1. Page 1 Recording of this session via any media type is strictly prohibited. ARM 56 – Risk Financing Exam Review Session RIMS 2014 – Denver, CO Presented By: Rich Berthelsen, JD, MBA, CPCU, AIC, ARe, AU, ARM Senior Director of Content Development The Institutes 610-644-2100, ext. 7995

2. Page 2 Recording of this session via any media type is strictly prohibited. Overview Exam Basics – What to Expect Test-Taking Tips Review of Sections Students Find Most Challenging

3. Page 3 Recording of this session via any media type is strictly prohibited. What to Expect on the Exam Educational Objectives Balanced Exam Pretest Items

4. Page 4 Recording of this session via any media type is strictly prohibited. Test-Taking Tips Time Get the easy ones Don’t get bogged down early Use the “mark for later review” feature Eliminate the obviously wrong answers Use your scratch paper to keep track

5. Page 5 Recording of this session via any media type is strictly prohibited.

6. Page 6 Recording of this session via any media type is strictly prohibited. Assignment 2 – Estimating Hazard Risk

7. Page 7 Recording of this session via any media type is strictly prohibited. Steps in Estimating Hazard Losses 1 st Collect and organize data 2 nd Limit individual losses 3 rd Apply loss development factors 4 th Forecast losses

8. Page 8 Recording of this session via any media type is strictly prohibited. Exposure Data Exposure unit defined: A fundamental measure of the loss exposure assumed by the insurer. Examples: manufacturers – sales apartments – square footage retail stores - ?

9. Page 9 Recording of this session via any media type is strictly prohibited.

10. Page 10 Recording of this session via any media type is strictly prohibited.

11. Page 11 Recording of this session via any media type is strictly prohibited.

12. Page 12 Recording of this session via any media type is strictly prohibited.

13. Page 13 Recording of this session via any media type is strictly prohibited.

14. Page 14 Recording of this session via any media type is strictly prohibited.

15. Page 15 Recording of this session via any media type is strictly prohibited.

16. Page 16 Recording of this session via any media type is strictly prohibited. Steps in Applying Increased Limit Factors 1 st Develop increased limit factors 2 nd Calculate the increased limit factor for each layer of losses 3 rd Forecasting losses at various loss limits

17. Page 17 Recording of this session via any media type is strictly prohibited.

18. Page 18 Recording of this session via any media type is strictly prohibited. Increased limit factor for range from $50,000 to $1 million is: 2.50 divided by 1.20 which equals 2.08

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21. Page 21 Recording of this session via any media type is strictly prohibited.

22. Page 22 Recording of this session via any media type is strictly prohibited.

23. Page 23 Recording of this session via any media type is strictly prohibited.

24. Page 24 Recording of this session via any media type is strictly prohibited.

25. Page 25 Recording of this session via any media type is strictly prohibited. Assignment 5 – Retrospective Rating Plans

26. Page 26 Recording of this session via any media type is strictly prohibited. Retrospective Rating Plan A rating plan that adjusts the insured’s premium for the current policy period based on the insured’s loss experience during the current period; paid losses or incurred losses may be used to determine loss experience.

27. Page 27 Recording of this session via any media type is strictly prohibited. Retrospective Rating Premium Formula Retrospective rating plan premium = (Basic premium + Converted losses + Excess loss premium) x Tax multiplier

28. Page 28 Recording of this session via any media type is strictly prohibited. Converted Losses An element of the retrospective rating formula that includes the actual losses incurred increased by a factor (loss conversion factor) that reflects loss adjustment expenses.

29. Page 29 Recording of this session via any media type is strictly prohibited. Loss Conversion Factor A factor applied to incurred losses so that the converted losses reflect unallocated loss adjustment expenses (ULAE)

30. Page 30 Recording of this session via any media type is strictly prohibited.

31. Page 31 Recording of this session via any media type is strictly prohibited. Formula for Converted Losses Converted losses = Loss conversion factor x Incurred losses

32. Page 32 Recording of this session via any media type is strictly prohibited. Excess Loss Premium An element of the retrospective rating plan formula that compensates the insurer for the risk that an individual loss will exceed the loss limit.

33. Page 33 Recording of this session via any media type is strictly prohibited. Loss Limit The level at which a loss occurrence is limited for the purpose of calculating a retrospectively rated premium.

34. Page 34 Recording of this session via any media type is strictly prohibited. Formula for Excess Loss Premium Excess loss premium = Standard premium x Excess loss premium factor x Loss conversion factor

35. Page 35 Recording of this session via any media type is strictly prohibited. Formula to Review in Preparation for Case Study Retrospective rating plan premium = (Basic premium + Converted losses + Excess loss premium) x Tax multiplier

36. Page 36 Recording of this session via any media type is strictly prohibited.

37. Page 37 Recording of this session via any media type is strictly prohibited. Paid Loss Retrospective Rating Plan A retrospective rating plan in which the insured pays a deposit premium at the beginning of the policy period and makes additional payments, usually monthly, to reimburse the insurer for the insured’s losses as they are paid.

38. Page 38 Recording of this session via any media type is strictly prohibited.

39. Page 39 Recording of this session via any media type is strictly prohibited.

40. Page 40 Recording of this session via any media type is strictly prohibited. Assignment 6 - Reinsurance

41. Page 41 Recording of this session via any media type is strictly prohibited. Reinsurance The transfer of insurance risk from one insurer to another through a contractual agreement under which one insurer (the reinsurer) agrees, in return for a reinsurance premium, to indemnify another insurer (the primary insurer) for some or all of the financial consequences covered by the primary’s insurance policies.

42. Page 42 Recording of this session via any media type is strictly prohibited. Reinsurance Transactions No single reinsurance agreement performs all the reinsurance functions. A primary insurer often combines several reinsurance agreements. There are 2 types of reinsurance transactions: treaty and facultative.

