1 The Value Proposition of DFA Presented by: Susan Witcraft Manuel Almagro June 7, 2001

2 Susan Witcraft FCAS, MAAA Current employment: Vice President and Chief Actuary, RTW, Inc. Prior employment: Consulting Actuary, Milliman & Robertson, Inc.

3 Manuel Almagro FCAS, MAAA Current Employment: Senior Vice President and Chief Actuary, Guilford Specialty Group Prior Employment: Consulting Actuary, Tillinghast-Towers Perrin Vice President, Swiss Re Investors

4 The Transition from Consulting to a Small Insurer: Pros and Cons Presented by: Susan Witcraft Manual Almagro June 7, 2001

5 For What is DFA Valuable? Asset allocation Reinsurance programs Capital adequacy Capital allocation Line of business mix Understanding income statement and balance sheet risks

6 For What is DFA Valuable? Enhancing corporate communication Expanding actuaries’ horizons –Overall company management –Investments –Improved analysis tools Enterprise risk management

7 Enhancing Corporate Communication Successful DFA implementation requires participation of all corporate departments. Topics of discussion are wide-ranging. Participants have varying levels of knowledge of these topics.

8 Expanding Actuaries’ Horizons: Overall Company Management Actuary –Oversees or implements model. –Understands issues important to all constituents. –Interprets results. –Participates in decision-making process.

9 Expanding Actuaries’ Horizons: Finance and Investments Enterprise risk management models include all corporate financial activities. Actuaries –Traditionally most familiar with underwriting issues. –Must become at least conversant with economic modeling, investment issues and finance to implement model and interpret results.

10 Expanding Actuaries’ Horizons: Analysis Tools DFA has required actuaries to refine and expand analysis techniques. Examples include modeling of: –Small, large and cat claims. –Development of booked reserves. –Payment pattern variability. –Links between losses and economic conditions. –Pricing process.

11 Improved Analysis Tools: Case Study Analysis tools can be used for other applications. Examples: –Reserve development and payment pattern variability for evaluating adverse development covers. –Separation of losses into small, large and cat for evaluating excess of loss or cat covers or for evaluating adequacy of rates for lines with facultative covers.

12 Case Study: Loss Portfolio Transfer Questions faced by company: –What is the economic cost of each loss portfolio transfer/adverse development cover proposal? –Does each proposal meet the auditors requirements for transfer of risk?

13 Background $200 million of loss and LAE reserves as of 12/31/99. Considering capital contribution or merger. Significant uncertainty surrounding reserve estimates. Want balance sheet protection.

14 Three Proposals 1. $75 million excess $175 million for $30 million. 2. $50 million excess $200 million for $15 million. 3. $250 million excess $0 for $190 million. All 3 include experience account with 7% interest credit guaranteed by ceding company and a reinsurers’ margin of $10 million {$15 million for (3)}.

15 Analysis Approach Simulate possible future payments by calendar year. Reflect differences in emergence patterns under varying historical reinsurance programs. Apply reinsurance terms to each scenario. Auditor defines risk transfer test. Calculate economic cost and risk transfer test.

16 Overall Approach Calendar Year Payments By Accident Year Calendar Year Payments By Accident Year Ending Reserve By Accident Year Ending Reserve By Accident Year Beginning Reserve By Accident Year

17 Payments x Inflation Claim Expected Inflation Claim Actual PaymentsActual  xReserveBeginning Component)RandomRatio(Payment 

18 Ending Reserve ComponentRandom ReserveinChange          ReserveEnding  Reserve Beginningx x                 InflationCost Claim Future Expected Prior Inflation Cost Claim Future Expected Current

19 Total Payments

20 Present Value of Payments

21 Evaluation of Proposals Proposal First Year Cost* Economic Cost Probability of Meeting Threshold $75 x $175$0$1.5 million34% $50 x $200$0 million$3 million30% $250 x $0$-10 million$4 million39% * Assumes no development.

22 Enterprise Risk Management: Case Study Analysis of investment strategy

23 The Value Proposition of DFA Presented by: Susan Witcraft Manuel Almagro June 7, 2001