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Specialty Lines Pricing. Gerson Smith CARe Seminar Washington, D.C. July 11, 2001. Surety Excess-of-Loss Reinsurance Pricing. Experience Rating Exposure Rating Economic Conditions Market Conditions . Surety Bonding: Estimation of Loss Amounts. Contract Balances (Revenues)

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specialty lines pricing

Specialty Lines Pricing

Gerson Smith

CARe Seminar

Washington, D.C.

July 11, 2001

surety excess of loss reinsurance pricing
Surety Excess-of-LossReinsurance Pricing
  • Experience Rating
  • Exposure Rating
  • Economic Conditions
  • Market Conditions
surety bonding estimation of loss amounts
Surety Bonding: Estimation of Loss Amounts
  • Contract Balances(Revenues)
  • Cost to Complete (Liabilities)
  • Other Costs
Contract Balance = Original Contract Price

+/- Change Orders

- Cash Payments Made by Obligee to Principal or Surety

Surety Bonding: Estimation of Loss Amounts

surety bonding estimation of loss amounts1
Cost to Complete: comprised of

-Variable Costs: Labor, Materials, Equipment

- Fixed Costs: Subcontractors & Suppliers

Surety Bonding: Estimation of Loss Amounts
surety bonding estimation of loss amounts2
Other Costs:

-Liquidated Costs

- Unpaid Suppliers

- Subcontractors’ Current Payments Due

- Contingencies

Surety Bonding: Estimation of Loss Amounts
experience rating loss data what to include
Experience Rating: Loss Data – What to Include?
  • Contract Balances
  • Collateral– cash or secured by LOC
  • Salvage (e.g. indemnities) – only when realized
  • Anticipated Salvage – no
surety bonding treatment of alae
Surety Bonding Treatment of ALAE
  • Proportional Treaties – ProRata in addition
  • Excess-of-Loss – included in definition of loss
  • SAA - ALAE appr. 5% of aggregate losses (decreasing trend over time)
experience rating parameter selection
Experience Rating:Parameter Selection
  • Loss Development
  • Trend– Severity / Frequency
  • Rate Level
exposure rating limits profiles
Exposure Rating: Limits Profiles
  • Per Bond vs. Per Principal
  • Max Work Program vs. Bonded Work-on-Hand
exposure rating limits profile adjustments
Exposure Rating: Limits Profile Adjustments
  • Co-Surety %’s
  • Bonded/Unbonded Split
  • Utilization
  • PML
  • Benefit of Inuring Reinsurance
exposure rating utilization
Def. - Ratio of bonded work-on-hand to total limits

(may be ratio to either bonded or unbonded)

Dependent upon:

- Amount of Construction Work (esp. public works)

- Seasonality

- Type of Project

- Project Duration

Exposure Rating: Utilization
exposure rating pml s
Def. - Probable Maximum Loss as a % of Exposure (may be relative to unbonded, bonded, or utilized work-on-hand)

Varies by:

- Region

- Contractor Size

- Contractor Type

Exposure Rating: PML’s
exposure rating steps to estimate benefit of inuring
1) Using cessions %’s on a per-bond basis, determine total retained % for portfolio

2) Judgmentally select per-contractor retained %’s by band, making sure to balance back to total retained %

3) Per-contractor retained %’s should decrease with contractor size

Exposure Rating: Steps to Estimate Benefit of Inuring
exposure rating steps to estimate benefit of inuring1
Alternate Method (where available)

1) For each contractor (or limits band), obtain number of bonds, work program limit & max bond limit

2) Assume largest bond ceded according to schedule

3) Calculate average limit excluding largest bond, apply cessions schedule.

4) Add retained amounts from 2) & 3)

5) Other possibilities, e.g. 2x or 3x average

Exposure Rating: Steps to Estimate Benefit of Inuring
exposure rating size of loss curves
Exposure Rating Size of Loss Curves
  • Loss-to-Value (PML)
  • Derived from coordinated loss & exposure data (preferable: remaining exposure @time of loss)
  • Alternate Method – Frequency/Severity approach, where severities are derived from loss data and frequencies are based on default rate for implicit contractor ratings
surety bonding commercial non contract surety
Surety Bonding Commercial (Non-Contract) Surety
  • Historically low limits and small portion of XS
  • Gradually including larger and riskier classes
  • Historical loss ratios ~ 20%
surety bonding historical perspective
Surety Bonding: Historical Perspective
  • SAA - 30 year (net) loss ratio result = 40%
  • Worst Years - 1975/76 (recession) and 1986/87 (expansion) Loss ratios ~ 70%-75%
  • Best Years - 1989-1999 (recession & expansion)

Loss ratios in the 30%’s throughout the period

  • Conclusion: Surety results not correlated w/economy
surety bonding profitability
Surety Bonding: Profitability
  • Contractor Profits / ROE’s follow the economy w/ peaks in mid-’80’s and mid to late ’90’s, trough in the early ’90’s
  • Surety Results stable since late ’80’s
  • Initial Conclusion: Surety results independent of construction industry profitability
  • Alternate Conclusion (pending updated results for 2000/2001): Surety results decline in the face of extended periods of profitability and economic prosperity
surety bonding can we anticipate the cycle
Surety Bonding: Can We Anticipate the Cycle?
  • Difficult for High Excess-of-Loss – Random Events
  • Consecutive Years generally correlated
  • Underpricing of underlying business not as apparent as in other P/C lines
  • Enhancements: 1) Improved rate monitoring techniques, 2) Econometric forecasting