1. Pricing Strategies for Multi-Line Multi-Year (MLMY) Policies April 12, 1999 CAS Financial Risk Management Seminar Denver, Colorado Nathan J. Babcock, ACAS, MAAA Deloitte & Touche LLP

2. Agenda I.MLMY Advantages, Disadvantages II.Pricing Example III.MLMY Pricing Considerations IV.Risk Loads V.Business Dynamics

3. Insurer/Seller l Extended duration of premium receipts l Enhanced market share l Relief from market cycles l Higher “implied” renewal rates generating a more “seasoned” book l Development of long-term relationships MLMY Advantages

4. Insured/Buyers l Lower, more stable premium l Lower commission l Simplified administration l Relief from market cycles l Enhanced Corporate Risk Management focus l Coverage for traditionally uninsurable risks l Guaranteed renewal l Customized program MLMY Advantages

5. MLMY Disadvantages Insurer/Seller l Limited ability to react to poor experience by increasing rates l Complex pricing l Complex profitability measures l Allocation issues (WP, UPR, capital)

6. MLMY Disadvantages Insured/Buyer l Possibility of an aberrant line or loss impacting overall coverage for all lines l Opportunity cost of locking-in l Lack of focus on traditional risk management l “All eggs in one basket”

7. Pricing Example

8. l Burning cost l On-level historical loss ratios l Exposure rating l Monte Carlo simulation Traditional Pricing Approaches

9. l Pricing of a layer excess of a self-insured retention l SIR applies per occurrence to all lines, with annual and term aggregates l Lines considered: WC, GL, EQ, FX l Model output = losses and premiums by layer Policy Example Baseline Assumptions

10. Example Loss Metrics WC Mean = $12 MM Std dev = $1.5 MM CV = 0.125 GL Mean = $4 MM Std dev = $1 MM CV = 0.250 EQ Mean = $2 MM Std dev = $25 MM CV = 12.500 FX Mean = $3 MM Std dev = $5 MM CV = 1.667

11. Scenario I $25 mm per occ. and ann. agg. SIR $100 mm annual aggregate limit Year 1 WC sublimit - $500k per occ. SIR

12. Scenarios II & III Prog: $25 mm WC: $500K (implicit $300 mm term aggregate) Year 1Year 2Year 3 $100 mm ann aggregate $100 mm ann aggregate $100 mm ann aggregate

13. Scenario IV Prog: $25 mm WC: $500K $100 mm term aggregate limit Year 1Year 2Year 3 $100 mm ann agg. $100 mm ann agg. $100 mm ann agg.

14. l Scenario I (1 one-year policy) $5 mm l Scenario II (3 one-year policies) $15 mm l Scenario III (1 three-year policy) $12.5 mm l Scenario IV (3-year policy with a term limit) $12 mm Modeled Premiums

15. Multi-Line / Multi-Year Pricing Considerations

16. Portfolio Effect

17. Correlation l Among lines of business l Among multiple years l More or less risk?

19. Discount Rate l Implied risk margin l Paying the “last losses” on aggregate l Appropriate patterns of premium and loss payments

20. Reinstatements l Use Monte Carlo simulation output to determine likelihood of limits “blown” l Or, model likelihood of limits “blown” once a significant loss has occurred. l When would limits be reinstated l Very judgmental -- adjust insured’s assumed loss distribution for large loss that has occurred?

21. Additional MLMY Pricing Considerations l Exposure growth l Sublimits/Towers l Knockout features l Residual Retentions

22. “THE INSURANCE PREMIUM FORMULA” P = (expected losses) + (risk load) 1 - (expense ratio)

23. Risk Loads

24. Risk Load Considerations Insured-Specific Attributes l Loss distribution - standard deviation l Loss distribution - coefficient of variation l Confidence level desired

25. Risk Load Considerations Insurer-Specific Attributes l Return on equity/surplus l Expected policyholder deficit l Limitations on probability of ruin l Probability of surplus declining by xx% l Value of RBC or AM Best ratings

26. Risk Load Considerations Categories of risk load factors l Insured-specific = process risk l Insurer-specific = parameter risk

28. Business Dynamics l Opportunity cost of locking in l Market cycle l Renewal retention pressures l Hedges in other areas of insurer’s operations l Can risk loads be achieved? –One risk vs. entire book –As a cost of liquidity

29. l Ensure no big hits early on in program l Dynamic modifications to program l Expense allocation/UPR l Accounting issues (FAS113) Business Dynamics