INTRODUCTION TO REINSURANCE NOLAN ASCH CAS RATEMAKING SEMINAR MARCH 10-11, 2005 INT-6

INSURANCE The insurer insures the individual or the corporation

REINSURANCE The REINSURER insures the insurance company

REINSURANCE PLACEMENT MECHANISMS n DIRECT n BROKER

INSURANCE vs. REINSURANCE n BOTH concerned with future contingencies n BOTH require underwriting skills (risk) n BOTH involve transfer of risk n BOTH require payment of premium n BOTH provide protection n BOTH subject to (some) regulation

REINSURANCE REINSURANCE n Buyers assumed to be knowledgeable n Responds to actual loss n Provides indemnification only n Reimburses for payments already made n Usually Global

FUNCTIONS OF REINSURANCE n CAPACITY

CAPACITY n Single Risk (Fac - Sears Tower) n PORTFOLIO (Treaty)

CAPACITY MECHANISMS n Excess-of-Loss n Quota Share

FUNCTIONS OF REINSURANCE n CAPACITY n CATASTROPHE

CATASTROPHE n QUOTA SHARE n EXCESS OF LOSS n SECURITIZATION

FUNCTIONS OF REINSURANCE n CAPACITY n CATASTROPHE n STABILIZATION

STABILIZATION Reduction in Variance (swings)

STABILIZATION Extreme contractual case “STOP-LOSS” Aggregate Excess

FUNCTIONS OF REINSURANCE n CAPACITY n CATASTROPHE n STABILIZATION n FINANCING

FINANCING Reducing Liabilities Ceding Commissions “Overrides”

FINANCING May increase PHS due to transaction

FINANCING Finite Reinsurance Pre-Elliott Spitzer ALL Reinsurance is Financial ALL Reinsurance is Financial Post Elliott Spitzer I don’t think so….

FUNCTIONS OF REINSURANCE n CAPACITY n CATASTROPHE n STABILIZATION n FINANCING n ENTER AND EXIT MARKETS

ENTER OR EXIT MARKETS Lessens risk as you learn With 100% Q/S you exit

FUNCTIONS OF REINSURANCE n CAPACITY n CATASTROPHE n STABILIZATION n FINANCING n ENTER AND EXIT MARKETS n UTILIZE REINSURER EXPERTISE

USING REINSURER EXPERTISE n Large or unusual claims n Large or unusual risks n Special relationships and/or knowledge

LIMITATIONS OF REINSURANCE n Will NOT make bad business profitable n Transaction Costs n Rating Agency Impacts (Gross/Net)

How Reinsurance Is Priced in Practice HypotheticalExamples

NO PRICE REGULATION n (virtually)

CASE BY CASE

NEGOTIATION

FLEXIBILITY IN STRUCTURE Contractual

EXCESS OF LOSS

LAYERING

$19.75 Mill xs $0.25 Mill (sounds like a wide layer)

TYPICAL LAYERING 10M xs 10M 5M xs 5M 3M xs 2M 1M xs 1M 500 xs xs 250 Price B Price A Price C Price D Price E Price F

High Frequency/ Low Severity Buffer layers ie 250 xs xs 250 Price A

Capacity Layers i.e. 10m xs 10m 10M xs 10M Price F Low Frequency/ High Severity

CLIENT/BROKER NEGOTIATION Change or re-subdivide the layering

LAYER TRAP MANY PERMUTATIONS n Pricing for 500 xs 500 n Later, request the 250xs 250

LAYER TRAP n at “last minute” Ask for 150 xs Requires more data

PRICING TRAPS n AGGREGATE ANNUAL DEDUCTIBLES

ASSUME A 10% RATE n Request a 1% AAD n Request a 2% AAD n Request an 8% AAD n NOW the risk/variance n becomes LARGE vs a 2% rate

INFORMATION FOR PRICING NO standards

WHAT THE REINSURER WANTS EVERYTHING

WHAT THE BROKER/CLIENT MAY WISH TO SUPPLY NOTHING

POSSIBLE OUTCOMES

GIGO Garbage-InGarbage-out

EL NIÑO

NINO Nothing-inNothing-out

EXPERIENCE RATING Using losses of the risk to price the risk.

STANDARD All losses at half the attachment point & up

ACTUARIAL APPROACH DETRENDED LOSSES Varies with age of claim BEGINS to show ACTUAL CLAIMS as a sample outcome

EXPOSURE RATING Attempt to rate Reinsurance based upon the TRUE underlying exposures Proxies for TRUE exposures: Limits Profiles = Subject Premium by policy limit Exposures by policy limit (still not the TRUE exposure)

LIMITS PROFILE $100,000 Policy Limit n Yr % of exposures at $100,000 n Yr % of exposures at $100,000 n Yr % of exposures at $100,000 n loss was atypical in 1997 n layer is effective 7/1/04 Include ‘97 and ‘98 losses at $100,000

LIMIT LOSS limit loss to 1997 policy limits or trend and develop loss beyond policy limits

“WE DON’T DO THIS ANYMORE” “Throw out “ claims from MGA’s, classes or states we no longer write

QUOTA SHARE ISSUES n Moral hazard and Retention - 1% net n Ceding Commission n Overrides n Sliding Scales n Loss Corridors