It’s pricing for large accounts, end of story.  

I am only half kidding, since the name does give it away, but why is there a distinction between other forms of actuarial pricing and large account pricing?  

What separates a large account from other kinds of risks is the volume of the insured’s historical data. A large account has enough loss data that its premium can be priced based on its own loss experience rather than being pooled with other accounts. Typically, these accounts have hundreds to thousands of claims over the past several years, with severities ranging from a few hundred dollars to millions of dollars. Rather than being a question of whether the account will have a claim, it’s a question of how large their claims will be. Some common lines of business that use this pricing are professional liability, commercial general liability, and commercial auto liability. 

The next big difference between traditional policies and large account policies is how the policies are structured. A typical insurance policy needs little explanation. An insured purchases a policy from an insurer with coverages, deductibles, and limits outlined, and the insurer pays whenever there’s a claim.  

A large account policy is much more complex. The policy is purchased through a broker. The policy is structured as a tower made up of layers. The layers represent the portion of a large loss an insurer agrees to cover. Multiple insurers are involved in the tower (e.g., Insurer A covers losses within layer 1, Insurer B covers layer 2, etc.). Each layer has a per-occurrence limit (i.e., the most the insurer will pay per claim) and an aggregate limit (i.e., the most an insurer will pay in a year). Insureds will often have a self-insurance retention (SIR), which is similar to deductible. Lastly, these policies are usually either written on a claims-made basis or an occurrence basis, which dictates whether losses are covered on a report-year basis or an accident-year basis (as you may remember from Exam 5).  

These types of accounts are easier to understand through an example. Suppose a large account policy has 10 layers. Each layer has a $5 million per-occurrence limit and a $5 million aggregate limit. The insured also has a $1 million SIR that will pay $1 million on each and every loss.  

Figure 2 shows the insured’s claims for the policy year. 

The 50 claims under $1 million would be fully covered by the insured because their severities are below the SIR. 

This leaves 11 claims with a combined incurred amount of $71 million. Figure 3 shows how the insured and insurer pay for these claims. 

The insured is responsible for the first $1 million of each loss, which ends up being $11 million of the $71M. Next, the insurers are responsible for 10 layers of $5 million, which ends up being $50 million of the $71 million. This leaves an extra $10 million that the insured is responsible for. 

Now if the $51 million claim never occurred, there would be 10 claims with a combined incurred amount of $20 million. Below shows how the insured and insurer pay for these claims. 

Same as before, the insured is responsible for the first $1 million of each loss, which ends up being $10 million of the $20 million. However, because layers pay out in order, only insurers in the first two layers are obligated to pay the remaining loss amounts. 

Something you may have noticed in the example is that loss experience seems to wane higher up the tower (i.e., small losses happen more frequently than large losses).  Losses are often modeled using a Pareto distribution to account for the decrease in losses higher up the tower. There are a few ways to price the higher layers where experience is limited. A common method is to use ILFs (as learned on Exam 5 and Exam 8). Another way is to combine the insured’s data with industry benchmark data at a point where the insured’s data become thin. In the previous example, that point would either be $1 million or $2 million. 

To answer the question of “why use large account pricing,” this method of pricing allows for insureds to a pay a premium that better reflects their loss experience. By sharing the tower with other insurers, it makes insuring these large entities less risky for each insurer and insurance more affordable and available.