2006 Seminar on Reinsurance Parameter Risk – Where Does it Come From and Why Rich Lino Consulting Actuary, Pinnacle Actuarial Resources

Sources of Parameter Risk Catastrophe exposure Pricing Loss development Changes in business mix Other changes in parameter risk Actions to mitigate parameter risk

Catastrophe Risk Accuracy of exposure data Weather cycles: 2006 predictions are for 150% to 200% of last century average (ISO- Dr. Gray) Model revisions Impact of growth in exposed areas Earthquake below long-term average?

Pricing Average price level change Impact of changes in terms/conditions/limits Miscoding of class, tier, E&S Vs. Standard Lines Price monitor for new business Changes in mix of business Winner’s Curse

Loss Development Cycle- Reserve weakening, payment slowdown will bias ultimates on the low side in soft markets and vice versa Variations by Company – Base, Cycle Variations by Layer Changes in terms/conditions/limits can affect development

Industry Aggregate-Med Mal Total Ultimate Using "LDFs As Of Y/E" Vs Estimate of Ultimate Data As OfIncurred LDFs Year-EndAY xAY x-1AY x %96%98% %88%92% %86%88% %83%88% %91%89% %98%99% Mean85%90%92%

Changes in Business Mix Prices declining, more exposure per premium dollar More adverse winner’s curse causes lower retention Lower retention means more new business per premium dollar Severe winner’s curse on new business Failure to adjust creates parameter risk

Drivers of Parameter Risk - WC Base Base Price Vs. Exposure0%-4%6% Tiers/Schedule Rating0%-10%9% R/N Retention80%86%82% R/N Quality97%98%92% New Business %20%35%15% New Quality Vs. Renewal115%130%118%

Parameter Risk From Reinsurer’s Perspective

Other Potential For Parameter Risk Offering limits not previously available Value of information not provided (cyclical) Buy downs of limit – asymmetric information Self-insurers moving in and out of the market Impact of acquisitions on pricing assumptions Cycle of ISO/NCCI pricing adequacy MGA cycle Optimism/pessimism cycle

Other Potential For Parameter Risk, cont’d Multi-year policies – direct and assumed Loosening terms and conditions Loosening underwriting standards Adverse selection as top tier companies refine rating structures Impact of changing mix of TPAs Beware high growth and “fighting claims”

Actions to mitigate parameter risk Measure all aspects of price change Monitor industry and client reserve adequacy Monitor total change in industry price & L/R Focus audits on new business Model impact of winner’s curse in soft market Pursue identification of turning points Set data quality standards and keep them Refine pricing by account

Source: Pinnacle calculations from AM Best data base