Introduction to Reinsurance

1. Introduction to Reinsurance NLC-RISC Trustee Conference May 2011 Spend some time focused on reinsurance. Common area of questions, unique needs and conversations you’ll likely be having as a Board. Spend some time focused on reinsurance. Common area of questions, unique needs and conversations you’ll likely be having as a Board.

2. 1 Presentation Agenda Types of reinsurance and cost-sharing options The key doctrines of reinsurance Why to buy reinsurance How to evaluate reinsurers Reinsurance market overview How reinsurance is purchased I’ve added this slide in recognition that since we haven’t printed slide handouts, it may sometimes be hard to follow along. Fair warning - we’ve moved almost entirely to providing handouts and PPT slides via the website. In part, this is to reduce costs of reproduction and such, but mostly it’s about not giving you a whole bunch of stuff you’ll probably end up throwing away. All the PPT presentations and supporting materials will be on the RISC website - so feel free to take notes if it helps you connect with the discussion, but please know that you will be able to access materials when you get back home. First two bullets are really the “what” of reinsurance. Then the question of why, which is also really a discussion of when to buy reinsurance. When we talk about evaluating reinsurers, we’ll really focus on where you’ll want to put your business. Then who the players are, and finally how you’ll actually make the reinsurance purchase.I’ve added this slide in recognition that since we haven’t printed slide handouts, it may sometimes be hard to follow along. Fair warning - we’ve moved almost entirely to providing handouts and PPT slides via the website. In part, this is to reduce costs of reproduction and such, but mostly it’s about not giving you a whole bunch of stuff you’ll probably end up throwing away. All the PPT presentations and supporting materials will be on the RISC website - so feel free to take notes if it helps you connect with the discussion, but please know that you will be able to access materials when you get back home. First two bullets are really the “what” of reinsurance. Then the question of why, which is also really a discussion of when to buy reinsurance. When we talk about evaluating reinsurers, we’ll really focus on where you’ll want to put your business. Then who the players are, and finally how you’ll actually make the reinsurance purchase.

3. 2 Reinsurance Contractual agreement Reinsurer agrees to indemnify the pool Some or all of certain losses covered by the pool The common explanation of reinsurance is “insurance for insurance companies”. That’s probably a bit over simplified, but generally accurate. Reinsurance is a trade of assumption of risk for premium. Reinsurance is contractual, just like your coverage for your members. In exchange for your premium payment, the reinsurer will indemnify - or reimburse - you for some or all of the financial loss, for whatever risks you buy the reinsurance. The common explanation of reinsurance is “insurance for insurance companies”. That’s probably a bit over simplified, but generally accurate. Reinsurance is a trade of assumption of risk for premium. Reinsurance is contractual, just like your coverage for your members. In exchange for your premium payment, the reinsurer will indemnify - or reimburse - you for some or all of the financial loss, for whatever risks you buy the reinsurance.

4. 3 Types of Reinsurance Facultative Reinsurance Coverage for a specific exposure or risk Attaches to a specific risk Treaty Reinsurance Cover for entire class or portfolio Sharing of losses Excess Insurance Transfer of risk There are two basic types of reinsurance - Facultative or Treaty. FACULTATIVE coverage is specific and limited. It is unique coverage for a pretty singular need. Pool might have a particular member with a unique operation or building. A city with civic center that’s value is far greater than any other property value the pool insures. Or maybe you have just a few cities in your pool who own and manage dam operations. The liability risk of a dam failure is pretty unique, and losses for failure can be costly. You might look to place facultative reinsurance for either of these kinds of exposures. Facultative reinsurance is very specifically purchased to cover a single kind of risk or exposure for one of YOUR insured pool members. When you purchase facultative reinsurance, the reinsurer examines the risk being underwritten and determines the risk premium charge, because ultimately in a facultative arrangement it’s the reinsure taking on risk of loss. The charge for facultative coverage might be then be handled mostly like a pass-through premium from you to your pool member. [NOTES CONTINUE BUT SLIDE DOESN’T CHANGE] There are two basic types of reinsurance - Facultative or Treaty. FACULTATIVE coverage is specific and limited. It is unique coverage for a pretty singular need. Pool might have a particular member with a unique operation or building. A city with civic center that’s value is far greater than any other property value the pool insures. Or maybe you have just a few cities in your pool who own and manage dam operations. The liability risk of a dam failure is pretty unique, and losses for failure can be costly. You might look to place facultative reinsurance for either of these kinds of exposures. Facultative reinsurance is very specifically purchased to cover a single kind of risk or exposure for one of YOUR insured pool members. When you purchase facultative reinsurance, the reinsurer examines the risk being underwritten and determines the risk premium charge, because ultimately in a facultative arrangement it’s the reinsure taking on risk of loss. The charge for facultative coverage might be then be handled mostly like a pass-through premium from you to your pool member. [NOTES CONTINUE BUT SLIDE DOESN’T CHANGE]

5. 4 Types of Reinsurance Unlike facultative, TREATY REINSURANCE covers not just a single risk, but a set of risks - you might buy treaty reinsurance for all your liability risks, or all your property risks, for example. In treaty reinsurance, you and the reinsurer SHARE IN LOSSES. So you might split property losses 50/50 with a treaty reinsurer. Your reinsurer helps you pay the loss costs your members incur. Sharing of losses is an important point of definition. Compare treaty reinsurance to EXCESS INSURANCE. Excess insurance is a way to TRANSFER losses over a specified, pre-determined dollar amount. For instance, you might transfer the $4 million of loss in excess of $1 million of loss (expressed as 4x1). This means the excess insurer will pay up to $4 million after the pool has first paid a total of $1 million for any particular loss. In an excess insurance relationship, the risk transfers based on a dollar amount and the excess insurer might not worry so much about any losses under that amount unless or until losses get to a point where they might pass over to the excess insurer. In treaty reinsurance, there’s true risk sharing between the pool and its reinsurance partner - both have an interest in how the loss develops pretty much from the get-go. I’ll tell you right up front that the difference between treaty reinsurance and excess insurance can be a fine nuance, and a tricky distinction. It helps to understand the underlying relationship in reinsurance. [NOTES CONTINUE - NO SLIDE CHANGE] Unlike facultative, TREATY REINSURANCE covers not just a single risk, but a set of risks - you might buy treaty reinsurance for all your liability risks, or all your property risks, for example. In treaty reinsurance, you and the reinsurer SHARE IN LOSSES. So you might split property losses 50/50 with a treaty reinsurer. Your reinsurer helps you pay the loss costs your members incur. Sharing of losses is an important point of definition. Compare treaty reinsurance to EXCESS INSURANCE. Excess insurance is a way to TRANSFER losses over a specified, pre-determined dollar amount. For instance, you might transfer the $4 million of loss in excess of $1 million of loss (expressed as 4x1). This means the excess insurer will pay up to $4 million after the pool has first paid a total of $1 million for any particular loss. In an excess insurance relationship, the risk transfers based on a dollar amount and the excess insurer might not worry so much about any losses under that amount unless or until losses get to a point where they might pass over to the excess insurer. In treaty reinsurance, there’s true risk sharing between the pool and its reinsurance partner - both have an interest in how the loss develops pretty much from the get-go. I’ll tell you right up front that the difference between treaty reinsurance and excess insurance can be a fine nuance, and a tricky distinction. It helps to understand the underlying relationship in reinsurance. [NOTES CONTINUE - NO SLIDE CHANGE]

6. 5 Types of Reinsurance The basis of a reinsurance relationship is the contract between the ultimate insured party (your member) and the pool. That coverage contract between you and your member becomes the basis for dealings with your reinsurer. Your reinsurer will share in your obligations under your coverage agreement. The basis of excess insurance is the agreement between the excess insurer and you. The coverage agreement between you and your members doesn’t come directly into play. The basis of a reinsurance relationship is the contract between the ultimate insured party (your member) and the pool. That coverage contract between you and your member becomes the basis for dealings with your reinsurer. Your reinsurer will share in your obligations under your coverage agreement. The basis of excess insurance is the agreement between the excess insurer and you. The coverage agreement between you and your members doesn’t come directly into play.

