managing overconfidence

Managing Overconfidence

Douglas J. Collins, FCAS, MAAA

[email protected]

Tillinghast London (Tel: 44 (0)207 170 2162)

CAE Zurich – 23 April 2004

2© Copyright Towers, Perrin, Forster & Crosby, Inc

Many factors contribute to errors (and bias!) in pricing and underwriting

Common Sources of Pricing and Underwriting Error/Bias (Micro)

Inadequate internal [historical] data upon which to develop estimates (e.g., old, incomplete or inaccurate data; inadequate/inappropriate sample)

Inability to collect and synthesize all relevant sources of data within the organization

Lack of reliable information about external market conditions and trends (e.g., inflation, tort costs)

Excessive concern for “competitive pressures”

Lack of adequate oversight over pricing decisions

Lack of “metaknowledge” — reinforces inherent overconfidence when making estimates, forecasts and predictions

Systemic Sources of Pricing and Underwriting Error/Bias (Macro)

Long feedback loop

No skin in the game


The results of a recent Tillinghast “Confidence Quiz” illustrate the prevalence of overconfidence

The Quiz

Objective: To test respondents understanding of the limits of their knowledge

Respondents were asked to answer ten questions related to their general knowledge of the global property/casualty industry

For each answer, respondents were asked to provide a range that offered a 90% confidence interval that they would answer correctly

Ideally (i.e., if “well calibrated”), respondents should have gotten nine out of ten questions correct 0

7

12

18

28

44

44

69

56

67

29

10

9

8

7

6

5

4

3

2

1

0

Number of Respondents

Raw Scores of Online Respondents

Note: based on 374 respondents as of 4/5/04.Profile of respondents: 86% work in P/C industry; 73% are actuaries.

Tillinghast Confidence Quiz


The best way to manage overconfidence is to implement a control cycle for pricing and underwriting

The Control Cycle: Retrospective Test of Pricing/Underwriting

A control cycle for P/C pricing and underwriting entails identifying, testing and validating all of the assumptions that underlie the projection of future loss costs used to price and underwrite the business

1. Define/Refine Process

2. ImplementProcess

3. MeasurePerformance

1. Pricing and Underwriting Process Elements Data required

Actuarial methods employed

Underwriting policies and rules

Decision authorities and reporting

Quality assurance

3. Formal Retrospective Performance Testing Data accurate and adequate?

Pricing methods sufficiently robust?

Policies and rules effective?

Decision authorities appropriate?

Variances between projected and actual experience within tolerances?


While improving pricing/underwriting requires a sustained commitment over time, three near-term steps will jump start the process

Retrospective Analysis

Process Design/Refinement

Case-study Training

Analyze relevant sample of pricing and underwriting results to identify/pinpoint specific causes and sources of error

Define (or refine) and institutionalize an ongoing process of continuous improvement (i.e., control cycle) for pricing and underwriting Incorporate insights from retrospective

analysis to address key challenges and deficiencies

Develop/institute case-study oriented training modules for underwriters and pricing actuaries to provide practical experience and rapid feedback Base training materials on past

business where results are already known


Managing overconfidence in pricing and underwriting

Pricing ElementBest

Estimate Standard Deviation

90% Confidence Low High

Historical experience not fully credible 957 5.0% 897 1,020

Historical experience not fully mature 191 20.0% 146 242

Subtotal Ultimate Historical Loss Costs 1,149 6.7% 1,052 1,249

Frequency and severity changes 138 50.0% 67 226

Mix of business or underlying exposure changes 10 200.0% 1 23

Subtotal Projected Future (Attritional) Loss Costs 1,297 12.0% 1,105 1,500

Non-attritional loss elements 610 33.0% 383 874

Total Projected Expected Future Loss Costs 1,906 17.3% 1,508 2,340

-20.9% 22.7%

managing overconfidence

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