Reinsurance Structures and Pricing Pro-Rata Treaties CARe Pricing Boot Camp August 10, 2009 Daniel Kamen, FCAS, MAAA Vice President Allied World Reinsurance Company

Types of Reinsurance Quota Share (Q/S) Quota Share (Q/S) Excess of Loss (XOL) Excess of Loss (XOL) Combo: Q/S & XOL Combo: Q/S & XOL Other Other

Q/S ‘Straight’ Q/S ‘Straight’ Q/S Variable Q/S Variable Q/S

‘Straight’ Q/S Example  70% Ceded 28% Ceding Commission Cedant’s Total Underlying Expenses are 25% Written Premium Expected Loss Ratio Expected Losses Expense Ratio Expenses Expected Combined Ratio Gross100,000,00060%60,000,00025%25,000,00085% Ceded [to Reinsurer] 70,000,00060%42,000,00028%19,600,00088% Net [to Cedant] 30,000,00060%18,000,00018%5,400,00078% # The Combined Ratio displayed for the Reinsurer is prior to brokerage and internal expenses.

Types of XOL Per Claim Per Claim Per Occurrence Per Occurrence Per Policy Per Policy Per Risk Per Risk Combination Combination

XOL – Premium Determination Rate Rate Cessions Rated Cessions Rated ILFs ILFs Cession Factors Cession Factors Pricing of Each Policy Pricing of Each Policy

Combo Structure Vertical Vertical Horizontal Horizontal

Combo Structure: Vertical Underlying Q/S Underlying Q/S XOL Layers on Top XOL Layers on Top Example: 1M Q/S 1M Q/S 4M xs 1M 4M xs 1M 5M xs 5M 5M xs 5M

Combo Structure: Horizontal Allocate/Prorate a Policy/Limit Allocate/Prorate a Policy/Limit Each Piece would be subject to different treaties Each Piece would be subject to different treaties Example: Allocate a 10M policy limit on a 60/40 basis Allocate a 10M policy limit on a 60/40 basis 60% Allocation  6M Q/S 60% Allocation  6M Q/S 40% Allocation  3M xs 1M XOL *** 40% Allocation  3M xs 1M XOL *** *** This part is equivalent to 40% of a 7.5M xs 2.5M on a ground-up basis.

Other Types of Reinsurance Example  Aggregate Stop Loss

Motivations for Purchasing Reinsurance 1) Limiting Liability [on specific risks] 2) Stabilization / Smoothing of Results 3) Catastrophe Protection 4) Increase Capacity / Surplus Relief 5) Arbitrage of Results / Profit Enterprise Items 1) – 4) are attributed to RAA|Reference (RAA Fundamentals of Property Casualty Reinsurance). Items 1) – 4) are attributed to RAA|Reference (RAA Fundamentals of Property Casualty Reinsurance). Item 5) is attributed to the speaker. Item 5) is attributed to the speaker.

Key Calculation On-Leveled,Trended, & Developed LOSS RATIO ** For The Prospective Treaty Structure**

On-Leveling Premium Essentially Same as in Primary Pricing Analysis Essentially Same as in Primary Pricing Analysis Rate Changes (NOT PREMIUM CHANGES) Rate Changes (NOT PREMIUM CHANGES) Exposure Trend Exposure Trend

Components of Rate Changes (1) Base Rate Changes Base Rate Changes LCM Changes LCM Changes ILF Changes ILF Changes Schedule Mod Changes Schedule Mod Changes

Components of Rate Changes (2) Renewal Rate Monitor Renewal Rate Monitor Monitoring of New Business Monitoring of New Business Deviation from ‘Manual’ Deviation from ‘Manual’ Comparison to Rates Charged on Renewals Comparison to Rates Charged on Renewals

Losses Essentially Same as in Primary Pricing Analysis Essentially Same as in Primary Pricing Analysis Develop Losses to Ultimate Develop Losses to Ultimate Trend Losses from Average Accident in Experience Period to Average Accident Date in Treaty Period Trend Losses from Average Accident in Experience Period to Average Accident Date in Treaty Period