7. 6 Key Doctrines - Reinsurance Utmost Good Faith Pool has obligation to reinsurer to act in good faith for underwriting, pricing and claims handling Pool keeps reinsurer informed of developments that would materially impact the reinsurer Follow the Fortunes Reinsurer agrees to follow the fortunes of the pool This helps explain two key concepts behind reinsurance. FIRST-- In reinsurance, the pool has a duty of utmost good faith. The pool must treat its reinsurers as partners, because reinsurers are sharing in the risks of the pool. You have to assure the reinsurer that you are reasonably considering and pricing pool member risks. The pool has to let reinsurers know if something material changes -- the state tort caps change and therefore the risk profile of liability losses changes, or there’s some new and worrisome trend in jury verdicts. Again, this is important because the reinsurers are sharing in losses. Not to suggest that you can act in bad faith in an excess insurance relationship -- just that the obligation is a bit more proactive and partner-based in reinsurance. The SECOND, major relationship implication of reinsurance as opposed to excess is “follow the fortunes”. In reinsurance, the reinsurer is a partner who agrees to let the pool run the day-to-day business of operations, including underwriting and pricing, renewals, coverage, and most importantly claims adjusting. When it comes to adjusting and paying claims, reinsurers are bound to the pool’s underlying member coverage contracts. So the reinsurer will generally follow the underlying pool’s determinations and obligations. The reinsurer “follows the fortunes” of the pool. [NOTES CONTINUE BUT SLIDE DOES NOT CHANGE] This helps explain two key concepts behind reinsurance. FIRST-- In reinsurance, the pool has a duty of utmost good faith. The pool must treat its reinsurers as partners, because reinsurers are sharing in the risks of the pool. You have to assure the reinsurer that you are reasonably considering and pricing pool member risks. The pool has to let reinsurers know if something material changes -- the state tort caps change and therefore the risk profile of liability losses changes, or there’s some new and worrisome trend in jury verdicts. Again, this is important because the reinsurers are sharing in losses. Not to suggest that you can act in bad faith in an excess insurance relationship -- just that the obligation is a bit more proactive and partner-based in reinsurance. The SECOND, major relationship implication of reinsurance as opposed to excess is “follow the fortunes”. In reinsurance, the reinsurer is a partner who agrees to let the pool run the day-to-day business of operations, including underwriting and pricing, renewals, coverage, and most importantly claims adjusting. When it comes to adjusting and paying claims, reinsurers are bound to the pool’s underlying member coverage contracts. So the reinsurer will generally follow the underlying pool’s determinations and obligations. The reinsurer “follows the fortunes” of the pool. [NOTES CONTINUE BUT SLIDE DOES NOT CHANGE]

8. 7 Key Doctrines - Reinsurance Let me offer a couple examples. Many pool property coverage documents say the pool will pay for property damages arising out of an occurrence. The definition of “occurrence” may not be defined much further. So, let’s say that you have a snowstorm that lasts two days and causes some damage. Then you have an 18 hour window of no snow. Then you have another 48 hours straight of snow, and some more damage. Part of the damage by the end of it all was because of the cumulative effect of all the snow that fell during the entire 4 or 5 day time period. Is that two snowstorms or one snowstorm? You can’t tell from the coverage definition of “occurrence”. In a reinsurance relationship, interpretation of the coverage document between the pool and its members will obligate both the pool and the reinsurer. The reinsurer SHARES IN THE RISK of the pool, bound by the pool’s own coverage document. Compare this to excess insurance, where the binding document is the agreement between the pool and the excess insurer - NOT the pool’s coverage documents with its members. Whatever the excess coverage agreement says about an occurrence will control at the pool level. So in the excess relationship, the pool will have to coordinate it’s own coverage to its members and the coverage it receives from an excess policy… and the two might not be the same terms. [OTHER EXAMPLES -- STRIP SEARCH, HOSTILE WORK ENVIRONMENT] Let me offer a couple examples. Many pool property coverage documents say the pool will pay for property damages arising out of an occurrence. The definition of “occurrence” may not be defined much further. So, let’s say that you have a snowstorm that lasts two days and causes some damage. Then you have an 18 hour window of no snow. Then you have another 48 hours straight of snow, and some more damage. Part of the damage by the end of it all was because of the cumulative effect of all the snow that fell during the entire 4 or 5 day time period. Is that two snowstorms or one snowstorm? You can’t tell from the coverage definition of “occurrence”. In a reinsurance relationship, interpretation of the coverage document between the pool and its members will obligate both the pool and the reinsurer. The reinsurer SHARES IN THE RISK of the pool, bound by the pool’s own coverage document. Compare this to excess insurance, where the binding document is the agreement between the pool and the excess insurer - NOT the pool’s coverage documents with its members. Whatever the excess coverage agreement says about an occurrence will control at the pool level. So in the excess relationship, the pool will have to coordinate it’s own coverage to its members and the coverage it receives from an excess policy… and the two might not be the same terms. [OTHER EXAMPLES -- STRIP SEARCH, HOSTILE WORK ENVIRONMENT]

9. 8 Basis of Paying Losses Most arrangements are hybrid Quota share Fixed proportionate share Variable quota share Excess of Loss Above a stipulated dollar amount So the first determination is whether you’re buying facultative or treaty reinsurance, or excess insurance (hint - the answer is quite probably yes to more than one). The second question is ON WHAT BASIS are you paying losses under whatever type of arrangement you have. QUOTA SHARE means you divvy up the losses you suffer between the pool and reinsurers. Quota share proportions can come in any magnitude - could be 50/50 or 25/75 or whatever. Variable quota share or “surplus share” reinsurance is another option, which defines the risk share by the size of the loss. Maybe the bigger the loss gets to be, the less proportionate share your pool holds. We tend to think quota share when we think treaty reinsurance - the pool and the reinsurer share losses by a specified allocation. But you could also have a quota share excess insurance policy -- for instance, your excess insurer could pay 80 percent of losses over and above $2 million. Another way to share loss costs is on an “excess of loss” basis. It gets tricky here, because it’s easy to confuse “excess insurance” with “excess of loss”. Excess insurance speaks to the relationship. Excess of loss speaks to the basis of paying loss. Treaty reinsurance sometimes begins after a stipulated dollar amount - you might share losses over $100,000 on a 50/50 basis. You might refer to that $100,000 as your retention, or your reinsurance attachment point. Most pools have this sort of blended arrangement -- a treaty reinsurance relationship with both a quota share and excess of loss method for paying losses. I know this can be confusing. Let me illustrate with an example. (A reminder here that I’m illustrating the confusion… not attempting to clarify!)So the first determination is whether you’re buying facultative or treaty reinsurance, or excess insurance (hint - the answer is quite probably yes to more than one). The second question is ON WHAT BASIS are you paying losses under whatever type of arrangement you have. QUOTA SHARE means you divvy up the losses you suffer between the pool and reinsurers. Quota share proportions can come in any magnitude - could be 50/50 or 25/75 or whatever. Variable quota share or “surplus share” reinsurance is another option, which defines the risk share by the size of the loss. Maybe the bigger the loss gets to be, the less proportionate share your pool holds. We tend to think quota share when we think treaty reinsurance - the pool and the reinsurer share losses by a specified allocation. But you could also have a quota share excess insurance policy -- for instance, your excess insurer could pay 80 percent of losses over and above $2 million. Another way to share loss costs is on an “excess of loss” basis. It gets tricky here, because it’s easy to confuse “excess insurance” with “excess of loss”. Excess insurance speaks to the relationship. Excess of loss speaks to the basis of paying loss. Treaty reinsurance sometimes begins after a stipulated dollar amount - you might share losses over $100,000 on a 50/50 basis. You might refer to that $100,000 as your retention, or your reinsurance attachment point. Most pools have this sort of blended arrangement -- a treaty reinsurance relationship with both a quota share and excess of loss method for paying losses. I know this can be confusing. Let me illustrate with an example. (A reminder here that I’m illustrating the confusion… not attempting to clarify!)

10. 9 Excess Insurance orExcess of Loss? The pool pays the first $250,000 The pool pays 50 percent of the next $250,000 ($125,000) RE pays the other 50 percent RE pays all loss amounts over $500,000 Let’s say you have this scenario for a liability loss worth over $1 million… pool pays first 250 of loss Pool and a reinsurance-like partner share 50/50 in the next 250 of loss (gets us to 500 total spent so far, of which the pool has actually paid 375) Partner pays after that (500++) 1). Can we tell whether this is excess insurance or treaty reinsurance; and 2). what’s the basis of sharing in losses? Let’s start with the second question first… how are losses shared? Shared on both an excess of loss basis (losses over $500) and a quota share (the $250 over $250) Can we tell whether it’s liability reinsurance or excess insurance? Not really. We can’t tell anything about the underlying relationship based on these facts. The second bullet - a sharing of loss at 50/50 - sort of sounds like reinsurance, but it could be an excess insurance arrangement split quota share between the excess insurer and the pool. We know the basis of cost split, but not the basis of relationship.Let’s say you have this scenario for a liability loss worth over $1 million… pool pays first 250 of loss Pool and a reinsurance-like partner share 50/50 in the next 250 of loss (gets us to 500 total spent so far, of which the pool has actually paid 375) Partner pays after that (500++) 1). Can we tell whether this is excess insurance or treaty reinsurance; and 2). what’s the basis of sharing in losses? Let’s start with the second question first… how are losses shared? Shared on both an excess of loss basis (losses over $500) and a quota share (the $250 over $250) Can we tell whether it’s liability reinsurance or excess insurance? Not really. We can’t tell anything about the underlying relationship based on these facts. The second bullet - a sharing of loss at 50/50 - sort of sounds like reinsurance, but it could be an excess insurance arrangement split quota share between the excess insurer and the pool. We know the basis of cost split, but not the basis of relationship.

