Pricing Excess and Surplus Lines COM4 Ronald J

Pricing Excess and Surplus Lines (COM-4) Ronald J. Herrig, FCAS Markel Corporation Deerfield, Illinois

What Is the Surplus Lines Industry?

The Surplus Lines industry provides a market for hard-toplace risks; risks the standard market chooses not to write.

Why are these risks not written by the standard market? • Distressed Risks/Markets • Unique Risks • High-Capacity Risks

Distressed Risks – Something about the risk itself that makes it undesirable to the standard market. • Start-Up Manufacturer – No track record • New Physician • Physician with a History of Drug-Abuse

Distressed Markets – Something about the entire category of risks that makes it undesirable to the standard market. • OB/GYNs - SOL • Junk Yards • Nutritional Supplements – What’s the new Ephedra?

Unique Risks – Characteristics of the risk make it too unusual to fall within standard U/W classes. • Fireworks Accounts • Shamu Transportation • Architectural Projects

High-Capacity Risks – Risks needing high limits of protection and in-depth underwriting • High Rise Buildings • Directors & Officers • Aviation Property/Liability

How Can Surplus Lines Companies write this Junk (Profitably)?

By being Fast, Fluid and Flexible!

Regulation • No need to file rates/forms • Licensing required only in state of domicile • Not an unregulated industry, though

Regulations That Do Apply • Annual Statements • Triennial Reviews • Market Conduct Exams • Risk-Based Capital Requirements • SEC Requirements

Adaptable Policies • Claims-Made Coverage • ALAE included within Limits • Sublimits • Customized Endorsements

And most importantly…

Expert Underwriting Underwriters need: • to understand their company’s appetite for risk – and abide by it • knowledge of book’s underlying statistics • to understand each insured and its associated risks

Claims Handling • Knowledgeable Claim Handlers • Standardized Approach to Claims Reserving • Consistent Approach to Claims Reserving

Effects of the Market Cycle

Hard Market and E&S • Admitted Companies become more selective. • Surplus Lines applications increase dramatically. • Rates Firm, Coverages Contract. • Small Decrease in Admitted Market can increase Non-Admitted Market Substantially.

Change in Applications (2000 Baseline = 100 units)

Soft Market and E&S • Admitted Companies become less selective in their Underwriting. • Fewer Risks are Declined. • E&S companies develop new products to maintain volume.

Examples of New Products • Employment Practices Liability • Tenant Discrimination • Environmental Impairment Liability

EPLI (1994 Baseline = 100 units)

New Product Development 1. Opportunity identification 2. Product design 3. Testing 4. Product introduction 5. Life-cycle management

Opportunity Identification • Broker Recommendations • Marketing • New Product Teams • Media

Product Design • Target Market • Coverages • Policy Wording • Rating

Testing • Beta-Test on Select Market • Honest Feedback • Rate, rate

Ratemaking Methods

Ratemaking Methods for New Products • Pure Premium Methods • Piggy-back Method • Festus Method

Pure Premium Methods 1. Ultimate Losses / Ultimate Exposures 2. Frequency x Severity

Pure Premium Methods 1. Trend individual ‘ground-up’ losses; remove base deductible 2. Develop losses; cap at basic limit 3. Aggregate all adjusted losses.

Pure Premium Method Treatment of Exposures 1. Multiply individual units of exposure by applicable relativity factors (state, class code, claims-made step-rate, etc. ) 2. Aggregate all adjusted exposures

Pure Premium Method Calculation of Rate Pure Premium = Aggregate Adjusted Losses Aggregate Adjusted Exposures Base Rate = Pure Premium Permissible L/R

Pure Premium Method • Works well for an existing product • Works best for a product with a welldefined exposure base (doctors, employees) • Requires detailed loss and exposure info (claim-by-claim, policy-by-policy) • Actuarially sound

Piggy-back Method 1. Start with Comparable Product 2. Adjust Rates for Coverage differences 3. Adjust for Limits/Deductible differences 4. Adjust for Expense differences 5. Others?

Piggy-back Method • Works well for Enhancement of Existing Product • Requires knowledge of Comparable Product • Judgmental • Danger of being too Conservative/Aggressive? • Difficult to Support to Others

The Festus Method

The Festus Method

Ratemaking Tools • Imagination! • Innovation! • Intuition! • Internet!

Useful Sites • www. google. com – Big Brother is Watching! • www. firstgov. gov - U. S. Government’s Official Web Portal • www. bls. gov - Bureau of Labor Statistics • www. federalreserve. gov - Interest Rates

Other Useful Websites • www. cas. org • www. cnn. com • Where ever else the web may take you!