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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

Specialty lines pricing

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

Experience rating loss development ground up
Experience Rating: Loss Development – Ground Up

Experience rating loss development excess of loss
Experience Rating: Loss Development – Excess of Loss

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) total retained % for portfolio

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 total retained % for portfolioSize 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 total retained % for portfolioCommercial (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: total retained % for portfolioHistorical 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: total retained % for portfolioProfitability

  • 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: total retained % for portfolioCan 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