11. 10 Other things out there… Aggregate policies Catastrophe policies Clash treaties …and more In addition to the basic types of reinsurance and excess insurance, and the bases of cost sharing we’ve identified, there are many other protective sorts of reinsurance arrangements you might have. Aggregate insurance - protects the pool from multiple small claims that together create significant loss costs. Catastrophe insurance - protection from one particularly risky source of loss. Clash treaties - protects you when you have claims in multiple lines of coverage so that you don’t face dangerous loss levels from one event that has both property and work comp implications, for instance. With all that “what is reinsurance” as background, let’s move now to the question of “why” you buy it. In addition to the basic types of reinsurance and excess insurance, and the bases of cost sharing we’ve identified, there are many other protective sorts of reinsurance arrangements you might have. Aggregate insurance - protects the pool from multiple small claims that together create significant loss costs. Catastrophe insurance - protection from one particularly risky source of loss. Clash treaties - protects you when you have claims in multiple lines of coverage so that you don’t face dangerous loss levels from one event that has both property and work comp implications, for instance. With all that “what is reinsurance” as background, let’s move now to the question of “why” you buy it.

12. 11 Why Buy Reinsurance? Catastrophic relief Stabilize loss experience & reduce uncertainty Capacity to write larger (or more) risks Ability to better meet member needs Premium capacity & regulatory compliance Reinsurance is really another way to protect the health and financial viability of your pool, and it can allow you to perhaps improve the level of flexibility you have to take on risk for your members. Clearly one role of reinsurance is to protect the pool against catastrophic losses. It’s pretty typical to consider reinsurance as protection against “the big one”, whatever that might mean in your part of the country and line of business- hurricanes or floods, police liability or employment issues, or a large work comp loss. Lucky for all of us, those big claims are pretty infrequent -- although we have to keep in mind that “infrequent” is different than “can’t happen twice in one year, or in two consecutive years”. If we think about the claims that can really hurt a pool, it’s not JUST the big ones. Think about claims in the category of “slightly more costly” and/or “slightly more frequent” than we’d really like. Ask yourself… would it be harder for you to absorb one $6 million liability claim every five years, or two $3 million claims within the next six months? The answer sorta depends on how comfortable you are that there are no more lurking $3 million claims! How would you know whether those two claims this year were it for the next five years, or the start of a very worrisome trend? These are claims in the “working layer” of reinsurance. Reinsurance allows you to deal with lots of uncertainty as claims develop and trends emerge - especially if you’re buying reinsurance on an excess-of-loss basis, where your dollars at risk are notably capped. [NOTES CONTINUE ON NEXT PAGE, NO SLIDE CHANGE]Reinsurance is really another way to protect the health and financial viability of your pool, and it can allow you to perhaps improve the level of flexibility you have to take on risk for your members. Clearly one role of reinsurance is to protect the pool against catastrophic losses. It’s pretty typical to consider reinsurance as protection against “the big one”, whatever that might mean in your part of the country and line of business- hurricanes or floods, police liability or employment issues, or a large work comp loss. Lucky for all of us, those big claims are pretty infrequent -- although we have to keep in mind that “infrequent” is different than “can’t happen twice in one year, or in two consecutive years”. If we think about the claims that can really hurt a pool, it’s not JUST the big ones. Think about claims in the category of “slightly more costly” and/or “slightly more frequent” than we’d really like. Ask yourself… would it be harder for you to absorb one $6 million liability claim every five years, or two $3 million claims within the next six months? The answer sorta depends on how comfortable you are that there are no more lurking $3 million claims! How would you know whether those two claims this year were it for the next five years, or the start of a very worrisome trend? These are claims in the “working layer” of reinsurance. Reinsurance allows you to deal with lots of uncertainty as claims develop and trends emerge - especially if you’re buying reinsurance on an excess-of-loss basis, where your dollars at risk are notably capped. [NOTES CONTINUE ON NEXT PAGE, NO SLIDE CHANGE]

13. 12 Why Buy Reinsurance? There’s another sort of uncertainty that reinsurance helps with -- identifying the next “new” trend. We’re going to spend some time at this conference talking about new loss areas - social media, medical marijuana, changing immunity protections, all sorts of pressures. Reinsurance is protection against the unknowns in local government losses. Reinsurance makes it possible for you to observe claims in that working layer over time and without direct financial risk, so that you can have the value of years as you evaluate what’s a blip on the radar and what’s a trend that’s going to have impact. That is important stabilization of great value to pools. The presence of reinsurance means that you have ability to take on larger risks your pool and its own financial resources wouldn’t otherwise be able to accommodate. You might also be able to take on larger individual risks your members have - like writing higher limits or a certain type of liability risk. Or, reinsurance might help you take on risks from more members - let’s say another pool in the state closes its doors and you have to absorb 100 new members. [NOTES CONTINUE ON NEXT PAGE, NO SLIDE CHANGE] There’s another sort of uncertainty that reinsurance helps with -- identifying the next “new” trend. We’re going to spend some time at this conference talking about new loss areas - social media, medical marijuana, changing immunity protections, all sorts of pressures. Reinsurance is protection against the unknowns in local government losses. Reinsurance makes it possible for you to observe claims in that working layer over time and without direct financial risk, so that you can have the value of years as you evaluate what’s a blip on the radar and what’s a trend that’s going to have impact. That is important stabilization of great value to pools. The presence of reinsurance means that you have ability to take on larger risks your pool and its own financial resources wouldn’t otherwise be able to accommodate. You might also be able to take on larger individual risks your members have - like writing higher limits or a certain type of liability risk. Or, reinsurance might help you take on risks from more members - let’s say another pool in the state closes its doors and you have to absorb 100 new members. [NOTES CONTINUE ON NEXT PAGE, NO SLIDE CHANGE]

14. 13 Why Buy Reinsurance? Reinsurance allows opportunity to moderate your risk, so you can bring a better total package of coverage to your member. -- You can bring in a facultative arrangement to meet the unique needs of one member who has a municipal airport. -- You can buy additional reinsurance on property risks while you focus on creating a building improvement risk management incentive for your members. Reinsurance is one tool you can use to maximize the premiums your pool receives from its members. Think of it like this -- there are a fairly limited number of things the premiums you receive are used for. Loss reserves and loss adjusting expenses, administrative expenses, and buying reinsurance. (maybe a couple others) Reinsurance premiums and loss reserves are directly connected - to the extent you’re reinsured for a loss, you are showing a lesser reserve, or showing a recoverable. Reinsurance comes at a cost of its own, but somewhere in there is the “sweet spot” that lets you hold the just right amount of member premium, reserve it, invest it, spend it on risk management incentives, or otherwise consider the host of ways it might allow you to do good things for your members. Finally, although most pools aren’t regulated on the basis of meeting certain financial thresholds, there are a few who are. Purchasing reinsurance helps those pools meet regulatory requirements for maximum risk retained as compared to premium volume, loss reserves, and other measures. Buying reinsurance may also be a way to transfer risks in order to make sure your balance sheet matches regulator requirements.Reinsurance allows opportunity to moderate your risk, so you can bring a better total package of coverage to your member. -- You can bring in a facultative arrangement to meet the unique needs of one member who has a municipal airport. -- You can buy additional reinsurance on property risks while you focus on creating a building improvement risk management incentive for your members. Reinsurance is one tool you can use to maximize the premiums your pool receives from its members. Think of it like this -- there are a fairly limited number of things the premiums you receive are used for. Loss reserves and loss adjusting expenses, administrative expenses, and buying reinsurance. (maybe a couple others) Reinsurance premiums and loss reserves are directly connected - to the extent you’re reinsured for a loss, you are showing a lesser reserve, or showing a recoverable. Reinsurance comes at a cost of its own, but somewhere in there is the “sweet spot” that lets you hold the just right amount of member premium, reserve it, invest it, spend it on risk management incentives, or otherwise consider the host of ways it might allow you to do good things for your members. Finally, although most pools aren’t regulated on the basis of meeting certain financial thresholds, there are a few who are. Purchasing reinsurance helps those pools meet regulatory requirements for maximum risk retained as compared to premium volume, loss reserves, and other measures. Buying reinsurance may also be a way to transfer risks in order to make sure your balance sheet matches regulator requirements.

