INTODUCTION TO REINSURANCE NOLAN ASCH CAS RATEMAKING SEMINAR

INTODUCTION TO REINSURANCE NOLAN ASCH CAS RATEMAKING SEMINAR INT-7

INSURANCE The insurer insures the individual or the corporation

REINSURANCE The REINSURER insures the insurance company

REINSURANCE PLACEMENT MECHANISMS n DIRECT n BROKER

INSURANCE vs. REINSURANCE BOTH concerned with future contingencies n BOTH require underwriting skills (risk) n BOTH involve transfer of risk n BOTH require payment of premium n BOTH provide protection n BOTH subject to (some) regulation n

REINSURANCE Buyers assumed to be knowledgeable n Responds to actual loss n Provides indemnification only n Reimburses for payments already made n Usually Global n

FUNCTIONS OF REINSURANCE n CAPACITY

CAPACITY Single Risk (FAC WTC) n PORTFOLIO (TREATY) n

CAPACITY MECHANISMS Excess-of-Loss n Quota Share n

FUNCTIONS OF REINSURANCE CAPACITY n CATASTROPHE n

CATASTROPHE QUOTA SHARE n EXCESS OF LOSS n SECURITIZATION n

FUNCTIONS OF REINSURANCE CAPACITY n CATASTROPHE n STABILIZATION n

STABILIZATION Reduction in Variance (swings)

STABILIZATION Extreme contractual case “STOP-LOSS” Aggregate Excess

FUNCTIONS OF REINSURANCE CAPACITY n CATASTROPHE n STABILIZATION n FINANCING n

FINANCING Reducing Liabilities Ceding Commissions “Overrides”

FINANCING May increase PHS due to transaction

FINANCING Finite Reinsurance. . . but ALL Reinsurance is Financial

FUNCTIONS OF REINSURANCE CAPACITY n CATASTROPHE n STABILIZATION n FINANCING n ENTER AND EXIT MARKETS n

ENTER OR EXIT MARKETS Lessens risk as you learn With 100% Q/S you exit

FUNCTIONS OF REINSURANCE CAPACITY n CATASTROPHE n STABILIZATION n FINANCING n ENTER AND EXIT MARKETS n UTILIZE REINSURER EXPERTISE n

USING REINSURER EXPERTISE Large or unusual claims n Large or unusual risks n Special relationships and/or knowledge n

LIMITATIONS OF REINSURANCE Will NOT make bad business profitable n Transaction Costs n Rating Agency Impacts (Gross/Net) n

How Reinsurance Is Priced in Practice Hypothetical Examples

NO PRICE REGULATION n (virtually)

CASE BY CASE

NEGOTIATION

FLEXIBILITY IN STRUCTURE Contractual

EXCESS OF LOSS

LAYERING

$19. 75 Mill xs $0. 25 Mill (sounds like a wide layer)

TYPICAL LAYERING n n n 250 xs 250 500 xs 500 1 M xs 1 M 3 M xs 2 M 5 M xs 5 M 10 M xs 10 M n n n Price Price A B C D E F

High Frequency/ Low Severity Buffer layers ie 250 xs 250

LOW FREQUENCY HIGH SEVERITY Capacity Layers ie 10 m xs 10 m

CLIENT/BROKER NEGOTIATION Change or resubdivide the layering

LAYER TRAP MANY PERMUTATIONS n Pricing for 500 xs 500 n Later, request the 250 xs 250

LAYER TRAP n at “last minute” Ask for 150 xs 100 --Requires more data

PRICING TRAPS n AGGREGATE ANNUAL DEDUCTIBLES

ASSUME A 10% RATE Request a 1% AAD n Request a 2% AAD n Request an 8% AAD n NOW the risk/variance n becomes LARGE vs a 2% rate n

INFORMATION FOR PRICING NO standards

WHAT THE REINSURER WANTS EVERYTHING

WHAT THE BROKER/CLIENT MAY WISH TO SUPPLY NOTHING

POSSIBLE OUTCOMES

GIGO Garbage-In Garbage-out

EL NIÑO

NINO Nothing-in Nothing-out

EXPERIENCE RATING Using losses of the risk to price the risk.

STANDARD All losses at half the attachment point & up

ACTUARIAL APPROACH DETRENDED LOSSES Varies with age of claim BEGINS to show ACTUAL CLAIMS as a sample outcome

EXPOSURE RATING Attempt to rate Reinsurance based upon the TRUE underlying exposures Proxies for TRUE exposures: Limits Profiles = Subject Premium by policy limit Exposures by policy limit ( still not the TRUE exposure)

LIMITS PROFILE $100, 000 Policy Limit Yr 1990 10% of exposures at $100, 000 n Yr 1991 25% of exposures at $100, 000 n Yr 1997 90% of exposures at $100, 000 n loss was atypical in 1990 n layer is effective 7/1/97 n Include the loss? ?

LIMIT LOSS limit loss to 1990 policy limits or trend and develop loss

“WE DON’T DO THIS ANYMORE” “Throw out “ claims from MGA’s, classes or states we no longer write

QUOTA SHARE ISSUES Moral hazard/ Retention 1% net n Ceding Commission n Overrides n Sliding Scales n Loss Corridors n