How to determine sources of error in the Frasier method?

By Mindy Epstein | May 01, 2017

Now that you've had an introduction to the Frasier method including what to consider when using it and when errors commonly occur, I'm hoping the concept is a little less scary to you. 

As I mentioned in my previous blog, reinsurance analysts usually fear the Frasier method because of the potential for errors. But what is the best way to address a fear? Take it head-on (at least for some!). When it comes to Frasier, this means getting an understanding of where the most common errors can occur.

Where can the most common errors occur in the Frasier method?

First Year Premium - Since each subsequent duration in the Frasier calculation is based on the probability of the prior duration, a mistake in duration one will impact all following durations.  First-year premium is frequently handled in two different ways depending on the treaty.  A first-year premium rate can be 0 or it can have a rate but is subject to a 100% allowance. The Frasier calculation will produce a different rate in subsequent durations depending on if a zero or non-zero rate is used for the first year. An illustration is below:

Frasier with Zero as the First Year Premium:

Policy Year Insured 1 Rate Insured 2 Rate Frasierized Rate
1 0.00 0.00 0.00000
2 4.41 8.94 0.15000
3 4.86 9.89 0.15000
4 5.40 10.93 0.25697
5 5.98 12.05 0.41366

* Assume NAR is $15,000 - Premium would be 0.0000 * (15,000/1000) =  $0.00

Frasier with Non-Zero as the First Year Premium - 100% Allowance: 

Policy Year Insured 1 Rate Insured 2 Rate Frasierized Rate
1 9.17 19.05 0.17643
2 4.41 8.94 0.20199
3 4.86 9.89 0.30978
4 5.40 10.93 0.44750
5 5.98 12.05 0.41366

* Assume NAR is $15,000 - Premium would be .17463 * (15,000/1000) =  $2.62
                                            Allowance - 100%                                         = -$2.62      
                                            Net Premium Owed                                      =  $0.00

The Net premium owed in both cases is the same, but as you can see the premium rates for durations 2 through 5 are different.  This difference compounds and can become significant at later durations. Knowing which method to use is crucial to getting accurate results throughout the life of the policy.

Insured Ages - in most cases the issue age for each insured is used in the Frasier calculation.  In some instances, a blended age or the oldest of the two insured is used for both insureds.  Knowing how age is calculated will help ensure that the information being reported and used is correct.

Uninsurable Life - If one of the lives is uninsurable at issue, there are several ways to account for it.  In some treaties, the Frasier calculation is not performed and a single life rate is used based on the characteristics of the insurable life.  The second life is not taken into consideration for premium rate purposes.  In other treaties, a flat rate is used for each duration rather than the actual rate based on the characteristics of the uninsurable life.  A third possibility is that the information on the uninsurable life is used with a high mortality rating factored into the Frasier calculation.

Change/Update of Insured Information –The one potential problem which can arise is if the insured’s data that is used to generate the Frasier premium rates initially is inaccurate or has changed.  This is something that is usually uncovered during a premium review.  The rates being used do not match the reported insured’s characteristics and therefore the premium rate is questioned.  If you are using TAI for reinsurance administration there is a function within the system that will update the premium rates based on the current cession information.

What financial impact do these errors have?

All the errors mentioned above have the potential of producing a large financial impact, both positive and negative.  Let's discover how:

The age of the insureds at issue, as well as the current policy duration, will significantly affect the impact depending on the error. The most common errors discovered during a premium review relate to incorrect insured characteristics from data feeds into the reinsurance systems.  Errors in age, gender, or mortality will produce inaccurate Frasier rates since each duration’s rate is based on these characteristics.  In addition, since each subsequent duration is based on the prior duration the error will continue to be compounded.

Another common error is the identification of uninsurable lives; the data feed may contain one set of identifiers which may not translate properly into the reinsurance system parameters.  Thus, the translation of the data feeds inaccurate data to the Frasier calculation and produces results that are both data and financially inaccurate. 

Implementing quality controls and conducting treaty reviews can help mitigate the risk of inaccurate data and major financial losses. Discover our treaty review methods here. 

To fear, or not to fear?

Hopefully, by now you can see that the Frasier method is not something to be feared. Now that you are equipped with knowledge on how to identify potential sources of error, comprehend the overall purpose and apply knowledge of reinsurance premium calculation, you should feel more confident the next time you tackle the Frasier Method.