Experience Rating (AER and EER)

[emg3000]

I'm having quite the time understanding the intuition behind experience rating as described in W&M and demonstrated on past exam questions. My confusion is mainly with the generalized experience rating topic, not the WC example in the following subsection. In particular, I'm struggling with the definitions for Actual Experience Ratio (AER) and Expected Experience Ratio (EER). These expressions are used in the following formula for the Credit/Debit: C/D = ((AER - EER)/EER)*Z.

Some of the past exam questions use a different formula, with the Actual LOSS Ratio (ALR) and Expected LOSS Ratio (ELR). (See '97 #36, '99 #36, '00 28). I find the intuition for these to be much more clear. For the ALR and ELR, losses, either actual or expected, are taken over subject premium.

For the AER, however, the denominator is not premium, but some function/expectation of losses. W&M offer the following:
"The actual experience ratio is the ultimate losses and ALAE (at basic limits and limited by the MSL) divided by company subject basic limits loss and unlimited ALAE costs. The Expected Experience Ratio is essentially the compliment of an expected deviation of the company's loss costs from the loss costs underlying the manual rate."

What???

So, does anybody else want to offer their understanding (preferably in English)?

[JasonScandopolous]

The AER is this:

AER = (Actual losses* + expected unreported losses*) / Subject Losses

-Actual losses = actual losses. You may be given factors to reduce total limit loss to basic limit, and then MSL-limited, loss.

-Subject losses: This is the current premium multiplied by an ELR and de-trended to the respective experience period(s) that the "Actual losses" are coming from.

-Expected Unreported: This can be given as-is. If not, it is equal to subject losses * EER (which is given to you) * % Unreported.

*Can include ALAE; can be limited by basic limit and/or MSL. Whichever of these is true (incl alae, is limited by such-and-such) must be applied to actual losses and expected unreported losses as well.


EDIT: I have no idea about the 98-2000 questions... I get frustrated enough dealing with off-the-syllabus terminology with post-2000 questions that I didnt even bother doing any before that. Probably another example of a terminology change due to a syllabus change around 2000.

[doop]

The way I think about it is this: the EER a factor that applies to the entire class to account for the reduction in cost due to the MSL. It's like the opposite of an ILF - the base class is unlimited, and the EER factor gets you to a lower limit. So in this case the EER is our "base".

The AER, if you break down the formula, goes like this: The numerator is essentially a Bornhuetter-Ferguson approximation of the specific insured's ultimate losses. It's equal to Reported Claims plus expected unreported claims based on industry (EER). The denominator is just the expected claims piece.

"Expected claims" is based on the current B/L loss&ALAE at MSL, times the detrend factor to get you back to the historical period we're talking about.

So the AER is basically giving an estimate of how the company's losses will develop compared to what was expected. If the AER is high, then it means they reported more losses than we thought they would, and if it's low then they didn't report as much loss. Since the EER is what I'll call the "industry norm", we subtract the EER and divide by it to see how the specific insured differs from industry. We assign a credit or debit accordingly.

Hope that helps!

[booyah81]

The way I think about it is this: the EER a factor that applies to the entire class to account for the reduction in cost due to the MSL. It's like the opposite of an ILF - the base class is unlimited, and the EER factor gets you to a lower limit. So in this case the EER is our "base".

The AER, if you break down the formula, goes like this: The numerator is essentially a Bornhuetter-Ferguson approximation of the specific insured's ultimate losses. It's equal to Reported Claims plus expected unreported claims based on industry (EER). The denominator is just the expected claims piece.

"Expected claims" is based on the current B/L loss&ALAE at MSL, times the detrend factor to get you back to the historical period we're talking about.

So the AER is basically giving an estimate of how the company's losses will develop compared to what was expected. If the AER is high, then it means they reported more losses than we thought they would, and if it's low then they didn't report as much loss. Since the EER is what I'll call the "industry norm", we subtract the EER and divide by it to see how the specific insured differs from industry. We assign a credit or debit accordingly.

Hope that helps!

:notworth:

[booyah81]

btw, what doop did here is something we should all do more of i.e. try to explain formulas in words. it forces you to understand what's going on instead of plugging 'n chugging numbers into an equation. props to doop!