Exams in Real Life: Exam 5

by Dan Watt, FCAS

The purpose of the "Exams in Real Life" series is to share how content from CAS exams is used in the workplace today. In essence, we would like to supply a little motivation by answering the questions, "Why am I learning this stuff?" and "When am I ever going to use any of it?" If you have not already done so, please read the two prior articles on MAS I & MAS II.

For this issue, we're focusing on Exam 5-Basic Techniques for Ratemaking and Estimating Claim Liabilities. Exam 5 is to P&C Actuaries as Anatomy 101 is to doctors — the class is super hard and worth 20 credits. The topics covered are the "bread and butter" of P&C actuarial work.

Oftentimes, friends and family will ask what actuaries do. Most of them assume we are accountants or something completely off, like assuming we work with birds. A good response may be to tell them that actuaries predict the future using math. Exam 5 is all about doing just this. In particular, the exam material teaches candidates to estimate the premiums we should be charging in the future and the proper amount of money to set aside for the future indemnification and defense of claims. The exam is split into two main sections: ratemaking and reserving.

The ratemaking section covers trending, on-leveling earned premium, calculating the overall rate level indication and understanding techniques used in risk classification. Many of you probably already use some of these concepts in your day-to-day work. Trending is vital to estimating the future environment. On-leveling premium is important in allowing for the use of additional relevant and credible data in the estimation of future expected values. The indication process provides a best estimate of future rate need, driving rate change discussions with our business partners and providing insight to departments of insurance. Risk classification drives class plan factors, allowing for fair premium to be charged to our policyholders. Understanding risk classification is vital because the proper classification of risks can allow a company to experience favorable selection, while classifying risks less effectively will cause adverse selection.

Understanding the underlying math behind ratemaking concepts is incredibly helpful, but the most important insight gained from Exam 5 is the ability to analyze ratemaking data, select appropriate methods and develop solutions to any issues that may surface. Candidates will learn the advantages and disadvantages of various techniques and be able to apply them to specific situations and different lines of business. On the job, it is the actuaries' responsibility to understand the methods and the assumptions that feed into them. They need to explain results to business partners and regulators. They need to ensure that data is proper for the desired analysis. Therefore, the actuary needs to have deep insight into the underlying workings of these processes.

During reserve calls, actuaries revisit a line of business's reserve amounts. Using the addition of new data, they estimate reserve need and decide if the line should make adjustments to the current reserves being held. In order to do so, the actuary will analyze the results of several reserve estimation methods, each with its own underlying assumptions, to select an indicated reserve recommendation. The reserving portion of Exam 5 covers the basic concepts and calculations needed to accomplish this reserve call process. Topics covered include aggregation of historical data, the development triangle and its use in diagnostics, basic methods to estimate unpaid claims, and the reconciliation of methods to select indicated reserves.

Similar to ratemaking, many of you probably already use some of these concepts in your day-to-day work. Aggregating data into calendar year, accident year, policy year, etc. are important ways to identify trends and patterns in historical data that can be used to predict the future environment. The concepts of homogeneity and credibility in data aggregation are discussed. Placing our data into development triangles and using these to diagnose drivers of change are vital for conversations with business partners and making assumption decisions for the various methods used. The cumulative loss development factors resulting from some of the methods are used in ratemaking and planning, and as payment patterns for investing.

Similar to ratemaking, the underlying math behind the reserving methods is helpful, but the most important insights gained from the exam are the abilities to understand the assumptions behind each of the methods and to use this insight to interpret results. The different methods have advantages and disadvantages, depending on the line of business and data used. The reserving actuary needs to be able to navigate the differences in the various methods' results, select a reasonable estimation of future reserve need and justify their selections by knowing the drivers of change in the data. They need to understand the impact of these changes on results and be able to clearly communicate to business partners when making indicated reserve recommendations.

As with all of the actuarial exams, Exam 5 is tough, but the concepts provided are the core to P&C actuarial work. While studying for the exam, our recommendation is to do it with the frame of mind that every topic you dig into will be useful during the span of your career. The methods learned will be used. The assumptions memorized will become second-nature. It really is an incredibly helpful exam!