Risk Transfer In The Real World Presentedby Jane C. Taylor, FCAS, MAAA Junction Consulting, Inc. Casualty Loss Reserve Seminar Boston, MA September 12, 2005

Risk Transfer: History Lesson 1980’s & 1990’s Disguised Loans Disguised Loans –“Borrow” $50MM Surplus Assistance –“Pay” $35MM for Assistance –Special Terms Repayments Scheduled, i.e. $5MM per year Repayments Scheduled, i.e. $5MM per year Funds Withheld – No Assets Transferred Funds Withheld – No Assets Transferred Guaranteed Interest Rate Credited Guaranteed Interest Rate Credited Year End Portfolio Trades Year End Portfolio Trades –Benefited both company’s bottom line –No risk to either company

Risk Transfer Regulation Began Late 1980’s and Early 1990’s Began Late 1980’s and Early 1990’s –Securities & Exchange Commission –Financial Accounting Standards Board FAS 113 FAS 113 –National Association of Insurance Commissioners Disclosures in Annual Statements Disclosures in Annual Statements Chapter 22 (Now SSAP 62) Chapter 22 (Now SSAP 62)

Risk Transfer: History Lesson 1990’s & 2000’s Finite Reinsurance Finite Reinsurance –Little or no risk to reinsurer –Unusual terms –Year end transactions –Smoothed or overstated balance sheet / income statement –Interlocking companies / directorates / ownership / influence

Risk Transfer Regulation Began Early 2000’s Began Early 2000’s –New York Attorney General Spitzer Criminal Charges Criminal Charges Law suits Law suits –National Association of Insurance Commissioners Changes to Annual Statement Changes to Annual Statement Proposed Changes to SSAP 62 Proposed Changes to SSAP 62

What Really Happens? Pre Contract Effective Date Pre Contract Effective Date –Is there Risk Transfer? –Terms Fluid –Internal Data Limited / Data Credibility –Unusual Policy Form / Terms / Conditions Post Contract Effective Date Post Contract Effective Date –Terms Set –Same Data Credibility Issues –Same Policy Form / Term / Conditions Issues –Funds Transferred –Contract Signed within 9 months?

Now What? Get a copy of the Cover Slip or Contract Get a copy of the Cover Slip or Contract –Read it –Read it again –Ask Questions for Better Understanding –Diagram / Analyze / Write Out Terms

Now What? Is there insurance risk? Is there insurance risk? Reasonable possibility of significant loss Reasonable possibility of significant loss Effective Date of Contract Effective Date of Contract –Contract Signed within 9 months? Other contracts (“reinsurance” or otherwise) between same two parties / subs / affiliates? Other contracts (“reinsurance” or otherwise) between same two parties / subs / affiliates?

Quota Share Reinsurance Simple Quota Share Simple Quota Share Complex Quota Share Complex Quota Share –Caps –Corridor / Loss Sharing –Sliding Scale Commission –Profit Sharing

Excess Reinsurance Simple Excess Simple Excess Complex Excess such as Complex Excess such as –Sliding Scale –Stop Loss –Cat Cover Complex Terms Complex Terms –Capped –Loss Carry Forward –Corridors –Etcetera, Etcetera, Etcetera

Issues Major Issue – Sufficient Data Major Issue – Sufficient Data –Internal May not be credible May not be credible Mix may have changed Mix may have changed –Reference Company Match books of business Match books of business Specialized policy terms Specialized policy terms –Industry Special policy terms Special policy terms Access to information Access to information

Analysis Exception to FAS 113 Exception to FAS 113 Focus on maximum loss Focus on maximum loss –Payment pattern of retention –Payment pattern of loss to reinsurer Focus on gross premium Focus on gross premium –Gross of ceding commission –Receipt of premium pattern –Losses Determine reasonable rate of return Determine reasonable rate of return

Quota Share Same economic position? Same economic position? –Simple Quota Share Falls in exception Falls in exception –Quota Share with Caps / Corridors / Deductibles / Retentions Exception or Full Analysis? Exception or Full Analysis?

