What does a pricing actuary do?

A pricing actuary sets premiums, so an insurer can achieve robust profitable growth.

Many insurers, especially larger protection providers, will know very well what their pricing actuaries do. Smaller mutuals and friendly societies often manage without internal dedicated pricing resource and reprice at lower frequency and with less sophistication than their larger peers.

Other disciplines e.g. advisers, underwriters, business development managers and marketeers are sometimes unclear on the role of a (senior and experienced) pricing actuary.

I hope this article will help all these parties.

Out of scope for this article are:

• Insurance actuaries who value assets and liabilities and (e.g.) set and project capital levels
• Pension actuaries, investment actuaries and those who work in banking and elsewhere

So we’re looking at quite a small subset of actuaries. For reasons beyond the scope of this article, the proportion of actuaries working in pricing and related fields, especially on the life insurance side, has probably shrunk over time, perhaps reducing the profile of pricing team.

Now let’s restrict to an individual protection pricing actuary, thereby excluding pricing actuaries working in general insurance (personal and commercial lines) and group business.

We present: the (individual) protection pricing actuary (PPA).

The PPA’s expertise and responsibility: a list

As listed below the range of potential responsibilities is enormous. A PPA may be called a Business Development Actuary or Commercial Actuary. Reasons for this include:

• A responsibility to manage and optimise profits – price optimisation.
• Exposure to a range of disciplines beyond the actuarial field: sales, underwriters and more.

The potential range of responsibilities is enormous. A PPA may be called a Business Development Actuary or Commercial Actuary, given the responsibility to manage and optimise prices and profits and his exposure to a range of disciplines beyond the actuarial field: sales, underwriters and more.

Team building and softer skills

A friend recently pointed to an impressive team achievement in my days at Munich Re, many years ago: “That combination of imagination, technical skills and curiosity made a big difference.” Well said: the technical skills are central, but surrounding them are important softer elements.

A PPA leading a team should model and instil the traits listed above, not least so that those in pricing take maximal enjoyment from the job and develop bench strength as soon as possible; it will also be apparent from the list below that there is simply too much work for one person.

On a personal note, I take enormous pride in the achievements of my former team members, both at the time and subsequently, and believe there is more to come from former teammates.

Pricing philosophy

A protection insurer will have an underwriting philosophy i.e. the guiding principles adopted by an insurance company when assessing risks to provide acceptance terms (if any) for applications.

Similarly pricing work should follow a pricing philosophy, agreed at the highest level. This outlines in detail the strategies employed by an insurance company to set premiums. The philosophy may include analyses – see below – competitive positioning, profitability goals, regulatory compliance, and customer value proposition. The aim is to set robust premiums that reflect risk and optimize profit, subject to agreed constraints, and to target sustainable profitability.

A touchstone for judging the quality of a pricing philosophy: does it contain specifics, not platitudes? Example: does it follow Shane Chalke’s Macro Pricing: A Comprehensive Product Development Process in tackling expenses directly or is it vague, giving no direct framework for profitable growth?

Market positioning

Your PPA should be the company expert in:

• Product positioning – see product development below.
• Pricing factors – e.g. smoker status and occupation for Income Protection (IP).
• Peer price competitiveness and optimal responses to others’ positioning.

Price optimisation and delivery – reprices and systems

The PPA needs to implement the philosophy, not just write it. A senior PPA is unlikely to carry out the reprices, although this is possible of course. More probably he will oversee it and ensure that it has sensible objectives and, as far as possible, delivers its intended outcomes.

The PPA will have hands-on experience of market pricing dynamics and the operational pricing processes. He may need to re-engineer pricing processes, leading to significant automation, both in setting recommendations and delivering rates. Leading protection providers can reprice in one day.

An important part of repricing is the governance process. The PPA will be able to carry out reprices within certain parameters, but credibility (and possibly authority) will rise as objectives are delivered.

Profitability

Price (and profit) optimization is central to good pricing. A good PPA emphasizes this, writes it into the pricing philosophy and regularly reflects it in his work and communication.

A good PPA will nail your profitability challenges and, where necessary, get you to scale.

Operations and business planning

A PPA should be cognisant of the operational implications of price changes, especially the impact of growing volumes on underwriters and new business staff. Some reprices will be experimental until confidence is gained and may target areas whether the operational impact, especially on underwriting, can be more easily managed (e.g. younger lives).

In my experience a PPA is not usually central to the business planning cycle, but as subject matter experts they are often ideally placed to contribute.

Analytics of many forms

Some insurers have separate analytics teams for this huge area of work. Linking analyses to pricing should be a useful discipline and reality check. A PPA will carry out, oversee and use the results of many analyses. Except where stated those listed below are based on internal data, although external data (e.g. postcode-related) are often added to supplement this.

The detail of these analyses is out of scope, but a good PPA will know when a traditional actuarial approach suffices and when more modern data science techniques will add value.

We can split analyses by subject matter:

• Expense analyses. An analysis splitting overheads and marginal expenses by type is rare in my experience, perhaps because it can fall into a departmental gap. Without a good understanding it is hard for a smaller insurer to map a growth path to scale. PPAs speak up!
• Underwriting analyses. A PPA may perform several forms of “straight through” analyses and provide further support e.g. for post-issue sampling (e.g. for non-disclosure purposes), the cost and value of medical evidence and data-driven development of the underwriting philosophy.
• Distribution quality management (DQM). DQM has been around for over 20 years, is beloved by reinsurers, and remains the key to managing overall lapse and mortality experience.