Premium and Losses – Types of Data Experience Period Experience Period Policy Year Policy Year Accident Year Accident Year Treaty Period Treaty Period Risks Attaching Risks Attaching Losses Occurring Losses Occurring Experience Period and Treaty Period  12 Month Block Experience Period and Treaty Period  12 Month Block 1/1 – 12/31 1/1 – 12/31 Other (e.g., 4/1 – 3/31, 9/1 – 8/31, etc.) Other (e.g., 4/1 – 3/31, 9/1 – 8/31, etc.)

Mix of Business Changes Subdivide Historical Experience into Relevant Homogeneous Segments (e.g., by state, class, business unit, etc.) Subdivide Historical Experience into Relevant Homogeneous Segments (e.g., by state, class, business unit, etc.) Project Loss Ratios for each Segment Project Loss Ratios for each Segment Weight Projections on Prospective Treaty Year Premium Weight Projections on Prospective Treaty Year Premium

Responsiveness vs. Stability Not an Exact Science Not an Exact Science Need to Consider the Following: Need to Consider the Following: Premium Volume by Year Premium Volume by Year Magnitude of the LDFs Magnitude of the LDFs Limits and Attachment Points of the Business Limits and Attachment Points of the Business Any Changes in the Book Any Changes in the Book (with respect to the items above, other types of mix changes, and changes in management) Quality of the Information Quality of the Information

Catastrophes and Large Losses Two Potential Situations Two Potential Situations No Catastrophes or Abnormally Large Losses [Relative to the Limit] Have Occurred in the Experience Period No Catastrophes or Abnormally Large Losses [Relative to the Limit] Have Occurred in the Experience Period Catastrophes or Large Losses Occurred During the Experience Period Catastrophes or Large Losses Occurred During the Experience Period

Large Loss Load Procedure Limit Large Losses or Remove Cats from the Experience (if they are present) Limit Large Losses or Remove Cats from the Experience (if they are present) Model the Load Model the Load For Property Cat business, use one of the Cat Models (e.g., RMS). For Property Cat business, use one of the Cat Models (e.g., RMS). For Other Lines, Model it via an Exposure Rating Model For Other Lines, Model it via an Exposure Rating Model Compare Experience Load to Modeled Load and Make a Selection Compare Experience Load to Modeled Load and Make a Selection

Start-ups and Limited Data Potential Items to Assess: 1) Analyze Experience from Management’s Former Company 2) Assess Rating Plan and Rating Factors as well as their Business Plan 3) Compare Rates to Similar Companies 4) Assess Pricing via an Audit *** For items 1) and 3), any comparison to another company should make an attempt to convert the benchmark company to an apples-to-apples basis (with respect to rate level, class mix, etc.).

Start-ups: Other Considerations Current State of the Underwriting Cycle Current State of the Underwriting Cycle Business Plan vs. Realistic Likelihood of Success Business Plan vs. Realistic Likelihood of Success Amount of Risk Being Retained by Cedant Amount of Risk Being Retained by Cedant Number and Size of Competitors Number and Size of Competitors Ability/Plan to Obtain Business from Competitors Other Than Based on Price Ability/Plan to Obtain Business from Competitors Other Than Based on Price

Final Thoughts Prior to Pricing Analysis, Make Sure Deal Makes Sense From an Underwriting Perspective Prior to Pricing Analysis, Make Sure Deal Makes Sense From an Underwriting Perspective Make Sure You Understand the Structure Make Sure You Understand the Structure Make Sure All of the Data is Clear and Complete; If Not, Make the Necessary Requests Make Sure All of the Data is Clear and Complete; If Not, Make the Necessary Requests Compare Your Projections to Other Similar Treaties; If the Results Differ Significantly, Make Sure You Understand Why Compare Your Projections to Other Similar Treaties; If the Results Differ Significantly, Make Sure You Understand Why