15. 14 Choosing to Reinsure Risk factors should impact the decision process Size of potential loss Unpredictable frequencies Length of time for claim payments Volatility of loss outcomes I mentioned that concept of the “sweet spot” of reinsurance -- that’s a spot you as a Trustee are hopefully going to spend some time considering. What you’ll essentially be doing is thinking about the cost of reinsurance as it compares to the risk you’ll be sharing or transferring. And you’ll be trying to decide whether there’s enough benefit in transferring that risk for whatever cost you’re being asked to pay. How you stack up your risks is going to impact your decision to reinsure and your evaluation of reinsurance cost. Some questions you might ask: 1 - how big of a loss might you sustain if you don’t reinsure? 2 - can you predict how frequently you might sustain losses? 3 - do you have enough time between a loss itself and the payout, such that you can manage funding for the loss without reinsurance? 4 - how much volatility can you withstand in claims from one year to the next? You’ll notice I didn’t list your prior loss experience. Loss experience is sort of an embedded concept - certainly you look at past experience to consider how frequently you might expect a loss in the future, or how big you think it might be. I challenge you, though, that your decision to reinsure going forward and your evaluation of the price you pay for reinsurance is one you ought to make annually based on today’s set of circumstances - don’t just roll into the thinking that status quo coverage and pricing is adequate. Your risk profile will change. Almost constantly. Reinsurance goals change. Almost constantly. It’s why we’re spending so much time on this stuff today.I mentioned that concept of the “sweet spot” of reinsurance -- that’s a spot you as a Trustee are hopefully going to spend some time considering. What you’ll essentially be doing is thinking about the cost of reinsurance as it compares to the risk you’ll be sharing or transferring. And you’ll be trying to decide whether there’s enough benefit in transferring that risk for whatever cost you’re being asked to pay. How you stack up your risks is going to impact your decision to reinsure and your evaluation of reinsurance cost. Some questions you might ask: 1 - how big of a loss might you sustain if you don’t reinsure? 2 - can you predict how frequently you might sustain losses? 3 - do you have enough time between a loss itself and the payout, such that you can manage funding for the loss without reinsurance? 4 - how much volatility can you withstand in claims from one year to the next? You’ll notice I didn’t list your prior loss experience. Loss experience is sort of an embedded concept - certainly you look at past experience to consider how frequently you might expect a loss in the future, or how big you think it might be. I challenge you, though, that your decision to reinsure going forward and your evaluation of the price you pay for reinsurance is one you ought to make annually based on today’s set of circumstances - don’t just roll into the thinking that status quo coverage and pricing is adequate. Your risk profile will change. Almost constantly. Reinsurance goals change. Almost constantly. It’s why we’re spending so much time on this stuff today.

16. 15 Evaluation of Reinsurers We’re going to talk about how a pool might evaluate reinsurance options and reinsurance partners. The basic kinds of considerations that come into play are - I think - pretty obvious. What kind of coverage are you going to get? At what cost? Is the reinsurer you’re selecting financially sound? Will you have a good relationship? Every pool in this room has a different set of needs it’s trying to meet. And every pool has different values. How you stack up these considerations, how you piece them together, which you give more or less value to… is individually unique to your operation. The Goldilocks Principle gets applied to decision-making in everything from heart surgery to technology investment - and it applies here too. I can’t tell you which reinsurer’s porridge or chair is going to be to your liking, but I can assure you that you’ll know “just right” when you see it. (Although, truth be told, it may not jump out at you with a flashing neon sign that actually says “just right”. Sometimes, what you may see is something like a printed t-shirt that says “this may be right and really, if not, how bad could it be?”) While there’s no single right answer, we can define a set of important considerations you might make while you’re testing chairs and tasting porridge…We’re going to talk about how a pool might evaluate reinsurance options and reinsurance partners. The basic kinds of considerations that come into play are - I think - pretty obvious. What kind of coverage are you going to get? At what cost? Is the reinsurer you’re selecting financially sound? Will you have a good relationship? Every pool in this room has a different set of needs it’s trying to meet. And every pool has different values. How you stack up these considerations, how you piece them together, which you give more or less value to… is individually unique to your operation. The Goldilocks Principle gets applied to decision-making in everything from heart surgery to technology investment - and it applies here too. I can’t tell you which reinsurer’s porridge or chair is going to be to your liking, but I can assure you that you’ll know “just right” when you see it. (Although, truth be told, it may not jump out at you with a flashing neon sign that actually says “just right”. Sometimes, what you may see is something like a printed t-shirt that says “this may be right and really, if not, how bad could it be?”) While there’s no single right answer, we can define a set of important considerations you might make while you’re testing chairs and tasting porridge…

17. 16 Evaluation of Reinsurers Financial standing and capabilities Commercial ratings & performance tests Size, leverage, liquidity of balance sheets Commitment to line of business Degree of input (interference) Underwriting and claims Claim payment reputation Organizational structure and management philosophy As you examine potential reinsurance partners, you’ll want to specifically look at their financial status. This might include commercial ratings and how the reinsurers perform relative to financial benchmarks and tests. You will want to have some sense of the reinsurer’s size in the marketplace, their financial leverage - including what is or isn’t included for purposes of evaluating leverage - and the liquidity of the corporate entity. We’ll talk more in a minute about financial standing and commercial ratings. You’ll want to know what the level of commitment is within the organization to whatever sort of risk you’re looking to have reinsured. There are some reinsurers who bounce in and out of certain lines of coverage, or for whom some lines are secondary. A reinsurer who isn’t committed to the business might not offer you a stable partnership, might not fully understand your risks and therefore might not have sustainable pricing, or could simply be difficult to work with because they aren’t as familiar with things as you are. You might not want a reinsurer who thinks they know your business better than you (unless of course they really do). Different reinsures will have different expertise they can offer you and that expert input can be very valuable. But there are times where too much input into underwriting or claims can become interfering. You’ll want to find the right amount of input for your pool that doesn’t tip over into the category of interference. [ADDITIONAL NOTES - NO CHANGE TO SLIDE]As you examine potential reinsurance partners, you’ll want to specifically look at their financial status. This might include commercial ratings and how the reinsurers perform relative to financial benchmarks and tests. You will want to have some sense of the reinsurer’s size in the marketplace, their financial leverage - including what is or isn’t included for purposes of evaluating leverage - and the liquidity of the corporate entity. We’ll talk more in a minute about financial standing and commercial ratings. You’ll want to know what the level of commitment is within the organization to whatever sort of risk you’re looking to have reinsured. There are some reinsurers who bounce in and out of certain lines of coverage, or for whom some lines are secondary. A reinsurer who isn’t committed to the business might not offer you a stable partnership, might not fully understand your risks and therefore might not have sustainable pricing, or could simply be difficult to work with because they aren’t as familiar with things as you are. You might not want a reinsurer who thinks they know your business better than you (unless of course they really do). Different reinsures will have different expertise they can offer you and that expert input can be very valuable. But there are times where too much input into underwriting or claims can become interfering. You’ll want to find the right amount of input for your pool that doesn’t tip over into the category of interference. [ADDITIONAL NOTES - NO CHANGE TO SLIDE]

18. 17 Evaluation of Reinsurers Claim practices and claim payment reputation are really important evaluation points. We talked earlier about the principles of good faith and follow the fortune. Those are contractual relationship pillars, but claim time is when those contract words flow through into actual performance. You want to avoid a reinsurer who doesn’t pay on a timely basis, or who requires you to jump through hoops, or who is otherwise just a pain in the arse at claims time. If you have no experience with a reinsurer, you’ll have to rely on others who do to share with you their experiences. This is admittedly a difficult point of the reinsurer evaluation to quantify, but I think anyone who’s had a bad claims experience with a reinsurer will tell you that it is absolutely a critical factor to consider. Finally, you’ll want to take a look at the organizational structure of your possible reinsurance partners and their overall management philosophy. Is there a clear line of escalation if you don’t get the response you think appropriate? Of course, the larger the reinsurer the more complex you might expect the organizational structure to be, and that very well may be reasonable -- but at the end of the day you have to feel comfortable about where you’re spending your premium dollars, and the people from whom you’re getting answers. Claim practices and claim payment reputation are really important evaluation points. We talked earlier about the principles of good faith and follow the fortune. Those are contractual relationship pillars, but claim time is when those contract words flow through into actual performance. You want to avoid a reinsurer who doesn’t pay on a timely basis, or who requires you to jump through hoops, or who is otherwise just a pain in the arse at claims time. If you have no experience with a reinsurer, you’ll have to rely on others who do to share with you their experiences. This is admittedly a difficult point of the reinsurer evaluation to quantify, but I think anyone who’s had a bad claims experience with a reinsurer will tell you that it is absolutely a critical factor to consider. Finally, you’ll want to take a look at the organizational structure of your possible reinsurance partners and their overall management philosophy. Is there a clear line of escalation if you don’t get the response you think appropriate? Of course, the larger the reinsurer the more complex you might expect the organizational structure to be, and that very well may be reasonable -- but at the end of the day you have to feel comfortable about where you’re spending your premium dollars, and the people from whom you’re getting answers.

19. 18 Financial Rating Systems for Insurance CompaniesWhy are they important? Reinsurance financials are complex Independent evaluations subject all insurers to the same criteria and provide benchmark Quantitative and qualitative review Balance sheet, operating performance Business profile Benchmarks even more important in an international market Let’s pause for a minute and talk about how you might evaluate a reinsurer’s financial standing. One obvious method is to look at how the reinsurer is rated. {NO SLIDE CHANGE - NOTES CONTINUE] Let’s pause for a minute and talk about how you might evaluate a reinsurer’s financial standing. One obvious method is to look at how the reinsurer is rated. {NO SLIDE CHANGE - NOTES CONTINUE]

20. 19 Financial Rating Systems for Insurance CompaniesWhy are they important? Insurance companies require complex financial management. It would be difficult for even the most savvy trustee or pool administrator to understand all the ways an insurance company’s financial picture might come together. The rating systems help by standardizing, to some extent, how those financials are formatted and reported. The rating process standardizes criterion and establishes a benchmark for comparison of one agency to another. It’s sort of like consumer reports… the rating isn’t going to tell you which reinsurance to buy, but it will provide you a method by which you can compare your options. The rating agency evaluations will generally include both quantitative and qualitative review of a company’s balance sheet and operating performance, as well as a review of the insurer’s business profile. I’d say rating agency benchmarks are particularly important when you’re dealing with sizable reinsurance agencies that do business internationally. Not all countries have the same financial and regulatory environment as does the United States, so having a rating agency evaluation is pretty useful. Insurance companies require complex financial management. It would be difficult for even the most savvy trustee or pool administrator to understand all the ways an insurance company’s financial picture might come together. The rating systems help by standardizing, to some extent, how those financials are formatted and reported. The rating process standardizes criterion and establishes a benchmark for comparison of one agency to another. It’s sort of like consumer reports… the rating isn’t going to tell you which reinsurance to buy, but it will provide you a method by which you can compare your options. The rating agency evaluations will generally include both quantitative and qualitative review of a company’s balance sheet and operating performance, as well as a review of the insurer’s business profile. I’d say rating agency benchmarks are particularly important when you’re dealing with sizable reinsurance agencies that do business internationally. Not all countries have the same financial and regulatory environment as does the United States, so having a rating agency evaluation is pretty useful.

