Figure 3.2 McClenahan Reading

[Macavity]

Dear Casualty Actuaries,

This is my first time with this stuff. I do not understand how the parallaelogram is constructed in the Ratemaking reading on page 95 (once given its construction I understand everything following)

Basically, when the +12.5% increase goes into affect 7/1/96, why does the 7/1/94 rate still in effect for 1/8 of the calendar 1997 year premium, ie. why are there diagonal lines separating rate increases and not vertical? I need this explained in English as the book just seems to assume you understand.

[mopete]

The new rate applies only to people who buy new policies on 7/1/96 and later. If I bought a policy on say, 3/1/96, I am at the old rates, and will be for the length of my policy (3/1/96 - 2/28/97). The company will earn money from me during 96 & 97, but at the older rates. If you bought a policy on say, 9/1/96, that's after the rate increase, so the company will earn money from you during 96 and 97, but at the newer rates.

If this rate change was applied to EVERYONE, i.e. people who buy new policies, and anyone who currently has a policy in force, then you'd be correct, the line would be vertical. (In that example, my policy would be at the old rates from 3/1/96-6/30/96, and then the remaining part, 7/1/96 - 2/28/97 would be at higher rates). But that's not what's going on.

It's possible for someone to buy a one year policy on 6/30/96 at the old rates, and have it go until 6/30/97. Hence the line joins those two dates. (It's diagonal because of a further assumption that policies are written to customers evenly throughout the year.

[Macavity]

Dear Mr. MoPete,

Thank you for the most excellent explanation. I understand perfectly now. I just wish the author could have added that extra sentence for a ultimate newbie like myself. Thanks again.