Pegasus Advisors - Towers Perrin Reinsurance CAS 2003 Seminar on Reinsurance Pricing Techniques - Casualty Lines Given by: Peter W. Wildman June 2003

1 1 Pitfalls in Pricing Reinsurance Coverage  Aggregate Excess of Loss  Loss Portfolio Transfers (Includes Adverse Development Covers) CAS 2003 Seminar on Reinsurance

2 2 General Issues to Consider (Quantitative and Qualitative)  Motivation of Buyer/Seller  Risk Reward/Tradeoff Desired  Mix of Business  Payout Patterns (correlation to Ultimate Loss Picks)  Parameter Risk/Process Risk  Data Issues  Terms & Conditions of Reinsurance Agreement  Claims Handling CAS 2003 Seminar on Reinsurance

3 3 Case Study #1 Prospective Accident Year Stop Loss Stabilization of results and reduction of reinsurance costs. CAS 2003 Seminar on Reinsurance

4 4 Case Study #1 Prospective Accident Year Stop Loss Company Information CAS 2003 Seminar on Reinsurance

5 5 êProvide reinsurance protection at a low cost êStabilize results êReduce/manage total reinsurance costs êProtect earnings and surplus êMaintain expense ratio êMaintain or improve AM Best rating êIncorporate sufficient risk transfer (timing & u/w risk) for accounting approval Case Study #1 Prospective Accident Year Stop Loss Objectives - Motivations CAS 2003 Seminar on Reinsurance

6 6 Case Study #1 Prospective Accident Year Stop Loss Stop Loss Terms CAS 2003 Seminar on Reinsurance Type:Aggregate Excess of Loss Term:Single Accident Year Subject Business:Whole Account SNEP:$500 million Attachment:60.0% (U/W neutral) Limit:$100 million (20% of SNEP)

7 7 Case Study #1 Prospective Accident Year Stop Loss Stop Loss Terms CAS 2003 Seminar on Reinsurance Minimum & Deposit: 6.0% of SNEP (est. $30 million) Additional Premium: 57.5% of UNL xs of 70.0% L/R Maximum Premium: (est. $58.75 million) Reinsurer Margin: 5% of All Premium

8 8 Case Study #1 Prospective Accident Year Stop Loss Stop Loss Terms  All other reinsurance purchased inures to the benefit of this cover. ê Funds Withheld - F/W. ê F/W balance is credited a contractual rate of 5.0% effective annually. ê Profit Commission of 100%. CAS 2003 Seminar on Reinsurance

9 9 Case Study #1 Prospective Accident Year Stop Loss Accounting Results 1) Expected - Company meets plan loss ratio SNEP = $500M Subject Losses = $330M (66% L/R) Calculations: Attachment = 60.0% x $500M=300.0M Limit = 20% x 500M= 100.0M Ceded Losses = 330M - 300M= 30.0M Net Ceded Premium = 6.0%x500M=300.0M Underwriting Income = 30M - 30M= 0.0M Potential PV Cost = 5.0% x 30M= 1.5M CAS 2003 Seminar on Reinsurance

10 Scenario #1 Prospective Accident Year Stop Loss Expected Payout (All Extra Losses Prorated) Reinsurer’s Results CAS 2003 Seminar on Reinsurance

11 Scenario #2 Prospective Accident Year Stop Loss Accelerated Payout Pattern Reinsurer’s Results CAS 2003 Seminar on Reinsurance

12 Scenario #3 Prospective Accident Year Stop Loss Expected Payout (All Extra Losses to Line 1) Reinsurer’s Results CAS 2003 Seminar on Reinsurance

13 Scenario #4 Prospective Accident Year Stop Loss Expected Payout (All Extra Losses to Line 2) Reinsurer’s Results CAS 2003 Seminar on Reinsurance

14 Prospective Accident Year Stop Loss (000) Line 1 Line 2 Total Premium250,000250, ,000 Expected Losses155,000175, ,000 Expected Loss Ratio 62.0% 70.0% 66.0% Payout Pattern (Expected) YearLine 1Line 2Total 142.3%10.0%25.2%  589.2%50.0%68.5%  %75.0%85.4%  %100.0%100.0% CAS 2003 Seminar on Reinsurance