21. 20 Financial Rating Systems for Insurance CompaniesWhy are they important? Perceived ability of a company to pay its claims Not a warranty of financial strength or ability to meet obligations 10 of 20 largest commercial insurance companies failed or were merged in the last 20 years All were rated A or better at the beginning of the period The rating a reinsurer receives is really a suggestion about its financial where-with-all to pay the claims it will receive. Think back to that question of how a reinsurer will respond at claims time…. A good rating is no guarantee that the reinsurer WILL do the right thing, but it should provide indication that the reinsurer CAN do the right thing. Although, we need to keep in mind that a good rating is no guarantee, as we’ve witnessed in the last several years. The truth is that ratings may be a good measure of past performance, but they might not have a lot of long-term predictive value. Rating agencies are - after all - the same folks that rated mortgage bonds. (incidentally, do you know that if you google the phrase “AIG CARTOON” you get 205,000 hits)? The rating a reinsurer receives is really a suggestion about its financial where-with-all to pay the claims it will receive. Think back to that question of how a reinsurer will respond at claims time…. A good rating is no guarantee that the reinsurer WILL do the right thing, but it should provide indication that the reinsurer CAN do the right thing. Although, we need to keep in mind that a good rating is no guarantee, as we’ve witnessed in the last several years. The truth is that ratings may be a good measure of past performance, but they might not have a lot of long-term predictive value. Rating agencies are - after all - the same folks that rated mortgage bonds. (incidentally, do you know that if you google the phrase “AIG CARTOON” you get 205,000 hits)?

22. 21 Rating Agencies A.M. Best Primarily focused on insurance Standard & Poor’s An investor rating service Moody’s An investor rating service Fitch An investor rating service I’m sure you are familiar with the major rating agencies Worth noting here that AM Best is really the only one specifically designed to rate the insurance industry. I’m sure you are familiar with the major rating agencies Worth noting here that AM Best is really the only one specifically designed to rate the insurance industry.

23. 22 Ratings Considerations Claims payment rating A company’s ability to pay its claims Investor ratings Risk-to-return ratio for investors Creates profit incentive that could lead to riskier behavior AIG Mortgage insurers There are two different factors that come into play in how an insurer is rated. First is claims payment rating - which is pretty much just as it sounds. Can an insurer pay it’s outstanding claim liabilities? The second is an investor rating. This is a rating method currently in favor which, in a world of greed, may be a bit problematic. Investor ratings examine how much risk a company holds against how much the company returns in profit to investors. Which means as long as you are returning big dollars, you get to take on big risks. Let’s use a personal sort of example…. Let’s say you decide that for every $10,000 you make from investments, you will give a member of your family $1,000. You might have family members who really need that $1,000 and you might have those who start expecting it. Because you feel obligated, your investment strategy might start to focus a little more on taking big gambles that are great when they pay off, but not so great if they don’t. And your entire strategy of taking greater risks to pay greater rewards might not be the best idea if, in the long run, you were supposed to be investing in a steady, reliable way to fund retirement goals. [NOTES CONTINUE - NO SLIDE CHANGE]There are two different factors that come into play in how an insurer is rated. First is claims payment rating - which is pretty much just as it sounds. Can an insurer pay it’s outstanding claim liabilities? The second is an investor rating. This is a rating method currently in favor which, in a world of greed, may be a bit problematic. Investor ratings examine how much risk a company holds against how much the company returns in profit to investors. Which means as long as you are returning big dollars, you get to take on big risks. Let’s use a personal sort of example…. Let’s say you decide that for every $10,000 you make from investments, you will give a member of your family $1,000. You might have family members who really need that $1,000 and you might have those who start expecting it. Because you feel obligated, your investment strategy might start to focus a little more on taking big gambles that are great when they pay off, but not so great if they don’t. And your entire strategy of taking greater risks to pay greater rewards might not be the best idea if, in the long run, you were supposed to be investing in a steady, reliable way to fund retirement goals. [NOTES CONTINUE - NO SLIDE CHANGE]

24. 23 Ratings Considerations And that, in part, is what happened to AIG, to Freddie and Fannie, and to others. Add a couple zeros. (There were of course other factors at play… prolonged underestimation of losses, poor underwriting…) But the point I hope is obvious. A focus on returning money to investors is great, but can lead to some isolation in focus that doesn’t help the company long-term. The rating system rewards investor returns - which indeed are a measure of financial strength. You have to be making money in order to give something back to investors. But the incentive created can lead a company into bad short-term decisions and long-term financial instability. Ratings can be helpful - they’re a good point of reference and for all their faults they establish useful benchmark comparisons. But their measures are in some cases perverse, so it’s important not to rely solely on ratings in your evaluation of reinsurer financial strength. And that, in part, is what happened to AIG, to Freddie and Fannie, and to others. Add a couple zeros. (There were of course other factors at play… prolonged underestimation of losses, poor underwriting…) But the point I hope is obvious. A focus on returning money to investors is great, but can lead to some isolation in focus that doesn’t help the company long-term. The rating system rewards investor returns - which indeed are a measure of financial strength. You have to be making money in order to give something back to investors. But the incentive created can lead a company into bad short-term decisions and long-term financial instability. Ratings can be helpful - they’re a good point of reference and for all their faults they establish useful benchmark comparisons. But their measures are in some cases perverse, so it’s important not to rely solely on ratings in your evaluation of reinsurer financial strength.

25. 24 Underneath it all… Reinsurers and excess insurers exist to make money for capital investors Expected to pay claims & expenses Must produce profit over time As you think back to this illustration of how to evaluate reinsurance partners - a balance of cost, coverage, financial stability and relationship, keep in mind this bit of cynical reality in how you evaluate your options… No matter what your relationship - whether on the basis of excess coverage or reinsurance - most of the folks at the table are there to make a buck. Reinsurers and excess carriers are there for the benefit of their owners or stockholders. Certainly part of the reinsurance business is to pay claims when they happen, but over time reinsurers need to make profit in order to continue their mission and operations. That mission is necessarily going to color their financial decisions, the coverage they are willing to provide and the premiums they charge to do so -- and ultimately their relationship with you over time. That’s not a bad thing in and of itself, but you should probably bring that measure of eyes open to your decisions. As you think back to this illustration of how to evaluate reinsurance partners - a balance of cost, coverage, financial stability and relationship, keep in mind this bit of cynical reality in how you evaluate your options… No matter what your relationship - whether on the basis of excess coverage or reinsurance - most of the folks at the table are there to make a buck. Reinsurers and excess carriers are there for the benefit of their owners or stockholders. Certainly part of the reinsurance business is to pay claims when they happen, but over time reinsurers need to make profit in order to continue their mission and operations. That mission is necessarily going to color their financial decisions, the coverage they are willing to provide and the premiums they charge to do so -- and ultimately their relationship with you over time. That’s not a bad thing in and of itself, but you should probably bring that measure of eyes open to your decisions.

