Determining Appropriate Retentions San Diego RIMS Monthly Meeting November 17, 2011 Brian Mercer, Principal

Copyright 2007, Integro USA Inc. 2 Agenda Today we explore two ways to think about setting deductibles: 1. Benchmarking against similar organizations 2. Analytic approach to matching deductibles to your organization’s risk tolerance

Copyright 2007, Integro USA Inc. 3 Benchmarking

Copyright 2007, Integro USA Inc. 4 Benchmarking deductibles Sources for benchmarking  Your broker  Your insurer  RIMS survey  Advisen  Your professional network Your organization’s tolerance for risk is more important than your revenue  Capacity to pay claims  Organizational attitudes

Copyright 2007, Integro USA Inc. 5 Analytic Approach

Copyright 2007, Integro USA Inc. 6 What Factors Drive the Retention Decision? Market Price Risk Tolerance Expected Losses Volatility Collateral Interest Rates Tax RatesCost of Capital Payment Patterns

Copyright 2007, Integro USA Inc. 7 Risk Tolerance

Copyright 2007, Integro USA Inc. 8 Determining a peer group: CareFusion

Copyright 2007, Integro USA Inc. 9 Determining a peer group: CareFusion

Copyright 2007, Integro USA Inc. 10 Determining a peer group: CareFusion Other Category 13s Health Care REIT Agilent Best Buy DirectTV Nordstrom Time Warner Humana

Copyright 2007, Integro USA Inc. 11 Benchmarking D&O Deductibles

Copyright 2007, Integro USA Inc. 12 Simplified Risk Tolerance Approach

Copyright 2007, Integro USA Inc. 13 Perception of Risk Tolerance by Role Source: IBM Institute for Business Value CFO CEO Source: IBM Institute for Business Value Adventuresome Visionaries Image Makers Operational Leaders Daily Operators

Copyright 2007, Integro USA Inc. 14 Perception of Risk Tolerance by Role Source: IBM Institute for Business Value CFO CEO Sales Source: IBM Institute for Business Value Adventuresome Visionaries Image Makers Operational Leaders Daily Operators

Copyright 2007, Integro USA Inc. 15 Perception of Risk Tolerance by Role Source: IBM Institute for Business Value CFO CEO Sales Marketing Source: IBM Institute for Business Value Line Executive Adventuresome Visionaries Image Makers Operational Leaders Daily Operators

Copyright 2007, Integro USA Inc. 16 Perception of Risk Tolerance by Role Source: IBM Institute for Business Value CFO CEO COO Sales Marketing CIO Source: IBM Institute for Business Value Line Executive Adventuresome Visionaries Image Makers Operational Leaders Daily Operators

Copyright 2007, Integro USA Inc. 17 Perception of Risk Tolerance by Role Source: IBM Institute for Business Value CFO CEO COO Sales Internal Audit Marketing CIO Source: IBM Institute for Business Value CRO Line Executive Adventuresome Visionaries Image Makers Operational Leaders Daily Operators

Copyright 2007, Integro USA Inc. 18 Perception of Risk Tolerance by Role Source: IBM Institute for Business Value CFO CEO COO Sales Internal Audit Marketing Risk Manager CIO Source: IBM Institute for Business Value CRO Line Executive Adventuresome Visionaries Image Makers Operational Leaders Daily Operators

Copyright 2007, Integro USA Inc. 19 Considering the Downside Source: IBM Institute for Business Value Risk Manager Source: IBM Institute for Business Value  Risk managers are among the most risk- averse professionals in the organization, because the focus is on the downside of risk  Brokers  Consultants  Insurers  Career concerns

Copyright 2007, Integro USA Inc. 20 Expected Losses and Volatility

Copyright 2007, Integro USA Inc. 21 Expected Losses and Volatility

Copyright 2007, Integro USA Inc. 22 Expected Losses and Volatility

Copyright 2007, Integro USA Inc. 23 Thinking about the likelihood of rare events Back of the envelope ways to calculate the likelihood of events: Example 1:  Imagine a rare event, such as a permanent disability, which happens only once every 5 years  The odds of this happening 3 times in a year is 0.8% Type this into Excel =(1/5)^3 Example 2:  Imagine a more common event that happens about four times per year on average, such as a car accident  The odds of this happening 10 or more times in a year is 2.9% Type this into Excel =POISSON(4,10,TRUE)

Copyright 2007, Integro USA Inc. 24 Thinking about the likelihood of rare events Using Insurance Pricing Tables Example 3:  Imagine you have a good handle on the typical number of large WC accidents that occur per year – In a typical year you have 2 large WC claims resulting in $100k or greater in damages You can use an insurer table to determine the likelihood of a very bad claim, resulting in $250k in payments Type this into Excel =2/276*50 You should expect.36 claims to exceed $250K (about 1 every three years)

Copyright 2007, Integro USA Inc. 25 Principles of setting deductibles  Set deductibles in line with your organization’s risk tolerance.  Set deductibles at high levels, but not so high that a claim would impact your future earnings beyond the cost of the claim itself  Prevent “microphone” risk  Consider the total cost of risk transfer: – Premium – Retained claims – Cost of providing collateral

Copyright 2007, Integro USA Inc. 26 Summary Both benchmarking and analytics are helpful ways to determine appropriate deductibles. To ensure that your choice of deductible is defensible, you should systematically consider:  The price of alternative deductibles  The odds that you’ll have a large claim  What similar sized (and shaped) companies are doing