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TRUSTING YOUR SURPLUS

TRUSTING YOUR SURPLUS. Prepared For: 2008 AGRiP Governance & Leadership Conference October 27, 2008 New Orleans, La Prepared By: Gary R. Josephson, FCAS, MAAA gary.josephson@milliman,com (262) 796-3305. SURPLUS (aka). Fund Balance Net Assets Retained Earnings Member Equity.

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TRUSTING YOUR SURPLUS

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  1. TRUSTING YOUR SURPLUS Prepared For: 2008 AGRiP Governance & Leadership Conference October 27, 2008 New Orleans, La Prepared By: Gary R. Josephson, FCAS, MAAA gary.josephson@milliman,com (262) 796-3305

  2. SURPLUS (aka) • Fund Balance • Net Assets • Retained Earnings • Member Equity

  3. GARY’S SURPLUS RULES

  4. GARY’S SURPLUS RULES • If you don’t need it, you can give it back!

  5. GARY’S SURPLUS RULES • If you don’t need it, you can give it back! • Once it’s gone, it’s hard to get back!

  6. SURPLUS CONSIDERATIONS • What • Why • How Much • “Excess” Surplus

  7. WHAT (is surplus)?

  8. SURPLUS = ASSETS minus LIABILITIES

  9. ASSETS Cash Bonds Stocks Real Estate Receivables Other LIABILITIES Losses Loss Adjustment Expenses Unearned Premiums Other SURPLUS BALANCE SHEET

  10. WHAT (is surplus)? • WHY (do pools need surplus)?

  11. SURPLUS PROVIDES PROTECTION

  12. SURPLUS PROVIDES PROTECTION • Asset Risk

  13. ASSET RISK • Stocks • Bonds • Real Estate • Other Investments

  14. SURPLUS PROVIDES PROTECTION • Asset Risk • Liability Risk

  15. LIABILITY RISK • Unpaid Loss and Loss Adjustment Expense

  16. LOSS AND LAE RESERVE RISK

  17. LOSS AND LAE RESERVE RISK • Expected = $1,525,000 • 75%ile = $1,850,000 • 90%ile = $2,200,000 • Discounted = $1,300,000

  18. Who needs more surplus? • Pool A – records discounted loss reserves ($1,300,000) • Pool B – records 90% probability level reserves ($2,200,000)

  19. LOSS AND LAE RESERVE RISK

  20. LIABILITY RISK • Unpaid Loss and Loss Adjustment Expense • Unearned Premiums (Contributions)

  21. LIABILITY RISK • Loss and Loss Adjustment Expense • Unearned Premiums (Contributions) • Other Liabilities

  22. SURPLUS PROVIDES PROTECTION • Asset Risk • Liability Risk • Premium Risk

  23. PREMIUM RISK • Expected Losses? or with Risk Margin? • Present Value? • Loss Trends? • Growth? • Large Losses/Catastrophes?

  24. SURPLUS PROVIDES PROTECTION • Asset Risk • Liability Risk • Premium Risk • Reinsurance Risk

  25. REINSURANCE RISK • What is your Gross Exposure (Policy Limits)? • How Strong is Your Reinsurer?

  26. OTHER RISKS • Operational Risk

  27. WHAT (is surplus)? • WHY (do pools need surplus)? • How Much (surplus do we need)?

  28. HOW MUCH • Rules of Thumb • State of Washington Guidelines • Regulatory and Rating Agency Formulas • Comparative Measures • The Dynamic Future

  29. SURPLUS – RULES OF THUMB • Premium/Surplus 2:1 • Loss Reserves/Surplus 3.5:1 • Surplus/Retention 10:1

  30. State of Washington Risk Management Department • Expected Losses to Equity Less than 1:1 • Net Reserves to Equity Less than 1.5:1 • Equity to SIR 5:1 to 10:1

  31. REGULATORY FORMULAS – IRIS TESTS (RED FLAGS) • Gross Premium/Surplus Less than 9:1 • Net Premium/Surplus Less than 3:1 • Reserve Development/Surplus Less than 20%

  32. Capital Charges for: Assets Credit Loss and LAE reserves Premium Other REGULATORY TESTS – RISK BASED CAPITAL

  33. Capital Charges for: Assets Credit Loss and LAE reserves Premium Other FOCUS ON SOLVENCY REGULATORY TESTS – RISK BASED CAPITAL

  34. RATING AGENCY FORMULAS • Similar to Risk Based Capital • Focus on Relative Financial Strength • Qualitative and Quantitative

  35. Why should a Pool be concerned about it Risk Based Capital or Rating Agency “score”?

  36. COMPARATIVE MEASURES 24 Pools • Loss Reserves/Surplus • Premium/Surplus • Reinsurance Utilization

  37. LOSS RESERVES TO SURPLUS • 24 Pools Average 1.27 • Commercial Insurers Average 1.54

  38. Actuarial Math • 1.3 is not equal to 1.3

  39. LOSS RESERVES TO SURPLUS • Consider: Pool A Pool B • Assets: $2,200,000 $2,200,000 • Liabilities: • Loss Reserves $1,050,000 $1,050,000 Other $ 350,000 $ 350,000 • Surplus $ 800,000 $ 800,000 • Reserve/Surplus 1.3 1.3

  40. BOOKED LOSS RESERVES • POOL A: Books discounted value of actuarial estimate • POOL B: Books undiscounted 80% probability level estimate

  41. WHAT IS LOSS RESERVE ESTIMATE • POOL A POOL B • ACTUARIAL ESTIMATE $1,250,000 $ 850,000 • DISCOUNTED ESTIMATE $1,050,000 $ 700,000 • 80% PROBABILTY $1,550,000 $1,050,000

  42. LOSS RESERVES TO SURPLUS • Consider: Pool A Pool B • Assets: $2,200,000 $2,200,000 • Liabilities: • Loss Reserves $1,050,000 $1,050,000 Other $ 350,000 $ 350,000 • Surplus $ 800,000 $ 800,000 • Reserve/Surplus 1.3 1.3

  43. LOSS RESERVES TO SURPLUS if both use actuarial estimate

  44. PREMIUM TO SURPLUS • 24 Pools Average 0.63 • Commercial Insurers Average 0.88

  45. PREMIUM ISSUES • Premium Adequacy (lower premium = lower premium/surplus ratio) • Discounted Losses • Risk Load • Catastrophe Exposures

  46. REINSURANCE

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