Reinsurance Pricing Perspective

1. Reinsurance Pricing Perspective

2. Pricing Actuary’s Responsibilities: • Review treaty reinsurance structure • Determine the expected loss cost for the proposed reinsurance treaty • Compute the reinsurance rate based on the expected loss cost, risk characteristics and volatility (capital requirements) of the treaty

3. I. Treaty Structure • Understand the ceding company’s motivation behind the reinsurance purchase • Discuss the alignment of the insurer’s and reinsurer’s interests • Determine whether the submission data is sufficient to analyze the proposed structure

4. I. Treaty Structure • The clock is ticking – manage expectations!

5. II. Pricing - Summary • Data Issues • Rating Considerations • Parameter Estimation • Interpreting Results

6. II. Pricing – Data Issues • Identify and quantify changes described in the submission’s narrative • Changes in class and product mix • Changes in policy limits usage and deductible levels • Changes in inuring business or facultative placements • Changes in risk concentrations • Etc.

7. II. Pricing – Data Issues • Small regional insurers may not be able to break-out their book into component sub-lines • Carriers may not be able to provide robust price monitoring reports • The impact of changes in claims handling or reserving may be based on anecdotal evidence from underwriting or claims rather than from hard data provided by the cedant • Request the independent actuarial reserve study (if available)

8. II. Pricing – Data Issues • Draw comparisons to the insurer’s peer group • Contact the insurer’s actuary • Develop a strategy to price the proposed reinsurance structure

9. II. Pricing • Make a concerted effort to understand the exposures being reinsured

10. II. Pricing – Rating Considerations • Actuarial first principles: “Rates are not to be inadequate, excessive, or unfairly discriminatory.” • Consider stability vs. responsiveness when selecting rating segments • Greater segmentation can lead to increased parameter risk, compounded conservatism, and pricing inaccuracies

11. II. Pricing – Rating Considerations • If excess loss experience is not credible or is inconsistent with exposure indications, consider experience rating a lower layer • This may be limited by the truncation point of your historical loss experience and your annual severity trends • The relative consistency of experience and exposure indications on a lower layer, may not hold as you extrapolate to a higher layer • Severity layers may require a frequency/severity approach

12. II. Pricing – Parameter Estimation • Niche carriers may have very different loss trends than national writers • Compare premium and loss trend assumptions to ensure consistency • Increased limits factors or exposure curves based on industry sources may also be inappropriate for niche or regional writers

13. II. Pricing – Interpreting Results • If attritional experience and exposure loss cost indications vary significantly, take the time to understand the differences • Decisions as to credibility rely on your understanding of these discrepancies • Experience based selections may result in “free cover” if historical experience does not contain losses that exhaust the reinsurance limit

14. II. Pricing – Interpreting Results • Shock losses may skew experience indications particularly if there are a limited number of years of credible historical experience • Examine both line of business and consolidated treaty experience indications to evaluate the benefit of line of business diversification • For composite rated accounts, shifts in the distribution of the underlying premium by line of business can have a material impact on the overall indicated loss cost

15. II. Pricing - Example • Consider an excess of loss treaty with the following projected subject premiums and loss cost indications. Note that the personal auto liability does not expose the reinsurance layer

16. II. Pricing – Example • If the company writes 20% more commercial umbrella business and 2% less personal auto liability business, then the overall loss cost indication increases by 11%

17. II. Pricing – Non-Attritional Exposures • Small regional insurers may not have sophisticated catastrophe models • Carriers may not capture all the data elements necessary for pricing the catastrophe exposure of the reinsurance treaty • Discuss the catastrophe modeling data and non-modeled catastrophe exposures with the underwriter and the catastrophe modeling unit • Make sure that exposure from secondary perils is not double counted or missed entirely

18. III. Evaluating The Reinsurance Rate • Aggregate loss distributions should be used to determine the economic value of treaty features • Post treaty feature profit distributions can be used to determine capital requirements for the treaty • Historical loss experience may provide some help in determining the appropriate shape of the aggregate loss distribution • 5 – 10 years of historical data provide little information about the tail of the distribution (1:50 yrs, 1:100 yrs, …) • There is considerable process risk and parameter risk involved in pricing small regional accounts

19. III. Evaluating The Reinsurance Rate • Don’t underestimate the downside risk!

20. III. Evaluating The Reinsurance Rate • Reinsurance treaty structures for small regional insurers can become unbalanced quickly: • Reinsurer can be exposed to limits that far exceed the ceded premium • A limit loss in a $4M xs $1M layer with $500k ceded premium will produce a loss ratio of 800% for the reinsurer • Low-frequency/high severity coverages (e.g. property cat, clash, ECO/XPL, and terrorism) can increase parameter risk significantly • The rating process must account for the volatility in results that arises from premium/limit imbalances

21. III. Evaluating The Reinsurance Rate • Small regional carriers can provide valuable diversification in a reinsurance portfolio: • May write niche products • Regional premium and loss trends are not fully correlated with national trends • Often serve localized markets that don’t aggregate with national accounts • These diversification benefits need to be considered in the rating process

22. Conclusions: • Take the time to discuss and understand the small regional carriers book of business and motivations • Evaluate the alignment of interests and make recommendations to strengthen the reinsurance partnership • Consider the amount of process/parameter risk in the pricing indications and the portfolio benefit of non-correlated exposures