Thinking about Decision Making

Maine Event 2004 Thinking about Decision Making Rich Clement: Underwriting Decisions Rick Leavitt: Actuarial Decisions - Issues - Simulation - Game Theory September Maine Event 2004 Underwriting Decisions September Maine Event 2004 Difficulties In Underwriting Limited to poor information Quick turnaround time Competition – Acquisition/Irrational Pricing Multiple Products Tenure of underwriters – size of accounts Economic conditions Evaluation periods are too short Most volatile time period September Maine Event 2004 Difficulties In Underwriting Limited Tools/Consistently Changing Tools Changing plan designs – move to employee contributions New sales and underwriting territories Aging workforce Obesity – co-morbid conditions Pressure on underwriting gain from poor investment income Limitations to Home Office Partners September Maine Event 2004 Difficulties In Underwriting Mind space for LTD Increasing medical costs Churning business Employer’s “attitude” towards employee’s Regulatory issues Internal meetings Profitable Growth Goals September Maine Event 2004 Traditional U/W Response September Maine Event 2004 Traditional U/W Response Risk Analysis Read and Understand the RFP Why is case out to bid? Who is the broker? Partner with sales on strategy Who is employer? – Financial Underwriting Manual rates SIC, OCC, Area factors September Maine Event 2004 Traditional U/W Response Risk Analysis (continued) Plan design features Experience evaluation Cause and effect Most recent period is volatile Credibility Other perspectives Claims, actuarial, similar customers trust yourself September Maine Event 2004 New Approaches Track Decisions Competitive advantage Learn from your mistakes Evaluate # of claims Strategic direction Understand where you make money Maintain underwriting discipline – mistakes sell “Hit them were they ain’t” – Ty Cobb September Maine Event 2004 Actuarial Decisions … Harder than I thought “All you need in this life is ignorance and confidence; then success is sure” - Mark Twain “The greatest obstacle to discovery is not ignorance it is the illusion of knowledge” - Daniel Boorstein September Maine Event 2004 Scenario 4: Light Acquisition: Two Renewal Increases limited to 5% Year 10 Close Ratio 7.0% 6.5% 6.6% 6.3% 6.5% 5.6% 5.0% 5.2% 5.2% 5.0% Persist 94.9% 93.5% 88.8% 90.9% 88.9% 86.5% 88.4% 86.6% 89.0% Average Growth Year 1-5 Year 6-10 Years 1-10 10.2% 3.8% 7.0% Gain 2.3% 3.7% 5.0% 6.3% 7.3% 8.5% 9.3% 9.9% 10.4% 10.8% Inforce Inforce Premium Growth 131,330K 142,877K 9.4% 162,392K 8.8% 181,092K 13.7% 194,838K 11.5% 205,957K 7.6% 210,020K 5.7% 219,274K 2.0% 226,125K 4.4% 235,147K 3.1% Close Ratio 1-Persistency 1-Persistency Gain 15% 5.1% InforceGrowth Inforce Premium 6.5% 13% 11.2% 9.1% 11% 11.1% 13.5% 9% 11.6% 13.4% 7% 11.0% 250M 200M 150M 100M 5% Gain 5.7% 9.9% 8.5% 3% 50M 1% -1% 0M Year September 10 Maine Event 2004 Scenario 5: Classic Underwriting Cycle Year 10 Close Ratio 10.4% 10.0% 9.9% 3.3% 3.2% 3.3% 8.7% 8.6% 8.5% 5.1% Persist 94.1% 95.5% 87.3% 76.1% 72.7% 75.2% 85.3% 88.5% 84.6% Average Growth Year 1-5 Year 6-10 Years 1-10 5.1% 5.6% 5.4% Gain -5.1% -5.9% -3.5% 5.8% 12.2% 14.9% 7.0% 4.4% 3.8% 7.1% Inforce Premium 140,374K 158,514K 187,305K 177,076K 153,933K 132,051K 144,912K 171,704K 195,680K 202,541K Inforce Growth 17.0% 12.9% 18.2% -5.5% -13.1% -14.2% 9.7% 18.5% 14.0% Close Ratio 1-Persistency 1-Persistency Gain 35% 5.9% InforceGrowth Inforce Premium 4.5% 30% 12.7% 25% 23.9% 27.3% 20% 24.8% 15% 14.7% 11.5% 10% 15.4% 250M 200M 150M 5% Gain 2.0% 6.8% 4.9% 100M 0% -5% 50M -10% -15% 0M Year September 10 Maine Event 2004 Scenario Outcomes Inforce Premium Annual Gain Target Pricing 280M 20% Modest Acquisition 260M Aggressive Acquisition 