Source of Earnings Analysis for Property-Casualty Insurers

Source of earnings analysis has long been a staple of life insurance policy pricing and profitability monitoring. It has grown in importance with the advent of universal life insurance and similar contracts with non-guaranteed benefits or charges. Statement of Financial Accounting Standard (SFAS) 97 requires insurers to use source of earnings analysis for Generally Accepted Ac-counting Practice (GAAP) reporting of universal life-type contracts. Source of earnings analysis is not a specific ratemaking method, like the loss ratio method or the pure premium method. Rather, source of earnings analysis is a reporting structure that reveals the sources of gain and loss on a block of business, highlighting errors in the pricing parameters, as well as the sensitivity of profit and loss to various pricing factors, and enabling more accurate selection of new parameters and factors. This paper applies source of earnings analysis to workers compensation and personal automobile insurance. The uncertainty in many casualty insurance pricing factors, such as loss development factors and loss trend factors, makes source of earnings analysis particularly important for casualty products. The paper shows how to use the source of earnings exhibits to better analyze insurance profitability. The private passenger auto illustration divides the difference between actual and expected results between estimation error, which is within the purview of the pricing actuary, and random errors, which result from stochastic fluctuations in loss occurrences, inflation rates, or interest rates. The workers compensation illustration focuses on the spread between the earned and credited interest rates, the solicitation costs for not-taken business, and the amortization of initial expense and loss costs by policy year. Analysis of the variances from previous years’ predictions is a means of improving next year’s predictions. Sources of earnings analysis provides the needed postmortem to judge the accuracy of the pricing assumptions.