43. Page 43 Recording of this session via any media type is strictly prohibited.

44. Page 44 Recording of this session via any media type is strictly prohibited. Facultative Reinsurance Reinsurance of individual loss exposures in which the primary insurer chooses which loss exposures to submit to the reinsurer, and the reinsurer can accept or reject any loss exposure submitted

45. Page 45 Recording of this session via any media type is strictly prohibited.

46. Page 46 Recording of this session via any media type is strictly prohibited.

47. Page 47 Recording of this session via any media type is strictly prohibited. Per Occurrence Excess of Loss A type of excess of loss reinsurance that applies the attachment point and reinsurance limit to the total losses arising from a single event affecting one or more of the primary insurer’s policies.

48. Page 48 Recording of this session via any media type is strictly prohibited. Attachment Point The dollar amount above which the reinsurer responds to losses.

49. Page 49 Recording of this session via any media type is strictly prohibited.

50. Page 50 Recording of this session via any media type is strictly prohibited. Pro Rata Reinsurance A type of reinsurance in which the primary insurer and reinsurer proportionally share the amounts of insurance, policy premiums, and losses (including LAE).

51. Page 51 Recording of this session via any media type is strictly prohibited.

52. Page 52 Recording of this session via any media type is strictly prohibited. Quota Share Reinsurance A type of pro rata reinsurance in which the primary insurer and the reinsurer share the amounts of insurance, policy premiums, and losses (LAE) using a fixed percentage.

53. Page 53 Recording of this session via any media type is strictly prohibited.

54. Page 54 Recording of this session via any media type is strictly prohibited. Surplus Share Reinsurance A type of pro rata reinsurance in which the policies covered are those whose amount of insurance exceeds a stipulated dollar amount.

55. Page 55 Recording of this session via any media type is strictly prohibited.

56. Page 56 Recording of this session via any media type is strictly prohibited. Assignment 7 – Captive Insurance

57. Page 57 Recording of this session via any media type is strictly prohibited. Obtaining Potential Cash Flow Advantages on Income Taxes Generally, a parent company may deduct from its taxes losses and other expenses paid by its captive insurer. IRS may also allow deduction of premiums paid to the captive if there is risk shifting and risk sharing.

58. Page 58 Recording of this session via any media type is strictly prohibited.

59. Page 59 Recording of this session via any media type is strictly prohibited. Premium Taxes and Residual Market Loadings One of several disadvantages of a captive insurance plan is that the losses retained by a captive insurer are paid for by the parent company as a premium on which premium taxes and residual market loadings are levied.

60. Page 60 Recording of this session via any media type is strictly prohibited. Assignment 10 – Transferring Risk to the Capital Markets

61. Page 61 Recording of this session via any media type is strictly prohibited. Advantages of Contingent Capital Arrangements The funds cost less than funds made available by insurance. Lower initial cost that lowers opportunity cost Able to obtain instant funds when most needed at predetermined price.

62. Page 62 Recording of this session via any media type is strictly prohibited. Catastrophe Equity Put Option A right to sell equity (stock) at a predetermined price in the event of a catastrophic loss

63. Page 63 Recording of this session via any media type is strictly prohibited.

64. Page 64 Recording of this session via any media type is strictly prohibited. Contingent Surplus Notes Surplus notes in which an insurer, at its option, can immediately obtain funds by issuing notes at a pre-agreed rate of interest and are counted as policyholders’ surplus rather than as a liability.

65. Page 65 Recording of this session via any media type is strictly prohibited. Organizations Transferring Risk Organizations that use insurance-linked securities and insurance derivatives to transfer risk are concerned with cost, the financial security (credit risk) of the parties supplying the risk capital, and the risk that the amount received may not match the amount of their loss (basis risk).

66. Page 66 Recording of this session via any media type is strictly prohibited.

67. Page 67 Recording of this session via any media type is strictly prohibited. Assignment 11 – Allocating Costs of Managing Risk

68. Page 68 Recording of this session via any media type is strictly prohibited. Allocated and Unallocated Loss Adjustment Expenses ALAE – attributed to a particular loss or claim Must be ALAE to be included in risk management costs ULAE – are not attributed to a particular loss or claim but still need to be charged to a dept.

69. Page 69 Recording of this session via any media type is strictly prohibited. Allocating Retained Losses Loss costs can be calculated 3 ways: Incurred loss basis: add amount paid for losses to reserves for pending claims, to the additions to those reserves and to IBNR Claims-made basis: add actual payments to changes in reserves for claims made during the period Claims-paid basis: use amount paid on losses during the period, regardless of when incurred

70. Page 70 Recording of this session via any media type is strictly prohibited. Types of Hazard Risk Management Costs to be Allocated Costs of accidental losses not reimbursed by insurance or outside sources Insurance premiums Cost of risk control techniques Costs of administering risk management activities

71. Page 71 Recording of this session via any media type is strictly prohibited.

72. Page 72 Recording of this session via any media type is strictly prohibited. Bases for Allocating Hazard Risk Management Costs Exposure based system – allocates costs to departments on the basis of their exposures, regardless of loss experience. Experienced based system – allocates costs to departments according to their pro rata portion of past losses.

73. Page 73 Recording of this session via any media type is strictly prohibited.

74. Page 74 Recording of this session via any media type is strictly prohibited. General Liability General liability loss exposures vary widely depending on the organization’s operations. The dominant liability exposure for allocating general liability costs could be square footage, payroll, number of full time employees, and sales.

75. Page 75 Recording of this session via any media type is strictly prohibited.

76. Page 76 Recording of this session via any media type is strictly prohibited. Questions?