26. 25 Excess Risk Pool Pool of similar insurers who in part self-insure for risks typically reinsured Requires capital commitment Long-term financial focus Participatory governance and direction Regulatory credit for reinsurance recoverable Generally no rating agency help to evaluate I want to move on to talk about current reinsurance providers and how reinsurance is purchased. But let me first mention one other kind of reinsurance. An excess risk pool is an alternative method of reinsurance or excess insurance. Generally a risk pool will not be a replacement option for your other reinsurance relationships. Rather it’s one tool among many you might use. There are a few of these risk pools out there for folks like you in NLC-RISC, including NLC Mutual and GEM. (You’ll understand if I’m a bit partial to one of them). These alternative structures function just like all of you in terms of pooling risks. You might think of these arrangements as a “pool of pools”. If you belong to a reinsurance pool like this, you probably had to pay in a capital contribution. This is the funding basis the reinsurance pool works from. Participation in an excess risk pool requires a very long-term financial focus, because in general the pool isn’t going to price-to-market for coverage -- rather the reinsurance pool is going to price for stability and value over many years (again, this probably sounds familiar because it’s just the same strategy most of you use with your members). [NOTES CONTINUE - NO SLIDE CHANGE]I want to move on to talk about current reinsurance providers and how reinsurance is purchased. But let me first mention one other kind of reinsurance. An excess risk pool is an alternative method of reinsurance or excess insurance. Generally a risk pool will not be a replacement option for your other reinsurance relationships. Rather it’s one tool among many you might use. There are a few of these risk pools out there for folks like you in NLC-RISC, including NLC Mutual and GEM. (You’ll understand if I’m a bit partial to one of them). These alternative structures function just like all of you in terms of pooling risks. You might think of these arrangements as a “pool of pools”. If you belong to a reinsurance pool like this, you probably had to pay in a capital contribution. This is the funding basis the reinsurance pool works from. Participation in an excess risk pool requires a very long-term financial focus, because in general the pool isn’t going to price-to-market for coverage -- rather the reinsurance pool is going to price for stability and value over many years (again, this probably sounds familiar because it’s just the same strategy most of you use with your members). [NOTES CONTINUE - NO SLIDE CHANGE]

27. 26 Excess Risk Pool Excess pools are made up of members, not stockholders. There’s usually a board of directors for the excess pool made up of the members it serves, just the same as you are here as a trustee for your pool membership. Any profit in excess risk pool belongs to the members of the pool, not shareholders. Just like you function with your members, the sole purpose of an excess risk pool is to meet its member needs. From a regulatory standpoint, for those government pools that are regulated, the claim reimbursement from an excess risk pool is handled as a reinsurance recoverable, just like it would be from any other reinsurer. Depending on how you are regulated, the capital contribution that your pool might make at the beginning may or may not be factored into your pool’s overall assets. That can be either a benefit or a detriment, depending on how you’re funded. Risk pools like NLC Mutual or GEM may not fit easily into the rating agency infrastructure, so evaluating them on the same basis as everyone else is tough.Excess pools are made up of members, not stockholders. There’s usually a board of directors for the excess pool made up of the members it serves, just the same as you are here as a trustee for your pool membership. Any profit in excess risk pool belongs to the members of the pool, not shareholders. Just like you function with your members, the sole purpose of an excess risk pool is to meet its member needs. From a regulatory standpoint, for those government pools that are regulated, the claim reimbursement from an excess risk pool is handled as a reinsurance recoverable, just like it would be from any other reinsurer. Depending on how you are regulated, the capital contribution that your pool might make at the beginning may or may not be factored into your pool’s overall assets. That can be either a benefit or a detriment, depending on how you’re funded. Risk pools like NLC Mutual or GEM may not fit easily into the rating agency infrastructure, so evaluating them on the same basis as everyone else is tough.

28. 27 Key Factors for Evaluating an Excess Risk Pool Capital adequacy Competency of management Risk-taking philosophy Commitment level of other participants Pricing philosophy Coverage philosophy Willingness to pay claims Long-term viability By-Laws Without the benefit of standardized evaluation options, if you decide to participate in an excess risk pool you’re going to have to do some additional work to determine whether it’s a good fit. I won’t comment on this list, because I think it’s pretty self-explanatory. Just know that there are some additional considerations because of the member-owned and directed philosophy, and the longer term view you’ll need to take in this structure. And, a note, you’re probably not going to be able to meet all your reinsurance needs through an excess risk pool arrangement.Without the benefit of standardized evaluation options, if you decide to participate in an excess risk pool you’re going to have to do some additional work to determine whether it’s a good fit. I won’t comment on this list, because I think it’s pretty self-explanatory. Just know that there are some additional considerations because of the member-owned and directed philosophy, and the longer term view you’ll need to take in this structure. And, a note, you’re probably not going to be able to meet all your reinsurance needs through an excess risk pool arrangement.

29. 28 Reinsurance Market GOOD PLACE FOR A STRETCH BREAK IF NEEDED Let’s get some perspective on how public entity risk - this room collectively - fits into the overall reinsurance marketplace. We have the commercial insurers - Travelers, for instance - And we have specialty carriers for things like marine risk. And then we have reinsurers. All three kinds of companies have a subset of business they term “alternative risk transfer”. ART is where insurers and reinsurers put non-traditional purchasers and product needs. Non-traditional typically means some sort of combination of insurance needs and financing needs. Helping to reinsure or bolster pooled self-insured arrangements is generally considered an ART activity. And within that grand subset, public entity risk is one smaller grouping. Within public entity risk, it might be useful to consider trends and the state of the reinsurance market for liability, property, and work comp reinsurance, as a general precursor to the conversation about how pools approach the reinsurance market.GOOD PLACE FOR A STRETCH BREAK IF NEEDED Let’s get some perspective on how public entity risk - this room collectively - fits into the overall reinsurance marketplace. We have the commercial insurers - Travelers, for instance - And we have specialty carriers for things like marine risk. And then we have reinsurers. All three kinds of companies have a subset of business they term “alternative risk transfer”. ART is where insurers and reinsurers put non-traditional purchasers and product needs. Non-traditional typically means some sort of combination of insurance needs and financing needs. Helping to reinsure or bolster pooled self-insured arrangements is generally considered an ART activity. And within that grand subset, public entity risk is one smaller grouping. Within public entity risk, it might be useful to consider trends and the state of the reinsurance market for liability, property, and work comp reinsurance, as a general precursor to the conversation about how pools approach the reinsurance market.

30. 29 Reinsurance Market Public Entity Liability Small number of reinsurers Losses had been declining relative to expenditures Trends in public officials, land use, law enforcement Reinsurers looking to expand market share Flat or decreasing rates In the world of public entity liability reinsurance, there are very few reinsurers. Liability loss costs had been generally been decreasing relative to public entity expenditures, although there are perhaps a few shifts starting. First, public entity expenditures are now on the decline as budgets get tight. We might expect liability loss costs to increase proportionately. And in some cases, loss costs look none too rosy, for instance in land use liability, public officials liability, and law enforcement liability. These are trends that the existing public entity liability reinsurance market are just beginning to see. We are starting to see a growing number of reinsurers interested in public entity liability business - it’s an areas reinsurers will actively market right now. odd at a time when there are some none-too-certain This active entry into the market is a little odd, perhaps, given those loss trends I just mentioned, but it’s possible the new players aren’t aware of some of those recent developments. Pricing will probably continue to be optimistic and favorable for pools, with flat renewal rates. If you were to bid broadly for liability reinsurance, you may even get a slight decrease in your rates. At least in the near term.In the world of public entity liability reinsurance, there are very few reinsurers. Liability loss costs had been generally been decreasing relative to public entity expenditures, although there are perhaps a few shifts starting. First, public entity expenditures are now on the decline as budgets get tight. We might expect liability loss costs to increase proportionately. And in some cases, loss costs look none too rosy, for instance in land use liability, public officials liability, and law enforcement liability. These are trends that the existing public entity liability reinsurance market are just beginning to see. We are starting to see a growing number of reinsurers interested in public entity liability business - it’s an areas reinsurers will actively market right now. odd at a time when there are some none-too-certain This active entry into the market is a little odd, perhaps, given those loss trends I just mentioned, but it’s possible the new players aren’t aware of some of those recent developments. Pricing will probably continue to be optimistic and favorable for pools, with flat renewal rates. If you were to bid broadly for liability reinsurance, you may even get a slight decrease in your rates. At least in the near term.

31. 30 Reinsurance Market Public Entity Property Small number of reinsurers May be hard for smaller pools to meet minimum premium requirements Coastal exposures difficult to place Large losses - global and U.S. Pricing generally flat, perhaps will begin to harden The property reinsurance market is also characterized by a small number of reinsurance players. Property is a tricky line of business within the public entity market, because many public entity pools are of a small size which means that it’s hard for them to meet underwriting minimums often required by the property reinsurers. This might be a little less true within the NLC-RISC membership, because most of you are of size and scope that you can meet premium minimums. There can be very divergent experiences among public sector pools when it comes to purchasing property reinsurance, based on where you are located. If you are on a coast, it may be hard to find reasonable property coverage. You are at a distinct advantage if you are buying property reinsurance in a state without hurricanes or earthquakes (so the four or five of you in that category can consider yourselves lucky). Overall, though, the pricing of property reinsurance has been pretty flat for the last couple of years. Again depending on location, you might have even see rates down a bit in the last couple of years. Now, we’ve had a couple recent property events that might suggest a bit of a shift. We have folks at the conference from North Carolina, Alabama, Arkansas, and other states where recent tornados and flooding is going to probably present a bit of hardening in the pricing of property reinsurance (not to mention a big headache in terms of cleanup and rebuilding). And we had the major global catastrophic activity in Japan. And cat models suggest that hurricane losses in 2011 through 2012 could be more significant, especially inland.The property reinsurance market is also characterized by a small number of reinsurance players. Property is a tricky line of business within the public entity market, because many public entity pools are of a small size which means that it’s hard for them to meet underwriting minimums often required by the property reinsurers. This might be a little less true within the NLC-RISC membership, because most of you are of size and scope that you can meet premium minimums. There can be very divergent experiences among public sector pools when it comes to purchasing property reinsurance, based on where you are located. If you are on a coast, it may be hard to find reasonable property coverage. You are at a distinct advantage if you are buying property reinsurance in a state without hurricanes or earthquakes (so the four or five of you in that category can consider yourselves lucky). Overall, though, the pricing of property reinsurance has been pretty flat for the last couple of years. Again depending on location, you might have even see rates down a bit in the last couple of years. Now, we’ve had a couple recent property events that might suggest a bit of a shift. We have folks at the conference from North Carolina, Alabama, Arkansas, and other states where recent tornados and flooding is going to probably present a bit of hardening in the pricing of property reinsurance (not to mention a big headache in terms of cleanup and rebuilding). And we had the major global catastrophic activity in Japan. And cat models suggest that hurricane losses in 2011 through 2012 could be more significant, especially inland.

