1. 2000 CAS Ratemaking Seminar Session REI-19 9 March 2000 Simon Sheaf Tillinghast-Towers Perrin London International Reinsurance Pricing and Challenges Liability

2. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 2 Agenda The need for benchmarks Deriving benchmarks Index clauses Changing international liability environments

3. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 3 General Issues Availability of data Country differences:-  minimum policy limits  inflation  legal environment  social attitude

4. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 4 Role of Benchmarking Lack of company data Standard to which individual company can be measured Determine if benchmark is appropriate Use range of benchmarks

5. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 5 Deriving Benchmarks - Methodology Collect data Create report year loss development triangles Select development patterns Trend losses to common accident date Develop individual claims to ultimate values Restate losses to level under current legislative system Select truncation and censorship points Fit size of loss curves Estimate portion below truncation point

6. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 6 Deriving Benchmarks - Issues Credibility of data set Verify that data is not just comprised of a few companies Confidentiality concerns Variations in reporting thresholds Consider a range of scenarios

7. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 7 Results - Size of Loss Curves Note: Before trend, development or filtering

8. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 8 Results - Excess Premium/Loss Factors Layer £1m xs £1m Rate for layer = EPF (£1m) - EPF (£2m) = 1.2% Simple application, but must understand origin of figures Illustrative Example Claim Limit (£) Excess Premium Factor 150,000 500,000 1,000,000 2,000,000 5,000,000 7.8% 3.8% 1.9% 0.7% 0.2%

9. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 9 Results - Loss Development Patterns - Claim Size Comparison

10. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 10 Results - Loss Development Patterns - Country Comparison

11. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 11 Results - Variability in Claims Development

12. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 12 Index Clauses in Excess of Loss Treaties Fully Indexed: the attachment point and coverage amount are adjusted freely with the index Franchise Index: the attachment point and coverage amount are adjusted with the index only if the accumulated inflation exceeds a certain level Severe Inflation Clause (SIC): the attachment point and coverage amount are adjusted with the index only if the accumulated inflation exceeds a certain level, and only to the extent that the accumulated inflation exceeds this level

13. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 13 Index Clauses - Example £1m xs £1m excess of loss reinsurance contract Contract index: European Expensive Stuff Index Base Index: EES index value at inception date = 100 Suppose a loss of £2m (from the ground up, in future nominal pounds) occurs How reinsurance contract reacts depends on:-  type of index clause  value of index at time of payment

14. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 14 Fully Indexed Original loss = £2m Index Value at Time of Payment Indexing Adjustment Indexed Layer (£m) Reinsurance Payment (£m) 101 101/100 1.01 xs 1.01 0.99 105 105/100 1.05 xs 1.05 0.95 110 110/100 1.10 xs 1.10 0.90 115 115/100 1.15 xs 1.15 0.85 120 120/100 1.20 xs 1.20 0.80 125 125/100 1.25 xs 1.25 0.75 Layer = £1m xs £1m Base Index = 100

15. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 15 Franchise Index Original loss = £2m Index Value at Time of Payment Indexing Adjustment Indexed Layer (£m) Reinsurance Payment (£m) 101 none 1.00 xs 1.00 1.00 105 none 1.00 xs 1.00 1.00 110 110/100 1.10 xs 1.10 0.90 115 115/100 1.15 xs 1.15 0.85 120 120/100 1.20 xs 1.20 0.80 125 125/100 1.25 xs 1.25 0.75 Layer = £1m xs £1m Base Index = 100; Franchise=10% inflation Index Value=110

16. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 16 Severe Inflation Clause Original loss = £2m Index Value at Time of Payment Indexing Adjustment Indexed Layer (£m) Reinsurance Payment (£m) 101 none 1.000 xs 1.000 1.000 105 none 1.000 xs 1.000 1.000 110 110/110 1.000 xs 1.000 1.000 115 115/110 1.045 xs 1.045 0.955 120 120/110 1.091 xs 1.091 0.909 125 125/110 1.136 xs 1.136 0.864 Layer = £1m xs £1m Base Index = 100; SIC = 10% inflation Index Value = 110

17. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 17 Comments About Index Clauses Appropriate with long-tail lines of business and inflationary environments Make the economics of the excess of loss deal fairer What determines which type of index clause will be used?  market practice  what the broker is used to  what the cedant will accept

18. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 18 UK Personal Injury Settlements - The Background Structured settlements becoming more common But lump sum payment is the norm in motor TPL claims How is lump sum calculated?  NPV  allowing for discount  allowing for mortality  using Ogden Tables

19. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 19 UK Personal Injury Settlements - Recent Judgement Historical view: plaintiffs would invest their money “prudently”, including some element of risk Recent House of Lords judgement: the plaintiff must not be compelled to speculate. Hence, the allowable discount rate is now lower This may encourage more structured settlements But lump sum award amounts will rise Difficult to estimate the effect. Consider:-  new claims handling strategies  changes in reserves for outstanding claims  “as-if” effect on a sample of settled claims

20. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 20 The Spanish Baremo Historically, motor liability awards in the Spanish courts were extremely unpredictable 1996: The Baremo legislation, to make awards more predictable A bodily injury reimbursement schedule with a daily living allowance 1999: Payment levels for the daily living allowance increased

21. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 21 Effects of the Baremo As liability awards are more predictable, plaintiffs are more likely to settle Loss experience before and after the Baremo is not comparable:-  payment pattern significantly shortened  age-to-age development factors are very different Difficult to quantify

22. Q:\CLIENT\SheafS\2000\ss0185cm.ppt Page 22 Summary There are differences between pricing liability reinsurance in the US and in other countries Examples:-  no market data  different treaty terms  diverse and changing liability environments

23. 2000 CAS Ratemaking Seminar Session REI-19 9 March 2000 Simon Sheaf Tillinghast-Towers Perrin London International Reinsurance Pricing and Challenges Liability