15% Light Acquisition 240M Underwriting Cycle 220M 10% 200M 5% 180M 0% 160M Target Pricing Modest Acquisition 140M -5% Aggressive Acquisition 120M Light Acquisition Underwriting Cycle -10% 100M Year September 10 Year 10 Maine Event 2004 Scenario Outcomes (Years 6-10) 12% 10% Yr Gain 8% 6% 4% 2% 0% 70M 75M 80M 85M 90M 95M 100M 105M 110M 115M 120M 5Yr Premium Priced at Target: No increase on renewal Priced at break even: 10% increase on renewal Priced at a loss: 20% increase on renewal Initially priced below target: 5% increase on renewal September Underwriting Cycle Increasing Rates Decreasing Rates Low rates Maine Event 2004 Other Approaches? Can Game Theory Help?? The theory of games is a theory of decision making in complex situations… when the outcome is uncertain (chance) and there are competing goals (other players) 1944, John Von Neumann – “Theory of Games and Economic Behavior” 1948, John Nash – “Nash’s Equilibrium” – identifies existence of optimal Strategy September Maine Event 2004 Game Theory Pure Skill Pure Luck Luck and Skill Chess War Poker Go Chutes and Stock Market Checkers Ladders LTD ?? Tic-Tac-Toe Trivial ! Categories Zero-Sum versus Non Zero-Sum Person versus Multi-person Cooperative versus Non-Cooperative September Maine Event 2004 Optimal Strategies?? Equilibrium Strategy Defined as a strategy in which you will have no regrets regardless of what the other players Nash Equilibrium – 1948 An equilibrium strategy exists for all two-person games zero-sum and non-zero sum September Maine Event 2004 Prisoner’s Dilemma Player Player Option Option Option 2,2 0,3 Option 3,0 1,1 Question: What is the equilibrium strategy? September Maine Event 2004 Prisoner’s Dilemma You and your partner are caught leaving the scene of a crime with no other evidence You are placed in separate rooms and pressured to testify What should you do? You Your Partner Keep Silent Testify Keep Silent Both go Free Testify You go free, but your partner goes to jail September You go to jail, but your partner goes free Both convicted of a lesser charge Maine Event 2004 Prisoner’s Dilemma Best Possible Payoff: Keep Silent If you keep silent and your partner testifies, you will regret decision If you testify: Partner keeps silent: You go free (Good decision) Partner Testifies: Lesser charge (Good decision) Both Partners testify = Nash Equilibrium September Maine Event 2004 Prisoner’s Dilemma Player Player Option Option Option 2,2 0,3 Option 3,0 1,1 Nash Equilibrium minimizes expected payout Is this really the optimal strategy? What strategy would you use over multiple games? September Maine Event 2004 Multi-player Games Complicated by Possibility of Alliances Start-up company offers the following bonuses 24K Actuary Underwriter 20K 16K Claims 27K if all three join Who should join? How much should each get? September Maine Event 2004 Multi player Games Option 1: All three join and get $9K each Option 2: Actuary and Underwriter get $12K each … but wait, Claims person offers the underwriter $13 (keeping $3) Actuary offers the claims person $4 (keep $16) Underwriter offers the claims person $5 (keeping $11) … where will the negotiation end up? September Maine Event 2004 Multi-player Games Any solution is unstable There can always be an alliance with another player that works better for one member of the alliance No Optimal Solution: Too often all parties end up with nothing September Maine Event 2004 Game Theory Interesting, but… N-player, non-zero sum, cooperative games are poorly understood Game Theory can characterize optimal solutions, but does not well at identifying actual solutions Defining player utility in real life is difficult Games are more fun to play than they are to study… September