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16 Case Study #1 Prospective Accident Year Stop Loss Data Issues - Reinsurer’s Analysis  Client Assessment - Published Rating ê Senior Management to communicate objectives ê Client Data Requirements l Historic subject base premiums ((5-10 years) larger if available) l Indication of any discontinued lines and corresponding premiums l Historical Rate Change, Rate Mods, by line, state, etc., Schedule Credits/Debits l Loss triangulations for past 5-10 U/W years, including the following: CAS 2003 Seminar on Reinsurance

17 Case Study #1 Prospective Accident Year Stop Loss Reinsurer’s Analysis  Client Data Requirements (continued) Incurred or outstanding indemnity; LAE, Combined l Paid indemnity, Claim Count Triangulations? (Depends on Line); Paid LAE l Policy limit(s) shift over time l Historical Reinsurance Retentions l Draft Placement Slip l Treatment of unique exposures CAS 2003 Seminar on Reinsurance

18 Case Study #1 Prospective Accident Year Stop Loss Reinsurer’s Analysis  Supplementary Data l Industry Losses l Industry Payout Patterns (What is the Tail?) l Other client information l Press releases CAS 2003 Seminar on Reinsurance

19 Case Study #2 Loss Portfolio Transfers CAS 2003 Seminar on Reinsurance Type:Adverse Development Cover Subject Business:Whole Account Subject Losses:$500M of carried reserves Premium:To be negotiated Attachment:$250M (= $500M - $250M) Limit:$400M Reporting:Quarterly 60 days in arrears Settlements:Quarterly 75 days in arrears

20 Loss Portfolio Transfers Pricing Considerations  Probability of Cover being used (Contingent, attachment relative to held reserves)  Who wants or is a natural buyer of Old Years’ Reserves? (lots of Sellers)  Insurance is easy business to enter, very difficult to exit.  Run-off Costs (How much Management time re: Actuarial, Claims, Financial, Ceded Reinsurance, etc.)  Motivations for Loss Portfolio Transfer CAS 2003 Seminar on Reinsurance

21 Loss Portfolio Transfers Motivations of Buyer/Seller  Sale of Company  Exit particular line of business/state of operation  Economic Risk Transfer  Financial Management CAS 2003 Seminar on Reinsurance

22 Loss Portfolio Transfers Data Analysis  Due Diligence (Internal or Third Party)  House Purchase Analogy (Who cares more about potential defects, buyer or home inspector?)  Ask any and all questions!  Any segments not reviewed CAS 2003 Seminar on Reinsurance

23 CAS 2003 Seminar on Reinsurance Loss Portfolio Transfers Data Issues - Reinsurer’s Analysis  Client Assessment - Published Rating ê Client Data Requirements l Independent Actuarial Review l Internal Actuarial Projections l Confidence Intervals l Incurred Loss Triangles (Gross and Net) l Paid Loss Triangles (Gross and Net)

24 CAS 2003 Seminar on Reinsurance Loss Portfolio Transfers Data Issues - Reinsurer’s Analysis  Client Data Requirements (continued) l Historical pricing of business l Historical inuring reinsurances l Claims audits l Reserving policies l Changes to claims handling

25 CAS 2003 Seminar on Reinsurance Loss Portfolio Transfers Data Issues - Reinsurer’s Analysis  Supplementary Data l Industry Losses l Industry Payout Patterns l Peer company information l Press releases

26 Loss Portfolio Transfers Claims Handling  Claims Audit - Access to Claim Files - Where are the Claim Files - Number of Open Claims  Adequacy of Held Reserves  Reconcile Claims Handling Philosophies CAS 2003 Seminar on Reinsurance

27 Loss Portfolio Transfers Claims Handling  Format of Claim Data (i.e, Electronic or Hard Copies)  Complete Claims History  Number of Years of History  Transferring Data from Buyer to Seller  Systems Compatibility/Reporting Responsibility CAS 2003 Seminar on Reinsurance

28 Loss Portfolio Transfers Claims Handling/Run Off Costs  Staffing Requirement  Intellectual Capital  Additional TPA Costs  Less attention paid to than Actuarial/Financial evaluation CAS 2003 Seminar on Reinsurance

29 CAS 2003 Seminar on Reinsurance Loss Portfolio Transfers Terms and Conditions of Reinsurance Agreement  Expected Results based upon actuarial projected probabilities ê Upside to downside relationship ê Return on Equity (Capital allocation) LOC usage ê Underwriting constraints ê Relationship implications - historical/prospective ê Subject Loss Limitations (Asbestos/EIL)