32. 31 Reinsurance Market Public Entity Work Comp Almost entirely made up of excess insurers Very few, at that Heavily competitive for good risks Soft pricing to increase market share Some market unknowns Impact of the recession Medicare as a Secondary Payer Presumption legislation Finally, we find even fewer players within the work comp reinsurance market for public entity business. Those in the business are primarily engaged as excess insurers - almost no availability of reinsurance. If you have relatively good loss experience in your work comp pool, you will probably find very competitive rates available for excess coverage. Excess carriers will price low in order to increase their market share right now. There may be some indication that reinsurers are beginning to recognize that their current rates are unsustainable. We’d expect that pools will start to see somewhat increased pricing in work comp excess insurance. There are some unknowns in the work comp world right now that make the outlook for reinsurance a bit questionable. Impact of recession - workers doing more b/c of layoffs, increased overtime = more injury; OR glad to have a job = less Great unknown of MSP - may have impact of driving up loss costs. Presumption statues in particular for public safety - mandated benefits for cancer Session later at conference about work comp trends you might want to check out.Finally, we find even fewer players within the work comp reinsurance market for public entity business. Those in the business are primarily engaged as excess insurers - almost no availability of reinsurance. If you have relatively good loss experience in your work comp pool, you will probably find very competitive rates available for excess coverage. Excess carriers will price low in order to increase their market share right now. There may be some indication that reinsurers are beginning to recognize that their current rates are unsustainable. We’d expect that pools will start to see somewhat increased pricing in work comp excess insurance. There are some unknowns in the work comp world right now that make the outlook for reinsurance a bit questionable. Impact of recession - workers doing more b/c of layoffs, increased overtime = more injury; OR glad to have a job = less Great unknown of MSP - may have impact of driving up loss costs. Presumption statues in particular for public safety - mandated benefits for cancer Session later at conference about work comp trends you might want to check out.

33. 32 Reinsurance Market Reinsurance Association of America 1982 - 68 reinsurance companies (84 total members) 2011 - 26 reinsurance companies (40 total members) I mentioned in each of the last three slides how small the market of available reinsurance is. There’s been a pretty dramatic decline in the number of reinsurers. Went from 68 reinsurers in the 1980’s to 26 today. And 26 actually represents some growth and development - in 2006 there were only 18 reinsurance companies. Lack of options is a pretty important concept when you’re considering your purchase mentality. You can’t just “go find coverage somewhere else”. In some ways, this might be okay -- forces all of us to take a longer-term, more strategic approach to reinsurance purchasing and relationships.I mentioned in each of the last three slides how small the market of available reinsurance is. There’s been a pretty dramatic decline in the number of reinsurers. Went from 68 reinsurers in the 1980’s to 26 today. And 26 actually represents some growth and development - in 2006 there were only 18 reinsurance companies. Lack of options is a pretty important concept when you’re considering your purchase mentality. You can’t just “go find coverage somewhere else”. In some ways, this might be okay -- forces all of us to take a longer-term, more strategic approach to reinsurance purchasing and relationships.

34. 33 Buying Reinsurance Apply Provide data Define terms and conditions Receive quote Agree Contract Here’s a really quick and high level look at how that purchase process for reinsurance looks. It’s a little different than what you might think of in terms of typical public entity purchases. You’re going to first apply to prospective reinsurers, and you’re going to submit that application with a whole lot of information about your pool, its members and risks, your management, pricing philosophy, etc. Remember that we said reinsurers need to have a good understanding of the risks they’re taking on -- this is one way they get it. Your data submission will include everything from insured values to coverage documentation, loss history, and anything else that might be pertinent to the underwriter. You and the reinsurers will spend time making sure there’s clarity in terms and conditions - what exclusions apply, how the aggregate loss provision works, what is defined as terrorism, etc. and so forth. Then you’ll get a price quote. [CONTINUE NOTES - NO SLIDE CHANGE]Here’s a really quick and high level look at how that purchase process for reinsurance looks. It’s a little different than what you might think of in terms of typical public entity purchases. You’re going to first apply to prospective reinsurers, and you’re going to submit that application with a whole lot of information about your pool, its members and risks, your management, pricing philosophy, etc. Remember that we said reinsurers need to have a good understanding of the risks they’re taking on -- this is one way they get it. Your data submission will include everything from insured values to coverage documentation, loss history, and anything else that might be pertinent to the underwriter. You and the reinsurers will spend time making sure there’s clarity in terms and conditions - what exclusions apply, how the aggregate loss provision works, what is defined as terrorism, etc. and so forth. Then you’ll get a price quote. [CONTINUE NOTES - NO SLIDE CHANGE]

35. 34 Buying Reinsurance If you agree the price is reasonable for the coverage, you move forward into the actual coverage contract. The steps are pretty simple, but the process is quite labor intensive. In your pools, you probably have staff who spend a good 3 to 4 months focused very heavily on the placement of reinsurance, changes in terms and conditions, options that might effect pricing, etc. And if you look, I’ll bet your pool administrator tends to take a couple days off not long after the board meeting at which your reinsurance arrangements are finalized and approved! It’s a pretty draining process.If you agree the price is reasonable for the coverage, you move forward into the actual coverage contract. The steps are pretty simple, but the process is quite labor intensive. In your pools, you probably have staff who spend a good 3 to 4 months focused very heavily on the placement of reinsurance, changes in terms and conditions, options that might effect pricing, etc. And if you look, I’ll bet your pool administrator tends to take a couple days off not long after the board meeting at which your reinsurance arrangements are finalized and approved! It’s a pretty draining process.

36. 35 Buying Reinsurance Direct Market Pool purchases direct from reinsurer Broker Market Pool must access reinsurer through a broker or intermediary You may have noted in your reinsurance dealings so far that there are a lot of people involved - brokers and intermediaries, among others. There are basically two approaches to access the reinsurance / excess insurance market. You may be able to go direct, where you purchase directly from the reinsurer. Or, the reinsurer may require you access coverage through a broker or intermediary. This is basically a decision made by the reinsurer, based on their size and scope, their business philosophy, etc. It’s sort of like your pool decision whether to use agents.You may have noted in your reinsurance dealings so far that there are a lot of people involved - brokers and intermediaries, among others. There are basically two approaches to access the reinsurance / excess insurance market. You may be able to go direct, where you purchase directly from the reinsurer. Or, the reinsurer may require you access coverage through a broker or intermediary. This is basically a decision made by the reinsurer, based on their size and scope, their business philosophy, etc. It’s sort of like your pool decision whether to use agents.

37. 36 Buying Reinsurance Let me say at the outset that my goal in showing this slide is simply to give you a sense of the complexity of different reinsurance market structures and why there may be so many players put together in different ways. This is not intended as an exhaustive illustration! Here you are. Here are the two options we talked about - direct or broker market. The only reinsurers you can access direct are those that have a domestic presence. You can also access those domestic reinsurers through a broker relationship. Plus, you can access bermuda and offshore markets. There may be additional players - other brokers - also required in those markets. And, you may have other folks advising your pool at your discretion and depending on your needs. So you could end up with three or even four different advisors / brokers on a reinsurance contract. And, you can’t tell just by who the reinsurer is what sort of broker or direct relationship a pool might have, because the pool may access some reinsurers in multiple ways. Not unusual to have a mix of broker and direct relationships, both which could even flow back through to a single reinsurer. Let me say at the outset that my goal in showing this slide is simply to give you a sense of the complexity of different reinsurance market structures and why there may be so many players put together in different ways. This is not intended as an exhaustive illustration! Here you are. Here are the two options we talked about - direct or broker market. The only reinsurers you can access direct are those that have a domestic presence. You can also access those domestic reinsurers through a broker relationship. Plus, you can access bermuda and offshore markets. There may be additional players - other brokers - also required in those markets. And, you may have other folks advising your pool at your discretion and depending on your needs. So you could end up with three or even four different advisors / brokers on a reinsurance contract. And, you can’t tell just by who the reinsurer is what sort of broker or direct relationship a pool might have, because the pool may access some reinsurers in multiple ways. Not unusual to have a mix of broker and direct relationships, both which could even flow back through to a single reinsurer.

