Excess Growth Charge
I get how the excess growth charge "works" but something I was wonder is why it applies to both the r4 and r5 risk charges. I guess why it would apply to r5 seems intuitive since that's our charge for NWP, but why does the same amount also apply to r4?
Comments
Oh sorry I think I may know - it's because one is accounting for the excessive growth of reserves (r4) while the other is accounting for the excessive growth of written premium (r5)
Yes, more or less. The excess growth factor is based on premium growth but of course premium growth likely means growth in losses and reserves also. Since growth is generally from new business rather than renewals (or rate increases), new business typically has worse loss experience which means more capital is required to support it. Also, setting reserves for a growing company is more uncertain than setting reserves for a company that has stable premiums from year to year and the extra capital required accounts for this uncertainty.
Could the excessive growth charge ever be negative? (if avg premium growth is declining over the last 3 years?) Or will it just be 0 in that case?
That would be kind of like credit for excess shrinkage. I don't believe there is any such credit. If premium was shrinking, the R5 charge would be reduced but there wouldn't be any extra reduction in cases where the premium was shrinking rapidly.
You wouldn't even have to be shrinking--just growing less than 10%!
Fortunately the formula in Odomirok throws in a cap to avoid going negative:
Average growth rate factor = Maximum (average gross premium growth over three years, 0.10) – 0.10
Yup, the growth charge is for growth in excess of 10%. (So if growth is less than 10%, the charge is 0.)