Other analyses will link naturally to the policy process from quote, to application, going on risk and beyond. Gradually over time increasing focus has been placed on earlier areas of the new business process, to manage expenses and quality. Therefore we’ll look at analyses in reverse order.

On risk policies: mortality, morbidity and lapse analyses for policies which go on risk. An actuary’s staple diet for decades. These are often outsourced to another department, but the PPA needs to be more hands-on. As with other areas, availability should be at the click of a button.

Applications: decrement analyses for applications which don’t proceed. In time order:

• applications indicated as not proceeding before an underwriting decision is made (NPWs).
• those not proceeding after an underwriting decision (not taken up or NTU).
• those cancelled in the first month (“cancelled from inception” or CFIs).

Application link expenses, underwriting and DQM. They’re important.

Quotes: estimating market mix. In my experience such analyses are still the exception rather than the rule. Applications and policies do not form an unbiased estimate of market mix; the over-weight the areas where the insurer is cheap. Quote analyses do better, although certain technical adjustments are still required.

Finally, supplementing all these will be an analysis of external portal data. Portals: iPipeline and Iress. Portals’ monthly data on quotations and applications is aggregated, but seriatim data including individual competitor prices can be requested from 6+ months back; creative use can be made of this. Portal data can feed nicely into price optimisation.

Distribution and deals

Depending on the insurer and its scale the PPA may be called upon to contribute to deal-specific pricing or, equivalently, setting distributor commission terms. This could be in the context of a large distributor, panel or even third-party relationship that (e.g.) Legal & General have with the financial providers such as Barclays and Nationwide.

Product development

Again, let’s take a friendly society with a protection product offering at the smaller end of the scale: age-costed IP only as an extreme example. A PPA should be able to tell you the likely value of developing:

• A guaranteed level premium IP product
• A wider range of benefit payment term options
• Life cover and critical illness (CIC)
• A menu range incorporating life, CIC and IP

These product offerings have been widely adopted in the IFA market since the late 1990s. Even at that stage a menu range was regarded as a hygiene factor. An informed and experiences PPA would highlight the relative ease of growing volume through expanding the product range to include established products. This assumes, of course, that adequately competitive prices can be set. This brings us to reinsurance.

Reinsurance

Unlike their larger peers, few friendly societies make significant use of reinsurance. The larger protection insurers often use 100% reinsurance for their life and critical illness products and have changed their reinsurance structures over time, seeking structural arbitrage.

Reinsurance protects against risk, but expert protection provider’s intent is generally to manage (and increase) best estimate profitability. That will also be the PPA’s aim.

A PPA will skilfully represent the insurer’s interests with reinsurers, genuinely reflecting the reinsurer’s interests too. A win-lose will ultimately mean lose-lose, as reinsurance capacity dries up and an insurer’s practice becomes more widely known.

An aside to reinsurers. Reinsurance pricing techniques usually have different emphases, but knowing about direct office techniques and metrics could be useful: that’s how your tender responses will be assessed and that may open up opportunities for reinsurance price optimisation.

Underwriting support

Time was when underwriting systems were developed by underwriters and internal (now more typically external) system providers. This has often not delivered the desired results e.g. development underwriters sometimes find they are unable to access the required data and reports.

A PPA can often help, providing several forms of “straight through” analyses and further support (e.g.)

• for post-issue sampling, usually confirming non-disclosure levels
• to measure the cost and value of medical evidence
• for data-driven development of the underwriting philosophy

This support naturally requires open access to and the integrity of data.

Systems

Most insurers face systems issues or constraints. Several players in the mutual sector have had multi-million pound write-offs following non-delivery of IT projects and systems, sometimes caused by challenges as (apparently) simple as a transfer of data between two systems.

While not a specialist, a PPA can often contribute. A PPA will appreciate the core requirements for data integrity and ease of reporting, together with the typical functionality required from a system to support the new business process and throughout the application and policy lifecycle.

A PPA’s expertise may be more apparent e.g. in specifying and checking calculations for insurance or reinsurance premium calculations or for another area of complication: contract changes.

ExCo and Board support

Not everyone who runs or oversees an insurer is a financial expert. Some may be embarrassed to ask about profitability metrics. A PPA who presents to the ExCo may proactively offer helpful explanations e.g. of why the profit metrics for level and age-costed IP return such different results.

Senior executives may wish to understand more about the financial dynamics of the business – how does profitability respond to lapses? – or even probe on components of the retail premium. The PPA should be there to help, and most probably will already have done this work.

A PPA can also step outside his daily role – typically value maximisation – to tackle some of the most important areas an insurer may face. Real life examples include:

• How can I free up trapped capital?
• How can I convert my illiquid value into cash I can spend (e.g. on commission)?

Do you need to take action on pricing?

Some insurers, especially smaller mutuals and friendly societies have limited internal expertise. Their actuarial function – and consequently the reporting, statutory valuation and ORSA – may be outsourced to firm of actuaries.

This may mean the role of pricing is downplayed; instead of a dynamic and commercial approach to pricing, reflecting a PPA’s many years of experience, an insurer may end up with pricing which emphasizes rate adequacy and solvency rather than commercial imperatives.

Frank Redington, voted the greatest actuary ever in 2003, once said: “The actuary who is only an actuary… is not an actuary.” I was tempted to misuse this, but I’d rather close with his:

The actuary’s danger may lie in too close preoccupation with his particular techniques … It is not the tools he uses which make a great craftsman. It is the way he feels and thinks.

Is it time to get a commercially-focused pricing actuary, who can feel and think?