38. 37 Buying Reinsurance Direct Market Might have more capacity for individual risks Traditional risk focus Direct relationship & communications Broker Market Increased pricing competition Specialty risk options Broker involved in communications & relationship management In general, the availability of direct market reinsurance is getting to be less and less. That’s in part because there are fewer reinsurers on the whole, but it’s also the result of the size and complexity of reinsurance placement and the need for a professional presence. The broker market is also seen as opportunity to increase competition -- it’s a broker’s job to find you the best deal possible. Said another way, without the presence of brokers, the direct market deals with some inertia on pricing. There are some strengths in both direct and broker market approaches to reinsurance. [NOTES CONTINUE WITHOUT SLIDE CHANGE]In general, the availability of direct market reinsurance is getting to be less and less. That’s in part because there are fewer reinsurers on the whole, but it’s also the result of the size and complexity of reinsurance placement and the need for a professional presence. The broker market is also seen as opportunity to increase competition -- it’s a broker’s job to find you the best deal possible. Said another way, without the presence of brokers, the direct market deals with some inertia on pricing. There are some strengths in both direct and broker market approaches to reinsurance. [NOTES CONTINUE WITHOUT SLIDE CHANGE]

39. 38 Buying Reinsurance DIRECT Just by virtue of the location (tend to be US companies) and financial structure, the direct market reinsurers will tend to have more capacity to take on individual risks - meaning single line or single retention risks. The kind of risks a direct market reinsurer will take on tend to be the traditional ones - so it’s a bit easier to know what your getting in terms and conditions. A direct relationship with reinsurers means that you have a chance to build familiarity and a good working relationship. This may lend itself to some flexibility if you want to try something new in your reinsurance structure, cover a new sort of risk area, or otherwise experiment. And of course because the relationship is direct so are the communications. So when it comes time to renew coverage or talk about how to handle a large claim, you’ll be talking directly with your reinsurer. [NOTES CONTINUE - NO SLIDE CHANGE]DIRECT Just by virtue of the location (tend to be US companies) and financial structure, the direct market reinsurers will tend to have more capacity to take on individual risks - meaning single line or single retention risks. The kind of risks a direct market reinsurer will take on tend to be the traditional ones - so it’s a bit easier to know what your getting in terms and conditions. A direct relationship with reinsurers means that you have a chance to build familiarity and a good working relationship. This may lend itself to some flexibility if you want to try something new in your reinsurance structure, cover a new sort of risk area, or otherwise experiment. And of course because the relationship is direct so are the communications. So when it comes time to renew coverage or talk about how to handle a large claim, you’ll be talking directly with your reinsurer. [NOTES CONTINUE - NO SLIDE CHANGE]

40. 39 Buying Reinsurance BROKER As I already mentioned, the broker market helps increase competition in the reinsurance marketplace. Those reinsurers that are brokered tend to be outside the US and very large in scope and size. They’re therefore structured to take on specialty risks - think of the kinds of things Lloyds has insured over the years. In a brokered arrangement, your relationship is going to be primarily with your broker. It would be a bit unusual for you to have a lot of direct contact with the reinsurer. You can use your broker to help communicate with the reinsurer and, since the broker knows the market, he or she should be able to help you assert your interests. That communications role for the broker also exists at renewal and claims time. The broker can help you exert pressure or leverage you may not have on your own. There is of course a fee involved with broker services - either paid as part of the purchase or as a direct contract for service. The general premise is that those costs should be offset by savings or service the broker helps you achieve. Choosing broker v. direct (for those reinsurers with whom you have a choice) goes right back to the Goldilocks principle-- you need to find the fit that’s just right for you. BROKER As I already mentioned, the broker market helps increase competition in the reinsurance marketplace. Those reinsurers that are brokered tend to be outside the US and very large in scope and size. They’re therefore structured to take on specialty risks - think of the kinds of things Lloyds has insured over the years. In a brokered arrangement, your relationship is going to be primarily with your broker. It would be a bit unusual for you to have a lot of direct contact with the reinsurer. You can use your broker to help communicate with the reinsurer and, since the broker knows the market, he or she should be able to help you assert your interests. That communications role for the broker also exists at renewal and claims time. The broker can help you exert pressure or leverage you may not have on your own. There is of course a fee involved with broker services - either paid as part of the purchase or as a direct contract for service. The general premise is that those costs should be offset by savings or service the broker helps you achieve. Choosing broker v. direct (for those reinsurers with whom you have a choice) goes right back to the Goldilocks principle-- you need to find the fit that’s just right for you.

41. 40 Direct Market Reinsurers General Re Munich Re Swiss Re Excess Risk Pools Here’s quick perspective on the existing direct market reinsurers. Not hard to commit these few to memory! There are a few smaller, specialty players. These guys are the major players. Here’s quick perspective on the existing direct market reinsurers. Not hard to commit these few to memory! There are a few smaller, specialty players. These guys are the major players.

42. 41 Broker Market Reinsurers ACE Arch Re Argo Re Aspen Re AXIS Employers Re Endurance Everest Re Hannover Re Harbor Point Hiscox Lloyds & Syndicates Partner Re Safety National Scor Re Transatlantic Re XL Re A sampling of folks available in the broker market - I think I listed 17 here plus the three on prior slide -- 20 out of the total 26 available. A sampling of folks available in the broker market - I think I listed 17 here plus the three on prior slide -- 20 out of the total 26 available.

43. 42 Sample Reinsurance Structure Here’s one example of how all this might come together in a multi-line pool Intended to be illustration of fairly complex structure, but we’ll break it down into reasonable chunks and you may find it’s not as daunting as it looks at first glance. Here we have a mix of reinsurance players (sorted by color). Some are reinsurers, some are excess insurers (RE or EX). You can see where the pool holds its own risk of loss (yellow) What you don’t see here are the impacts of any aggregate or cumulative loss coverage the pool might buy. Or any facultative arrangements. FIRST LOOK AT LIABILITY Pool has amount it holds itself Quota share split b/t pool and reinsurer Large excess insurer [MORE NOTES - NO SLIDE CHANGE]Here’s one example of how all this might come together in a multi-line pool Intended to be illustration of fairly complex structure, but we’ll break it down into reasonable chunks and you may find it’s not as daunting as it looks at first glance. Here we have a mix of reinsurance players (sorted by color). Some are reinsurers, some are excess insurers (RE or EX). You can see where the pool holds its own risk of loss (yellow) What you don’t see here are the impacts of any aggregate or cumulative loss coverage the pool might buy. Or any facultative arrangements. FIRST LOOK AT LIABILITY Pool has amount it holds itself Quota share split b/t pool and reinsurer Large excess insurer [MORE NOTES - NO SLIDE CHANGE]

44. 43 Sample Reinsurance Structure PROPERTY - more complex More players, more layers - good illustration of important concept. There is a lot of opportunity to spread risk among multiple reinsurance partners. You can see that illustrated here at a couple of different points. Certainly, the larger the risk the better off you are having multiple players such that you can spread costs and be assured of even greater security. And, there may be value in not having all your eggs in one basket. It’s not such a farfetched thing to consider what might happen if one of your reinsurance partners goes belly-up, or refuses to pay on a claim, or otherwise doesn’t perform as expected. Having a mix of players and partners can be a very good thing. (C might be willing to take on another chunk next year). Also a good way to get to know claims practices and gauge relationship. Remember, too, though that you may accidentally end up with fewer eggs in the basket because of the way you purchase reinsurance - maybe you bought one block with the B carrier direct, and another block through a broker. A view like this helps to make sure you see the overall fit of B into this mix and the ultimate weight B is carrying for you. [MORE NOTES - NO SLIDE CHANGE]PROPERTY - more complex More players, more layers - good illustration of important concept. There is a lot of opportunity to spread risk among multiple reinsurance partners. You can see that illustrated here at a couple of different points. Certainly, the larger the risk the better off you are having multiple players such that you can spread costs and be assured of even greater security. And, there may be value in not having all your eggs in one basket. It’s not such a farfetched thing to consider what might happen if one of your reinsurance partners goes belly-up, or refuses to pay on a claim, or otherwise doesn’t perform as expected. Having a mix of players and partners can be a very good thing. (C might be willing to take on another chunk next year). Also a good way to get to know claims practices and gauge relationship. Remember, too, though that you may accidentally end up with fewer eggs in the basket because of the way you purchase reinsurance - maybe you bought one block with the B carrier direct, and another block through a broker. A view like this helps to make sure you see the overall fit of B into this mix and the ultimate weight B is carrying for you. [MORE NOTES - NO SLIDE CHANGE]

45. 44 Sample Reinsurance Structure Going to leave this slide up as my close, because I think it’s a pretty good capstone of everything we’ve covered. Reinsurance is one of most important things you do as trustee - it protects your pool and allows you to focus on all the other good work you do for your members. Reinsurance helps maintain your pool’s financial viability. Important that you understand the risks you’re keeping vs. passing along, stay cognizant of trends, issues, and other items that bear monitoring. The goal is to maintain awareness of both the dangers and the opportunities. [take questions or take a break!]Going to leave this slide up as my close, because I think it’s a pretty good capstone of everything we’ve covered. Reinsurance is one of most important things you do as trustee - it protects your pool and allows you to focus on all the other good work you do for your members. Reinsurance helps maintain your pool’s financial viability. Important that you understand the risks you’re keeping vs. passing along, stay cognizant of trends, issues, and other items that bear monitoring. The goal is to maintain awareness of both the dangers and the opportunities. [take questions or take a break!]