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MathGuy
01-08-2003, 04:05 PM
First off, let me just say how great it feels to be able to hang out in the “CAS Exams” forum.

Now, let me knock myself down a couple of notches: According McClenahan, “skimming the cream” occurs when a positive rating characteristic (one that reduces loss propensity) is not reflected in a rating plan. So, the rate applied to risks with this positive characteristic will be too high. So far so good. The part that gets me is the next sentence, “This would encourage these risks to the partial or total exclusion of risks not possessing this characteristic.” HUH?

I can see why an insurer would be “encouraged” to only write these overcharged people, but I don’t see why they would be able to. Seems to me that these “good” risks would take off for an insurer which does include this characteristic in their rating plan, and we would be stuck insuring those who don’t possess the characteristic. That is, the result would be similar to adverse selection, in which failure to reflect a negative characteristic attracts the bad risks.

Can anyone offer any insight into this?

Maine-iac
01-08-2003, 04:15 PM
Adverse selection does result.

The variable is not in the rating plan, but my company recognizes that it is desirable. Thus, through underwriting, we accept those with the characteristic, and reject those without it. We are skimming the cream, and our average rate is now lower than everybody else's. Now all risks apply to my firm, and we still only accept the goodies, but now we get ALL the goodies. Everybody else has to raise their rates because the goodies are out of their book.

It only works until everybody else catches on. Either we all make it a rating variable and have a low rate for the goodies and a high one for the baddies, or we all try to cream skim and the baddies can't get coverage and the regulators intervene.

Better for everyone if we make it a rating variable, then the goodies and the baddies can all get coverage, at fair rates.

Basso
01-08-2003, 05:35 PM
. . . goodies and . . .baddies

[PC hat]
It is generally bad form to call your insureds "baddies." The preferred terms are high cost and low cost.
[/PC hat]

:)

whisper
01-08-2003, 05:37 PM
You jumped ahead of the logic.

Make the assumption that everyone uses the same rating characteristics. If insurer A discovers another characteristic that the others don't know about that can determine good versus bad risks, insurer A will only accept the good risks and reject the bad risks. This way, insurer A is "skimming the cream". Once another insurer discovers this variable, the advantage is lost.

Dooby Scoo
01-08-2003, 06:38 PM
I thought Skimming the Cream was a term for what you do when you can't decide which flavor to get at Baskin Robbins.

robgalb
01-08-2003, 08:00 PM
The reason that skimming the cream is bad seems to only be implied in the paper since McClenahan really doesn't explicit state his logic. The implicit argument is that by overcharging the best risks, they will go elsewhere where they can get a lower premium. The resulting risks aren't necessarily being undercharged, leading to adverse selection, but certainly profitability will be lowered. If the overcharged insureds were subsidizing other insureds (implying they are being undercharged), then adverse selection will result from skimming the cream.

Been There Done That
01-08-2003, 08:19 PM
The "good" risks inside of the class are certainly subsidizing the "bad" risks.

Everybody in the class is charged the same rate, the "pooled rate". If classification is possible (and allowed), the lower loss cost risks will all be written by somebody that can identify them. This removes the "good" risks from the class and the average for that class goes up (because the class changed).

The interesting case is when classification is not allowed, but that insureds can classify themselves, then a Nash separating equilibrium can arise. In this situation, if insureds are willing to pay a risk premium for insurance (and some other conditions are met), two policies will be offered: a low limits policy at the pooled rate and a higher limits policy at the bad risks' rate. THAT is cool! (but a topic for a different exam ....)

Maine-iac
01-08-2003, 09:36 PM
WARNING:
Been There Done That has just strayed into the dangerous waters of Part 9! :o :o :o

Basso
01-09-2003, 01:08 AM
The "good" risks inside of the class are certainly subsidizing the "bad" risks.

Everybody in the class is charged the same rate, the "pooled rate". If classification is possible (and allowed), the lower loss cost risks will all be written by somebody that can identify them. This removes the "good" risks from the class and the average for that class goes up (because the class changed).

The interesting case is when classification is not allowed, but that insureds can classify themselves, then a Nash separating equilibrium can arise. In this situation, if insureds are willing to pay a risk premium for insurance (and some other conditions are met), two policies will be offered: a low limits policy at the pooled rate and a higher limits policy at the bad risks' rate. THAT is cool! (but a topic for a different exam ....)

As Maine-iac mentioned, this is from Exam 9. If you are really bored, and don't have enough challenge with exam 5, read the Cummins articles from the Exam 9 syllabus, and you will learn all about Nash separating equilibriums and the pareto superior situation. Personally, I recommend you not do that unless you need some sleep :)

I also reiterate that referring to risks as "good" or "bad" is improper terminology. All risks are good risks if the price is correct!!!!

jets fan
01-09-2003, 08:41 AM
Mathguy, the best advice that can be given to you is to ignore every single post in this thread, especially BTDT's post which will definitely NOT be on the Part 5 exam. In response to your question, he really shouldn't even have written that - FYI, BTDT is referring to a life insurance based article anyhow.

What you should do is simply memorize what McClenahan says, verbatim. On your exam, they won't ask you what the holy truth is - they will ask you to regurgitate.

Basso
01-09-2003, 10:53 AM
18. (3 Points) Please describe the Holy Truth about "Skimming the Cream" according to McClenahan.

But you never know..... :D (I concur with Jets Fan)

frummie
01-10-2003, 12:37 PM
I thought this was confusing, too, the first few times I read it. I even emailed McClenahan and he tried to explain it better. Maine-iac did a good job.

moj
01-13-2003, 09:02 AM
Thos indepth analysis of one minor statement in a long and important paper is the difference between a 5 and a 6. Move on and learn something that may be on the exam.

MathGuy
01-13-2003, 09:14 AM
See, the beauty of this forum is that I type a message asking a question, and others do the in-depth analysis for me, so I figure I'm all set. I also think that if I don't consider the exam process to be an educational endeavour (rather than just a contest), then I give up my rights to complain about it when it becomes necessary.

Thanks for all the help, BTW.