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Program Design and Pricing Options for Integrated Risk Policies. Will Dove, Centre Group Casualty Actuarial Society Financial Risk Management Seminar April 12-13, 1999 – Denver, CO. out of our minds. What is Integrated Risk?.

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Program Design and Pricing Options for Integrated Risk Policies

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Program design and pricing options for integrated risk policies l.jpg

Program Design and Pricing Options for Integrated Risk Policies

Will Dove, Centre Group

Casualty Actuarial SocietyFinancial Risk Management SeminarApril 12-13, 1999 – Denver, CO


What is integrated risk l.jpg

out of our minds

What is Integrated Risk?

  • Single contract covering both traditional insurance risks and other risks

    • Insurance policy

    • Surety bond

    • Corporate guarantee

    • Put option

    • Contingent equity/liquidity contract


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out of our minds

What is Integrated Risk?

  • Examples of other risks

    • Business risk

    • Credit risk

    • Liquidity risk

    • Market risk

      • Foreign exchange rates

      • Commodity prices

      • Asset prices


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out of our minds

What is Integrated Risk?

  • How is coverage provided?

    • Coverage part

    • Indexed retention or limit

    • Investment credit to experience account


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Coverage Trigger

  • Accounting: goal is to stabilize accounting results (income statement, balance sheet)

  • Economic/Cash Flow: goal is to stabilize future cash flows/asset values


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Advantages of Integrated Risk

  • Can allow customer to purchase less coverage on more flexible terms

    • Single limit available to cover a broad collection of risks can be superior to a collection of smaller limits each covering a single risks

  • Administrative efficiency: fewer pieces of paper to manage

  • Can facilitate transactions, reduce equity requirements and/or cost of debt in some circumstances


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out of our minds

Disadvantages of Integrated Risk

  • Soft insurance markets can provide insurance at less than cost for some period of time

  • Contracts must be individually structured: lot of work, can involve significant costs

  • May require changes to traditional risk management practices


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out of our minds

How can economies be achieved?

  • Total risk management

    • Insurer and customer must take a holistic risk management approach instead of stapling together multiple policies that are separately priced

  • Customer

    • Must integrate risk management and other financial management functions (e.g. treasury) to evaluate pricing and coverage terms

  • Insurer


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How can economies be achieved?

  • Insurer

    • Must integrate underwriting/pricing/reserving for insurance and other risks: risk premium example

      • Assume that risk premium is proportional to variance of losses

      • Let A denote traditional insurance losses, B denote other losses covered by an integrated contract

      • Expected losses E(A+B)=E(A)+E(B)

      • Risk premium kVar(A+B)=k[Var(A)+Var(B)+2Cov(A,B)]

      • If Cov(A,B)<0 then insurer can pass benefit on to the customer through reduced risk premium only if it retains both risks A and B on the same balance sheet

      • Insurer must consider correlation of new contract with its existing risk portfolio as part of the underwriting process


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Accounting Issues

  • FAS 133: Hedge vs investment vs insurance accounting


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Examples of Integrated Risk Transactions

  • Basket Aggregate program for US-based multinational: multiple property and casualty coverage, foreign exchange risks

  • USAir: Collateral substitution program covering WC loss payments contingent on airline’s credit worthiness and asset value risk

  • Lan Chile: Credit enhancement of notes supported by credit card receivables

  • Canadian Airlines: Senior debt put option combining credit risk and asset value risk


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