Pricing Aggregate Risk and Credit Risk for Risk
- Slides: 18
Pricing Aggregate Risk and Credit Risk for Risk Sharing Entities John D. Deacon CAS Ratemaking Seminar Ratemaking Call Paper Tampa, FL March 7 -8, 2002
Quotation: ”The best and safest thing is to keep BALANCE in your life…If you can do that and live that way, you are really a wise man” -Euripides 406 B. C.
Our Context: • Deals involving insurance entities which: >SHARE RISK (RSE) >DESIRE AGGREGATE REINSURANCE • Focus on deals with <$10 M annual losses • Goal: price adequately for aggregate and credit risk
Our Context con’t: • Why would an entity want to share risk? • How do these entities share risk? • Examples of entities which share risk. . .
Example of a Deal Parameters: • Homogeneous captive • Per occurrence limit = $500 k • Annual aggregate limit = 90% gross prem
Aggregate Risk Simulation Basics: • Methods of simulation: 1. Frequency/severity - complex and precise 2. Loss ratios - simple and accurate • To simulate loss ratios we need: – distribution (Lognormal) – mean – variance
Aggregate Risk Example Historical Results:
Aggregate Risk Graphical Simulation Results: Captive Loss Agg Loss 60% expected Limited Loss Ratios (% gross prem) 90% agg attach pt
Aggregate Risk Pricing: 90% LR agg attach pt
Are we done yet? • What about credit risk? • What IS credit risk? • When do we get to BALANCE?
Credit Risk Fundamentals Balance: Credit Risk Aggregate Attachment Point • Reducing risk of credit losses by decreasing attachment increases agg risk • Reducing risk of agg losses by increasing agg attachment increases credit risk
Credit Risk Fundamentals LR outcomes and how covered “GAP” RSE Loss Funds Collateral incl. Inv Inc RSE Expected Losses Probable RSE Equity Potential Credit Risk Agg Loss Agg Attach Point %ile 0% 50% 100%
Credit Risk Pricing Steps: Easy as ABC(D) Determine: A Size of the gap B Probability of losses above loss funds C How much equity the entity (RSE) has D “Creditworthiness” - Probability of tapping into this equity
Credit Risk Pricing: Probability wtd Loss [(Prem x Gap) x Prob[LR>loss funds] less Probability wtd Equity RSE Equity x Creditworthiness ] A B $7 M x 36% x 35. 5% - - C $3 M x 25% x x D divided by prem =1. 7%
Credit Risk Assumptions: • Loss distribution accurately depicts reality • Credit risk is easily modeled • Accurate liabilities on RSE financial stmts
Future Enhancements Acknowledge multi-year exposures: – incorporate risk of RSE uncertain liabilities – equity not allocated to current year
Close When pricing deals risk with agg cover: • Price the agg • Structure a deal with BALANCE • Price the credit risk A x B - C x D
Questions?
- Sras lras
- How to calculate aggregate demand
- Tableau cannot mix aggregate and non aggregate
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- Risk return and capital asset pricing model
- Credit risk management and advisory goldman sachs
- Lending policies and procedures managing credit risk
- Measuring and managing credit risk
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