The Actuary In Ceded Reinsurance: Non-Actuarial Considerations CAS Seminar On Reinsurance June 2-4, 2002 Tarrytown, New York Edward P. Lotkowski, FCAS Main Street America Group

2 This discussion is not… Actuarial: Actuarial: –Actuarial expertise is assumed, but… –Model everything! Retention settingRetention setting PricingPricing Portfolio – level analysisPortfolio – level analysis Definitive: Definitive: –Reinsurance buyer’s behavior influenced by specific situation ConstituenciesConstituencies Market conditionsMarket conditions

3 This discussion has: General themes: General themes:  Who are your customers?  The Actuary-Buyer is also a Broker and a Seller  Pertinent information takes many forms  Buying requires active management, not passive participation  Buyer succeeds when he/she leverages actuarial skills with communication and people skills

4 The Buyer’s Customers Arrows Mean: –Reciprocal customer relationships –Reciprocal flows of information –Reciprocal responsibilities Company Management Buyer BrokersReinsurers

5 Company Management as Customer Issues Ceding company management has several audiences Ceding company management has several audiences –Board of Directors –Wall Street –Stockholders –Rating Agencies What drives corporate risk philosophy? What drives corporate risk philosophy? –Is a philosophy articulated? –Is it “robust”? –Is it consistent with yours? “Hard” vs. “Soft” drivers of risk philosophy “Hard” vs. “Soft” drivers of risk philosophy

6 Company management as customer “Hard” Drivers Corporate Form Corporate Form –Access to capital Profile of investment portfolio Profile of investment portfolio –Equity/Fixed income composition –Liquidity Diversification among businesses Diversification among businesses –Stand-alone P & C vs. –P & C with Life, Annuities, Asset Management

7 Company management as customer “Soft” Drivers Management's constituencies Management's constituencies –Removed from reinsurance arena Need for clear communication Need for clear communication –Can dictate program structure e.g., variable retentionse.g., variable retentions –May preclude forms of reinsurance e.g., traditional vs. finitee.g., traditional vs. finite Management’s P & C/Reinsurance background Management’s P & C/Reinsurance background –Holding company structure

8 Company management as customer “Soft” Drivers, cont’d Management’s attitudes towards reinsurance Management’s attitudes towards reinsurance –Transaction vs. relationship –Attitude towards “payback” notions –Depth of understanding Mean vs. varianceMean vs. variance Individuals’ risk tolerances Individuals’ risk tolerances

9 Company management as customer Issue Management’s appetite for analytics Management’s appetite for analytics –Appetite is often low; actuary’s appetite is higher –Management’s appetite is often hard to gauge –Actuary-Buyer’s analytical expertise is assumed –Example (amounts are hypothetical): Retention options considered: Existing $1.5m per occurrenceExisting $1.5m per occurrence Existing with $2m AADExisting with $2m AAD $2m per occurrence$2m per occurrence

10 (Example) Price/Volatility Tradeoff Idea Idea –Analyze difference among purchasing options –All program differences occur in ($1.5m, $2.5m) –So, model activity in ($1.5m, $2.5m) Simulated risk process produces: Simulated risk process produces:

11 (Example) Ceded Losses Percentiles of Annual Loss Option 1 Annual Loss in ($1.5m, $2.5m) Option 2 Annual Loss ($1.5m, $2.5m) After AAD After AAD Option 3 Annual Loss ($1.5m, $2.5m) Higher Retention 25%$4.0m$2.0m$1.0m 50% % % %$11.0m$9.0m$4.0m

12 (Example) Current structure as baseline Percentiles of Annual Loss Option 1 Current Structure Option 2 Current With AAD Option 3 Retention 25%$0m$2m$3.0m 50% % % %027.0 Est. Premium Saving$0m$2m$4.5m

13 Reinsurer as Customer Buyer to Reinsurer “Perfect submission” “Perfect submission” –Stable primary company –Well-articulated and executed business strategy –Lots of (accurate!) data –Timely response –Complementary exposure –Large “bank” “Face time” important –Meetings  Especially after big loss –Audits What does your company have to offer? –Your company –Yourself

14 Reinsurer as Customer Reinsurer to Buyer Reinsurer’s attitude toward the market Reinsurer’s attitude toward the market –Where does it write? – e.g. clash vs. working layers –Transaction – oriented vs. –Relationship – oriented Efficient pricing & terms Efficient pricing & terms –The market is efficient in the long run –Not necessarily so in the short run  Wide variance in quotes, even in working layers  Result: e.g., might fill programs by moving money between layers

15 Reinsurer as Customer Security Spread cover over capital bases: Spread cover over capital bases: –U.S., London, Bermuda, Europe, other Specific reinsurers/markets Specific reinsurers/markets –Reinsurer eligibility criteria –Leading indicators –Post 9/11…a new game

16 Reinsurer as Customer Security (cont’d) Willingness to pay Willingness to pay –Recent claims payment history –Reputation Willingness to play Willingness to play –Do they still want to be in the business? –Reliance on retrocessional capacity –Corporate structure – who is calling the shots? –If new, are they “in, hard market”, “out, soft market”?

17 Broker as Customer Buyer to broker Buyer to broker –Company’s needs, risk philosophy –Discussion of prospective risk profile –Best data possible –Frequent and proactive communication – evolving needs

18 Broker as Customer Broker to buyer Broker to buyer –Advice on risks and needs –Current market knowledge –Aggressive representation  “The market says…” vs. “We should go to market with…”  Advice on specific placements (e.g., sign on /sign down) –Solid analytics  Actuarial/financial/risk theoretic  Pricing  Reinsurance as element of DFA  Modeling capabilities  Retention & limits  Treaty terms –Strong back room  Security analysis  Claims  Contracts

19 Some Post 9/11 Questions Who is standing (counterparty risk)? Who is standing (counterparty risk)? What is terrorism? What is terrorism? –What are the dimensions of cyber-terrorism? Do relationships matter? Do relationships matter? What is a fair price? What is a fair price?