Sliding Ceding Commission Quota Share Quota Share of General Liability Quota Share of General Liability Sliding Scale Ceding Commission Sliding Scale Ceding Commission Cap: 140.0% Cap: 140.0%

Sliding Ceding Commission Quota Share Start with Rule Start with Rule 10% Probability of 10% loss 10% Probability of 10% loss Therefore, loss ratio must be Therefore, loss ratio must be 110.0% % % = 20.0% 110.0% % % = 20.0% Loss Ratio = 72.5% % = 92.5% Loss Ratio = 72.5% % = 92.5% Probability of Loss > 92.5% = 4.27% Probability of Loss > 92.5% = 4.27%

Excess “Pass Through” Same economic position? Same economic position? –Reinsurer assumes all premium for layer and all loss for layer –Excess Caps / Corridors / Deductibles / Retentions on Layer Exception or Full Analysis? Exception or Full Analysis?

All Other Excess Same economic position? Same economic position? –Sliding Scale –Excess Caps / Corridors / Deductibles / Retentions on Layer Exception or Full Analysis? Exception or Full Analysis?

Stop Loss Transaction: Terms Ceding Company protection for potential under reserving Ceding Company protection for potential under reserving –Aggregate Adverse Loss Development Ceded: $500 million Ceded: $500 million Cap: $600 million Cap: $600 million Max Loss to reinsurer: $100 million Max Loss to reinsurer: $100 million Reinsurers Margin: $10 million Reinsurers Margin: $10 million

Stop Loss Transaction: Terms Funds withheld: 98.0% Funds withheld: 98.0% Experience Account: 3.0% Interest Experience Account: 3.0% Interest Usual reporting requirements, definitions, etc. Usual reporting requirements, definitions, etc. Contains regulatory terms such as Insolvency Clause Contains regulatory terms such as Insolvency Clause

Stop Loss Transaction: Analysis Prospective or retrospective reserves? Prospective or retrospective reserves? Funds withheld: 98.0% ($10 million) Funds withheld: 98.0% ($10 million) Experience Account: 3.0% Interest Experience Account: 3.0% Interest –Assume no payments from Experience Account –Approximately 7 years to make up $100 million of total funds –What is payout pattern?

Stop Loss Transaction: Analysis Transaction effective fourth quarter Transaction effective fourth quarter In a draft memo dated December 12, 2000 and actually sent December 17, 2000 from ceding company to reinsurer: In a draft memo dated December 12, 2000 and actually sent December 17, 2000 from ceding company to reinsurer: Exhibit 1

Stop Loss Transaction: Analysis In an internal memo dated October 17, 2000, the ceding company makes the following comments: Exhibit 6, GR1_

Stop Loss Transaction: The Final Analysis March 30, 2005

Loss Ratio Stop Loss Transaction: Terms Attachment Point: 69.5% Loss Ratio Attachment Point: 69.5% Loss Ratio Subject Premium: $180 Million Subject Premium: $180 Million Initial Premium: $1 million Initial Premium: $1 million Added Premium: Added Premium: Max Added Premium: $14 million Max Added Premium: $14 million Reinsurance Aggregate Max: $15 Million Reinsurance Aggregate Max: $15 Million

Loss Ratio Stop Loss Transaction: Terms Funds Withheld Account Funds Withheld Account Interest: Interest: –2.05% per quarter, ~8.5% per year –Credited to inception date

Loss Ratio Stop Loss Transaction: Analysis Next Steps Next Steps –Determine maximum premium –Determine maximum subject loss –Determine probability of maximum loss –Answer question as to when maximum premium will be achieved

Risk Transfer In The Real World Presentedby Jane C. Taylor, FCAS, MAAA Junction Consulting, Inc. Casualty Loss Reserve Seminar Boston, MA September 12, 2005