loading for profit commission is modeled stochastically to allow

for the specific characteristics of the profit commission structure.

 Variables included in the simulation would be

– Profit commission characteristics
– Size of the portfolio
– Age of portfolio
– Distribution of sums assured
– Required margins for expense and capital

 The lower the upside potential for the insurer, the greater the cost
of the profit share.
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 Profit commission characteristics

PC = PC% * (Premium - Claims - Expenses)

e.g. 50% ( 90% Premium – Claim)

 Layers - structures are possible where greater levels of profit

include greater levels of return

 If the expense deduction in the PC formula is less than the

insurer’s requirement, there is a dramatic impact on the PC loading

 EXPENSES SHOULD INCLUDE COST OF CAPITAL

 Longer loss carry forward periods reduce PC loadings

– However, schemes that have losses are not persistent
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 Profit Distribution

Expected Margin

Profit
Distribution
curve

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 Profit curve is a function of

 Deviation in premium from that expected

– as a result of changes in group demographics

 Deviation in the number and amount of claims

 Number of claims (k) can be modelled using a poisson

distribution as:
e  np (np) k
k!
 Claim amounts can be modelled as lognormal

 Sum of k lognormal claims can be modelled using Box-Muller

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approach.
 Profit Commission

Expected Margin

Profit
Distribution
curve

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 Profit commission

Expected Margin

Profit
Distribution
curve

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 Profit commission

Profit Share
Expense allowance

Profit share
amount

Profit
Distribution
curve

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 Profit commission

Additional
premium

Revised
Profit
Distribution
curve

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 Profit commission

Profit Share
Expense allowance

New Profit share

amount

Revised
Profit
Distribution
curve

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 Profit commission

Profit Share
Expense allowance

Previously paid
Profit share
amount

Revised
Profit
Distribution
curve

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 Profit commission
Additional premium
previously added

Revised
Profit
Distribution
curve

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 Profit commission

Profit
commission
An iterative process

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 Profit commission - Size of
portfolio

Profit
commission

Profit
commission

0
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 Profit commission - Size of
portfolio

For a larger portfolio

Profit
profit commission
commission has a much smaller
impact on reinsurance
price

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 A model interface
Simple Group Profit s hare calculator

Portfolio Parameters Bas ic Premium parameters

Reins ured Portfolio Size 2 ,0 0 0 Bes t Es timate Claim Rate 1 .0 0 0 per mille
Average Sum Ins ured 2 0 0 ,0 0 0 Per Mille expens e 0 .3 0
Std Dev Sum Ins ured 1 0 0 ,0 0 0 Net Premium Loading 5 .0 0 %
Gross Premium Loading 7 .0 0 %
Profit Share Formula a(eP-C) Final Gros s Premium 1 .8 2 6

Percentage Profit (a) 50% Simulation parameters

Percentage Expens es (e) 85%
Number of Simulations 4 0 ,0 0 0
Calculated WP Loading 2 5 .7 6 % Interes t 0 .0 %

Calcu lat e load ing

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