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Casualty Actuarial Society Loss Reserving Seminar Washington, D.C. September 18-19, 2008 PowerPoint Presentation
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Concurrent Session REI2 Impact of Reinsurance and Reinsurers on your Financials Evaluating Reinsurance: Different Metrics, Different Perspectives. Casualty Actuarial Society Loss Reserving Seminar Washington, D.C. September 18-19, 2008. A Typical Reinsurance Analysis.

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Concurrent Session REI2Impact of Reinsurance and Reinsurers on your FinancialsEvaluating Reinsurance:Different Metrics, Different Perspectives

Casualty Actuarial Society

Loss Reserving Seminar

Washington, D.C.

September 18-19, 2008

a typical reinsurance analysis
A Typical Reinsurance Analysis
  • Company entering a new product line
  • Considering a reinsurance program on the new business to mitigate risk
  • Used a simulation model to quantify distribution of outcomes
    • Benefits of these models include:
      • Ability to consider several metrics
      • Easy ability to do multiple what-if’s
measures of risk reflect the mean or not
Measures of Risk – Reflect the Mean or Not?
  • Measures of pure volatility, independent of mean
    • Standard deviation
    • Percentile-based (VaR or TVar) relative to the mean
  • Measures that reflect level of mean as well
    • Percentile-based on absolute result (e.g., underwriting profit or combined ratio)
    • Probability of ruin or capital impairment
standard deviation and percentiles of underwriting result
Standard Deviation and Percentiles of Underwriting Result

Average Outcome – Reinsurance Costs Money

Standard Deviation – Reinsurance Reduces

Downside Percentile (10%) – About the same across options

measures that integrate risk and reward
Measures That Integrate Risk and Reward
  • When risk/reward plots slope up to the right, they usually do not clearly indicate a “best” option
  • Economic Value Added (EVA), Return on Risk Adjusted Capital (RORAC), etc. translate the risk measure into a cost of capital, which is measured in the same units as the average outcome, so they can be netted against each other

EVA = Avg. Rtn. – (Capital Rqd. x Cost of Capital),

where Capital Required is function of risk

sample eva calculation
Sample EVA Calculation
  • Note that with EVA, zero is a good outcome
  • Answer often depends crucially on how capital requirement is calculated (could do many sessions on this alone)
how to make a decision
How to Make a Decision?
  • Typically several metrics should be considered, as they will emphasize different aspects of risk
  • Management needs to articulate nature of risk it is most concerned with
    • Glenn’s PML curve regions gets at this directly
    • Sensitivity to “middle of distribution” volatility, or extreme downsides?
    • Willingness to accept greater volatility in pursuit of higher gains?
    • Focus on company level impact or segment level?
zooming out marginal impact on book of business in total
Zooming Out - Marginal Impact on Book of Business in Total

Average Outcome – Same Marginal Effect

Standard Deviation – Reinsurance still reduces, but not as much

Downside Percentile (1%) – Marginal impact smaller

(Product-level underwriting results from earlier page, for reference)

eva for whole book of business
EVA for Whole Book of Business

Bottom line:

  • Much less clear that this reinsurance helps
  • Final answer requires management to be clear on risk tolerance

Capital Based on 1% Downside

Capital Based on 0.1% Downside

effects of volume
Effects of Volume
  • If some is good, more is not always better…..
summary
Summary
  • Multiple perspectives, depending on management priorities
    • Absolute downside
    • Earnings stability
    • Appetite for higher reward/aversion to higher risk
  • Need to consider marginal impact on whole company