[[Actuarial Notes Wiki|Wiki]] / [[Exam 5 (CAS)]] / **Classification Ratemaking** ## Definition ==Classification Ratemaking== Classification ratemaking is the process of segmenting risks into classes with similar characteristics and developing relative rates for each class. ## Purpose - Achieve rate equity - Reflect cost differences - Competitive positioning - Regulatory compliance ## Process ### 1. Define Classes Group risks by characteristics: - Age, gender (personal auto) - Territory - Vehicle type - Industry classification (workers comp) - Construction type (property) ### 2. Calculate Class Relativities ``` Relativity = Class Loss Cost / Base Class Loss Cost Example - Auto Liability: Class A losses: $250 per exposure Base class losses: $200 per exposure Relativity: $250 / $200 = 1.25 or 125% ``` ### 3. Apply Credibility ``` Final Relativity = Z × Indicated + (1-Z) × Current ``` ### 4. Constrain if Needed - Maximum rate change limits - Competitive considerations - Regulatory restrictions ## Common Rating Variables ### Personal Auto - Driver age - Vehicle year/make/model - Territory - Coverage selections - Prior claims ### Workers Compensation - Classification code - Experience modification - Safety programs ### Commercial Property - Construction type - Protection class - Occupancy - Territory ## Example Calculation ``` Territory Rating Analysis: Territory Exposures Losses Pure Prem Relativity Base 10,000 $2,000,000 $200 1.00 Urban 5,000 $1,500,000 $300 1.50 Suburban 8,000 $1,760,000 $220 1.10 Rural 3,000 $450,000 $150 0.75 Rates (assume 60% loss ratio target): Base: $200 / 0.60 = $333 Urban: $333 × 1.50 = $500 Suburban: $333 × 1.10 = $366 Rural: $333 × 0.75 = $250 ``` ## Testing Classification Plans ### Statistical Significance - Chi-square test - Z-scores for differences - Confidence intervals ### Homogeneity - Within-class similarity - Between-class differences - Coefficient of variation ### Practicality - Operational feasibility - Data availability - Ease of administration ## Regulatory Considerations Classes must be: - Actuarially justified - Not unfairly discriminatory - Based on objective criteria - Properly documented ## Related Concepts - [[Homogeneity]] - [[Credibility]] - [[Rate Equity]] - [[ASOP 12 - Risk Classification]] ## References - Werner & Modlin, Chapter 10 - ASOP 12