How to Maintain Flexibility and Competitiveness in Long-Term Contract Rating Plans

There are many different types of long-term contracts, many of which are backed by contractual liability insurance policies (“CLIP”) and require admitted rate filings, such as auto warranty, guaranteed auto protection (“GAP”), and ancillary products, which include excess lease wear and tear, tire and wheel, theft, key replacement, interior/exterior appearance protection, windshield, paintless dent repair (“PDR”), and pre-paid maintenance.

There are also home warranties covering brown and white goods, such as televisions, audio speakers, mobile electronics, washers / dryers, appliances, and much more. Since these rating manuals are historically simple from a rating structure standpoint, it has been difficult to maintain flexibility and a good competitive position over time.

The actuarial consulting experts at Perr&Knight have identified key steps to help ensure a more flexible and competitive rating plan in the long-term contract space.

Experience Rating

Experience rating is the method in which the actual loss experience of the insured group is compared to the expected loss experience within the insured’s class. In long-term contracts, experience rating plans can be very simple and typically calculate a loss ratio by taking paid losses (over the experience period) divided by earned premium (over that same experience period).

Because long-term contracts earn premiums differently than standard contracts, the paid/earned loss ratio is more closely related to an ultimate loss ratio (assuming premium is earned appropriately). Premium adjustments are typically capped between +/-25% to +/-50%, similar to schedule rating. Schedule rating is not supposed to contemplate actual historical loss experience.

If you do include experience rating within schedule rating, you are limiting the intended use and available max/mins within schedule rating and could exhaust schedule rating max/mins solely by experience rating. Experience rating can help to keep the rates of your insured groups more in line with historical experience. This helps maintain your competitive position and profitability.

Expense Modification

Expense modification plans compare the actual underwriting expenses for an insured group to the standard allowance (or average) expenses of that group. If the actual expenses are lower, an associated credit is given, and vice versa.

Similar to experience rating, you should not include expense modifications within schedule rating as this again will limit the use of schedule rating due to required capping of the allowable debits and credits.

Interpolation and Extrapolation

Premiums can be calculated for various time periods, terms, mileage, initial mileage, coverage plans, deductibles, limits of liability, eligibility criteria, etc., using interpolation or extrapolation.

This is an excellent flexibility to include in rating plans, as it gives you almost unlimited options for all these rating variables, thus preventing the need for refiling when an insured is looking for a combination not specifically offered in your approved rating plan.

Additional Makes / Models

For coverages that have vehicle makes and models as rating variables, such as auto warranty, tire & wheel, etc., newly introduced vehicle makes and models can be classified in the same class as existing models that exhibit similar characteristics. Also, missing vehicle models (within available makes) can be classified in the same class as existing models that exhibit similar characteristics.

This adds additional flexibility and speed-to-market as you will not have to make additional rate filings for newly introduced or missed makes / models.

Class Plan Updates

Class plan may be updated due to emerging experience and the introduction of new vehicles.

For coverages that have vehicle class plans, typically auto warranty and tire & wheel, but there are others, a class plan is very detailed and typically assigns a class factor to every make/model or vehicle for both new and used vehicles.

This wording allows you to update the class assignments (thus the rate charged) based on historical experience and add new vehicles to the class plan without having to refile, resulting in a more accurate rate for the risk, speed to market and enhanced profitability.

Base Rate for Other Products

This rating variable is similar to (a) rating or refer to company rating such that if the product does not fit into any of the criteria within the approved rating plan, the following steps can be taken to develop a new base rate.

The frequency can be multiplied by the severity to obtain the loss cost. The loss cost will then be divided by the permissible / target loss ratio. The result will be the new base rate.

When available, our actuarial consulting experts recommend using a minimum of three years of historical data to develop the loss cost. If historical experience is not available, or not credible, the expected frequency and severity can be used to determine the expected loss cost.

This gives your company the ability to write a risk that falls under the main coverage type, but does not fit the approved rating plan. It provides significant flexibility and a definite competitive advantage.

Market Price Point

Many times, a price point such as $9.99 or $29.99 is more pleasing to an insured and easier to market compared to price points like $10.02 or $30.37. A downward adjustment in price, typically not to exceed 5%, may be applied to the premium.

This adjustment (which is generally downward and not upward) helps the marketing side of the equation assisting in product sales, and also prevents the need to refile when small adjustments are needed to align final rates with marketing desires.

Achieving rating flexibility in your long-term contract rating plan can improve your company’s competitiveness and enhance your bottom line. Our actuarial consulting experts can help.

Contact Perr&Knight today to get started.