Loss ratio under strategy A (current situation) = 875,000/1,250,000 = 0.7
Loss ratio under strategy B = (current loss ratio) x (premium at old rates
/ premium at new rates) = .7 x ( 1 / 0.95) = .737
Think of it this way: The expected loss experience per policy is the same
under both strategies. Since rates are being decreased under strategy B,
the loss ratio is going to have to increase. Remember that the rate
decrease is for marketing reasons and has nothing to do with expected loss
experience. Under the current situation (strategy A), you have
Losses / Premium(at current rates) = 0.7
Under strategy B, you write 30% more policies, so the expected losses
increase by 30%. But premiums do not increase by 30% due to the rate
decrease. The premiums only increase by 1.3 x 0.95. So the new loss ratio
is:
New Losses / New Premiums = (1.3 x old losses) / (1.3 x .95 x old
premiums) = old losses / (old premiums x .95)
= .7/.95
Dave
>From: AMFMPIP@aol.com
>Date: Sat, 24 Apr 1999 14:54:49 EDT
>Subject: 1998 #51
>To: studygroup6@casact.org
>X-Mailer: AOL for Macintosh sub 54
>Reply-To: AMFMPIP@aol.com
>
>Could someone please explain to me why the loss ratio increases from .70 to
>.70/.95 = .737? Thanks.
>
>Faith
>
>