Chapter 11 Quiz

Twenty questions — fifteen multiple choice and five short answer — covering the pricing and rating machinery and, above all, the discipline of rate adequacy. Answers are in the collapsed key at the bottom. All figures are constructed teaching examples.

Multiple choice

1. A premium is composed of three blocks. Which is correct?

  • A. Pure premium + commission + taxes
  • B. Pure premium + expense load + profit and contingencies load
  • C. Loss cost + reinsurance + surplus
  • D. Base rate + experience mod + schedule mod

2. The pure premium is best described as:

  • A. The minimum premium an insurer will accept
  • B. The premium after all credits and debits
  • C. The expected loss per unit of exposure (frequency × severity), before expenses and profit
  • D. The premium net of the broker's commission

3. An ISO or NCCI loss cost differs from a manual rate because the loss cost:

  • A. Includes a larger profit margin
  • B. Contains the expected-loss component only — no expense or profit load
  • C. Is set by the individual carrier, not an advisory organization
  • D. Already includes the loss cost multiplier

4. A carrier turns a loss cost into a chargeable rate by applying its:

  • A. Experience modification factor
  • B. Schedule-rating credit
  • C. Loss cost multiplier (LCM)
  • D. Retrospective adjustment

5. A rating factor (relativity) of 0.85 means the characteristic is associated with:

  • A. An 85% chance of loss
  • B. 15% less expected loss than baseline, lowering the price 15%
  • C. 85% more expected loss than baseline
  • D. A schedule credit of 85%

6. The statutory standard that filed rates must satisfy is that they must not be:

  • A. Public, filed, or approved
  • B. Inadequate, excessive, or unfairly discriminatory
  • C. Manual, composite, or retrospective
  • D. Pure, loaded, or modified

7. Experience rating adjusts a risk's premium based on:

  • A. The underwriter's judgment of future controls
  • B. The risk's own loss history relative to the class, weighted by credibility
  • C. The minimum premium for the line
  • D. The insurer's expense ratio

8. Why does credibility limit how far experience rating can move the price for a small risk?

  • A. Regulators cap all experience modifications at 10%
  • B. A small risk's thin loss history is mostly noise, so the class remains the better predictor
  • C. Small risks are always priced at the minimum premium
  • D. Schedule rating overrides experience rating for small risks

9. Schedule rating prices:

  • A. The losses that have already occurred
  • B. The expense load only
  • C. Risk characteristics — management, protection, controls — that the class rate and experience rating do not capture
  • D. The reinsurance cost of the account

10. A schedule-rating credit granted "because we want to keep the account" is:

  • A. A best practice in a soft market
  • B. Permissible if under 5%
  • C. Undocumented and indefensible — a likely unfair-discrimination and rating violation
  • D. Required by the loss cost multiplier

11. An account carries a debit experience modification and a credit schedule modification. This is:

  • A. A contradiction that must be resolved before quoting
  • B. Consistent — past losses justify the debit; newly installed controls justify the credit
  • C. Only possible in personal lines
  • D. A sign the rate was filed incorrectly

12. Under retrospective rating, the final premium is:

  • A. Set entirely before the policy period and never changed
  • B. Determined largely by the insured's actual losses during the period, bounded by a minimum and maximum
  • C. Always equal to the minimum premium
  • D. The loss cost without a multiplier

13. A minimum premium exists primarily because:

  • A. Regulators forbid low premiums
  • B. Fixed expenses to underwrite, issue, and service a policy must be covered regardless of how small the risk is
  • C. Small risks are always bad risks
  • D. The pure premium cannot be calculated for small risks

14. The reason rate adequacy is so hard to enforce is that:

  • A. Regulators rarely review rates
  • B. The losses that make an inadequate rate inadequate typically arrive two or three years later, after the account looked clean and the growth was praised
  • C. Adequate rates are illegal in soft markets
  • D. The expense load is unpredictable

15. "Meeting the market" in a soft market by cutting rate and granting soft credits most directly threatens:

  • A. The expense ratio only
  • B. The combined ratio — pushing it toward and above 100% once the delayed losses arrive
  • C. The minimum premium
  • D. The loss cost multiplier

Short answer

16. Explain, in two or three sentences, why the profit and contingencies load being thin (often around 5%) makes a small error in the pure premium so dangerous to the combined ratio.

