CAS Ratemaking Seminar RCM-2 Town Hall Session

1. CAS Ratemaking SeminarRCM-2Town Hall Session Remarks by Glenn Meyers Insurance Services Office, Inc. March 13, 2006

2. Insurer Risk and Capital Management Perspective • Risk based capital • The insurer's risk, as measured by its stochastic distribution of outcomes, provides a meaningful yardstick that can be used to set capital requirements. • Insurer risk management • The insurer manages its business to minimize its cost of financing, i.e. its cost of capital plus the net cost of reinsurance.

3. Insurer Risk Measurement • Use a coherent measure of risk r(X) • e.g. Tail Value-at-Risk • Define random variables: • A = Assets • X = Liabilities • Insurer has sufficient assets if r(X – A) = 0 • Define: Capital = E(A) – E(X)

4. Insurer Risk Management • Choose insurance portfolio (lines of business and reinsurance strategies) to minimize cost of financing insurance. • Two equivalent techniques • Efficient frontier management • Marginal cost of capital analyses • Capital Allocation • In general unnecessary, but it is desirable for communicating financially oriented objectives.

5. Insurer Risk Management • Reserve Risk contributes to the need for capital and hence it contributes to the ($) cost of capital. • How long you need to hold capital is a consideration in determining an acceptable price. • Easy to implement by allocating capital

6. Recent Debates onCAS Valcon Listserve • How do you allocate capital? • In proportion to marginal capital • RMK and/or Capital Consumption • My stand • Prefer marginal capital • Not fighting hard for it at this point. Other parts of the problem have higher priority. • Kalkbrener • “An Axiomatic Approach to Capital Allocation” http://www.casact.org/pubs/actrev/nov05/brainstorms.htm http://www.gloriamundi.org/

7. Recent Debates onCAS Valcon Listserve • Determine ROE • Corporately • Separately by line of business • Investor vs Policyholder interest • Solvency vs Profitability • Use financial formula such as CAPM? • My stand • Corporate ROE • Do not use financial formulas • Done informally for years!

8. Prediction This how actuaries will include the cost of capital in future insurance costing. Main Obstacles to Overcome • Fuzzy relationship between risk and capital • EU Solvency II may change all that • Quantification of all risks • Underwriting risk • Asset risk - Several commercial models • Operational risk • Other • Consensus • Will not come until above issues are substantially settled.