Exams IRL: Exam 8 (Advanced Ratemaking)

by Celeste Bremen, ACAS

When you’re studying for an exam, do you ever wonder, “Why am I learning this stuff?” and “When am I ever going to use any of it?” This is the sixth article in a series that will answer these questions for you! Read on below to see how you might use Exam 8 in your day-to-day work. For previous articles about other exams, please see the links at the end of this article.

Ratemaking is one of the main activities that actuaries participate in, and Exam 8 builds on the introduction to ratemaking found in Exam 5. One of the first syllabus topics is classification, which covers how we can group different risks together when creating a risk classification system. Of course, we should consider credibility, homogeneity, and the relationship between the risk characteristic and the expected outcome, as we learned in Exam 5. But risk classification goes beyond statistical methods and considers more qualitative factors, as we see in ASOP 12, which follows the law, ethical considerations, and industry practices. For example, when building a pricing model, an actuary will take all of these qualitative factors into consideration. Maybe a variable is statistically significant, but if it’s ethically questionable to include it, it should be excluded. For the past year, I’ve been working on a pricing model, and I asked myself these questions frequently throughout the process. By doing so I was able to take into consideration the technical and statistical considerations of modeling while also creating something that made intuitive sense and met the standards set forth in the ASOPs.

Exam 8 also delves into generalized linear models (GLMs). CAS Monograph #5 is a great introduction to GLMs in an insurance context. You’ll learn about model structure and which distributions to use for frequency, severity, or loss cost, how to modify your variables to get the best fit, and how to assess the fit of your model. In fact, while working on the model I mentioned earlier, I found myself thinking back to this monograph throughout the model-building process! I was excited to see that lift charts (which help you assess the performance of your model) are used in the workplace — I even sent the monograph to several of my colleagues who had not yet read it. Even if you don’t create models in your role, you never know when you might have to use output from one, and it’s important to understand how the model is made and what its benefits and shortcomings are. As was mentioned in a previous post about MAS II, as an actuary you need to understand what a model is doing and how it is performing rather than blindly trusting it.

Next up on the syllabus is excess, deductible, and individual risk rating. You’ll learn how to calculate losses that are above a certain threshold or subject to certain limits. While Table M savings and charges might look confusing at first, you’ll get the chance to see how you can use this information to estimate what losses fall below a deductible or above a limit, and how this affects the price of a policy. Individual risk rating includes experience rating and retrospective rating. While Exam 5 took a broader approach to ratemaking, Exam 8 shows you how you can use an individual policy’s experience to modify its price. For policies that are large enough and have data from prior years, you can use this experience to modify the rate. Retrospective rating allows you to adjust the premium charged based on the insureds’ experience during that period, subject to caps. The NCCI experience and rating plans for workers’ compensation plans and the ISO commercial general liability plan are important parts of an actuary’s tool kit for these lines — you’ll get plenty of exposure in using all three while studying for Exam 8.

Finally, the last major syllabus items are catastrophe and reinsurance pricing. Any low-frequency, high-severity events can be tricky parts of the portfolio to manage, and catastrophes are perhaps the best example of this. You’ll learn how catastrophe models are used — once again, even though you probably aren’t creating the models yourself, you’ll need to understand how to appropriately use them in your work. The Grossi and Kunreuther text also introduces exceedance probability curves, which show the probability that losses exceed a certain amount. This can help you understand the riskiness of your portfolio, particularly in the tail where you might be most concerned with losses. One way to manage catastrophes is through reinsurance, and there are many different types that a primary insurer can purchase. Even actuaries who work with primary insurance companies need to know these differences. Sometimes you’ll have gross losses and need to calculate net losses, so it’s important to understand how reinsurance affects your net losses. Or you might be part of the team that purchases reinsurance for your primary insurer, in which case you’ll become very familiar with how these contracts work and which best meet the needs of the company.

Studying for exams can be exhausting, challenging, and sometimes discouraging, but it can provide some motivation to understand how you might use the things you learn in the workplace. Even if you think that you don’t use something directly in your current role, you might discover that some of your work relies on the work of other actuaries and you consequently need to understand their work. It’s always best to be prepared, and through your studies you can rest assured that you’ll have a good foundation for whatever actuarial challenges you face in the future!


Other Exams in Real Life articles:



Exam 5

Exam 6

Exam 7