Leveraged effect from primary loss pick
Hi,
Could someone explain more clear what this paragraph means, ideally with a simple example?
The choice of primary loss pick has an increasingly leveraged effect on the insurance charge as the size of the deductible/per-occurrence limit increases, or as the primary entry ratio becomes smaller (i.e. the aggregate limit is close to the per-occurrence limit).
Thank you!
CFX
Comments
The primary loss pick is the insured's estimate of the largest per-occurrence loss on a policy. When pricing a policy with both a per-occurrence and an aggregate limit we form the entry ratio by taking the ratio of the policy aggregate limit divided by the primary loss pick.
As the primary loss pick gets large in relation to the aggregate limit, the entry ratio approaches 1 from above., i.e. the entry ratio becomes smaller.
This is likely fringe material which is why we didn't include Fisher's two examples in detail in the wiki. Take a look at the source text for how Fisher shows the following leverage effects:
In both cases the magnitude by which the insurance charge is off is greater than the magnitude by which the primary loss pick is off. This is the leverage effect and it gets worse the further away the primary pick is from its true value.