17. Two insurers price the same risk from the same loss cost but charge different rates. Give the single most likely reason, and explain why it is not that one insurer judges the risk to be safer.

18. Distinguish experience rating from schedule rating in terms of what each one looks at (past losses vs. present conditions) and how each is applied (mechanically vs. judgmentally).

19. A broker asks you to grant a hot-work-program schedule credit on a fabricator before the program is installed. Explain why you cannot, and what the correct underwriting mechanism is for rewarding the control once it actually exists.

20. Make the argument that charging an adequate rate is an ethical act and not merely a profit- seeking one. Connect adequacy to the insurer's solvency and to the claimants who depend on the carrier still being there to pay.

Answer key (click to expand) **1. B.** A premium = pure premium + expense load + profit and contingencies load. (Commissions and taxes are *components of* the expense load, not separate blocks at this level.) (§11.1) **2. C.** The pure premium is the expected loss per exposure — frequency × severity — before any expense or profit. (§11.1; Ch. 10) **3. B.** A loss cost is the expected-loss component only; it contains no expense or profit load. Treating it as a rate is the §11.2 trap. (§11.2) **4. C.** The loss cost multiplier grosses the loss cost up for the carrier's own expenses and profit target. (§11.2) **5. B.** A relativity of 0.85 means 15% less expected loss than baseline, so a 15% price reduction. (It is *not* a probability of loss.) (§11.3) **6. B.** Rates must not be inadequate, excessive, or unfairly discriminatory — the statutory standard from Chapter 4. (§11.2; Ch. 4) **7. B.** Experience rating uses the risk's own loss history relative to the class, weighted by credibility. (§11.4) **8. B.** A small risk's thin history is mostly noise (low credibility), so the class average remains the better predictor and the experience adjustment is correspondingly small. (§11.4; Ch. 10) **9. C.** Schedule rating prices management, protection, equipment, and loss-control characteristics not captured by the class rate or experience rating. (§11.5) **10. C.** "We want the account" is not a filed risk-based category; the credit is undocumented, indefensible, and a likely unfair-discrimination and rating violation. (§11.5) **11. B.** Consistent: the debit experience mod reflects bad *past* losses; the schedule credit reflects new controls that improve the *future*. This is exactly the Harbor Steel situation. (§11.4, §11.5) **12. B.** Retrospective rating sets the final premium largely from the insured's actual losses, bounded by a contractual minimum and maximum. (§11.6) **13. B.** The minimum premium ensures the fixed expenses of being a policy are covered even when the rated premium is tiny. (§11.6, §11.1) **14. B.** The punishment for inadequacy is delayed — the losses arrive in year two or three, long after the account looked clean and the growth was rewarded. (§11.7) **15. B.** Soft-market rate-cutting and soft credits push the combined ratio toward and above 100% once the delayed losses land. (§11.7; Ch. 3) **16.** With only ~5 points of margin, a pricing error larger than that (e.g., a 7-point miss in the loss ratio) consumes the entire profit load and pushes the combined ratio above 100% — an underwriting loss. The cushion is too thin to absorb a casual mistake, which is why pure-premium accuracy is a survival skill. (§11.1) **17.** The most likely reason is a *different expense structure* producing a different loss cost multiplier (e.g., a low-commission direct writer vs. a higher-commission agency carrier). Both may see the same expected loss; the cheaper carrier simply has lower expenses to load on top, not a more favorable view of the risk. (§11.2) **18.** Experience rating looks *backward* at the risk's actual losses and applies a *credibility-weighted formula* (mechanical). Schedule rating looks *forward* at present conditions and controls and applies the *underwriter's documented judgment*. One prices what happened; the other prices what the conditions imply about the future. (§11.4, §11.5) **19.** A promised-but-unverified control is not yet a fact, so it cannot yet be a credit. The correct mechanism is to write the account on its current merits and attach the control as a *subjectivity* (condition to binding — Chapter 13); once verified, the credit can be applied (or the rate adjusted at the next term). (§11.5; Ch. 13) **20.** An insurer that prices inadequately and becomes insolvent protects no one: its promises evaporate and its claimants go unpaid. The premium is the fuel that pays claims; a rate that cannot cover expected losses is a promise the carrier cannot keep. Adequate pricing is therefore the precondition for the protection being *real* — an ethical obligation to every future claimant, not just a profit target. (§11.7; Ch. 1)