Exam 5: McClenahan Paper-"Skimming the Cream"

[rafkooch]

McClenahan explains that skimming the cream is when you don't account for a positive characteristic and therefore the rate is too high for this class of risk and you will therefore only end up insuring those with this positive characteristic. According to this, you would be better off NOT giving a discount to the better risks.

I always thought that if you would not give a discount to those who have this positive characteristic, then these good risks would go to an insurer who WILL give them a discount - and you will then be stuck with the lousy risks? Am I misunderstanding McClenahan? Or is he wrong? :-?

[Avi]

If you can get away with it, skimming the cream is beneficial. It's just that savvy consumers will go to companies that identify the positive characteristics and price for them accordingly.

[Brad Gile]

If you can get away with it, skimming the cream is beneficial. It's just that savvy consumers will go to companies that identify the positive characteristics and price for them accordingly.

When "skimming" exists, it may be evidence of a non-competitive market and is a concern for regulators. For this reason, the NAIC has always had one or more task forces on this subject.

Brad

[PAC]

For further insights check the discussion here (http://actuary.ca/phpBB/viewtopic.php?t=22427)

[Tex Act]

I don't know if this will answer the question or add to it, but here is a thought I had on the subject. Isn't it true that in every case where one company is being adversly selected against another company is skimming the cream?

[Colymbosathon ecplecticos]

Not necessarily, for example it is possible that the good risks all self-insure.

[Avi]

Then there is no adverse selection, because the only risks IN the market are bad. Selection implies more than one class of risk.

[JGL]

McClenahan explains that skimming the cream is when you don't account for a positive characteristic and therefore the rate is too high for this class of risk and you will therefore only end up insuring those with this positive characteristic. According to this, you would be better off NOT giving a discount to the better risks.

I always thought that if you would not give a discount to those who have this positive characteristic, then these good risks would go to an insurer who WILL give them a discount - and you will then be stuck with the lousy risks? Am I misunderstanding McClenahan? Or is he wrong? :-?

To my knowledge, Chuck has never been wrong about anything so I doubt this is his first time. An earlier PCAS paper discussed skimming the cream (Bailey). It may help for you to supplement your study with that paper. The essential idea, as I understand it, is that an average rate is not perfectly correct for all risks in the class so, if you can identify those that are being charged more than their "true" expected losses, you should be profitable. This is no worse than looking for stocks with positive alpha.

[jets fan]

It's funny how these topics come up over and over again. Notice the similarity in the titles of this current thread and the one below:

http://actuary.ca/phpBB/viewtopic.php?t=9139

[Wigmeister General]

Can one skim half-and-half?

[Colymbosathon ecplecticos]

No, half-and-half is homogenized. In order to skim, you need to be able to refine the class plan. If the risks are indistinguishable, skimming is not possible even if the population is a mixture. (However, experience rating can ameliorate this problem to some extent.)

[JGL]

If you refine the class plan, then you eliminate the opportunity to skim the cream through selective underwriting because your rates will now be "trued up". The idea is simply to look for mispriced policies, where mispriced means overpriced.

[rafkooch]

It's funny how these topics come up over and over again. Notice the similarity in the titles of this current thread and the one below:

http://actuary.ca/phpBB/viewtopic.php?t=9139

:oops: Sorry about that. And thanks to all!