Transcript CAS Seminar on Risk and Capital Management DFA-7: DFA and Reinsurance Using DFA to Align Reinsurance with Corporate Strategy Raju Bohra FCAS Vice-President, American Re-Insurance.

CAS Seminar on Risk and Capital Management
DFA-7: DFA and Reinsurance
Using DFA to Align Reinsurance with
Corporate Strategy
Raju Bohra FCAS
Vice-President, American Re-Insurance
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Discussion Outline

Aligning reinsurance with corporate
strategy

Typical DFA process

Case study
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Introduction
Comments and Caveats

Reinsurance analysis has been the “Killer
Application” for DFA
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Focus on DFA application, not much on model
building and parameterization

Will not deal with asset and economic
modeling side of DFA modeling but it can be
incorporated
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DFA, Reinsurance, and
Corporate Planning
DFA, Reinsurance, and Planning
Current Practices
Strategic Planning
 Financial objectives
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•
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•
Threats
•
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•

Surplus growth
Earnings stability
Reinsurance Purchasing
 Old habits
 Rules of thumb
Extreme events
Volatility
Rating agencies
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Financial pro forma’s
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Detailed (BS, IS, CF)
Summary reinsurance
“Net-to-Direct” ratios
Rating agency driven
Budget or cost driven
•

XOL ret. < 1% of surplus
Cat ret. < 5% of surplus
Only consider ceded
premium as “cost”
Uncertain how changes
will impact financials
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DFA, Reinsurance, and Planning
Better Process
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Companies have a corporate strategy defined
by their financial plans
DFA provides a link between these plans and
their reinsurance purchases
•
Risk Management
– Volatility of plan numbers
– Impact of reinsurance on plan volatility
•
Financial Management
– “Direct-to-Net” financial impact of reinsurance
– More than Loss Ratios
– Expenses
– Investment income
– Regulatory and Rating Agency ratios
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DFA, Reinsurance, and Planning
Benefits of Process

Enhance reinsurance program design
•
Deeper understanding of liabilities
– Quantify gross risk profile
– Impact of reinsurance
– Sensitivities to changes
•
Capability to evaluate reinsurance alternatives
– Distill impact of programs into key statistics and charts

Tie reinsurance purchase to company’s
strategic objectives
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Traditional risk management
Capital management
Financial objectives
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DFA, Reinsurance, and Planning
Benefits of Process

Holistic approach to reinsurance
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
Measure “value” of reinsurance transaction
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Go beyond seeing “cost = ceded premium”
See impact or risk reduction in financial plan
Provides objective basis for decision-making
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•

Framework to analyze entire program
Analyze contracts and coverage terms as a whole
Common “apples-to-apples” comparison
Quantifies risk-reward trade-off
Customized to company’s needs
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DFA Process for
Reinsurance
Typical DFA Process
General Overview


Use DFA simulation to model impact of
alternatives reinsurance programs
Limit scope given objectives and timelines
•
Only model relevant detail
– Simplified asset portfolio
– Subject business groupings
•
Keep other sources of variation static
– Economic variables
– Reserve development

Model detail needed to support decision making
Ranking of alternatives based on objectives
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Typical DFA Process
Outline of Process

Preliminary work
•
Identify company’s needs and objectives
– Return – usually stated in accounting terms
– Risk – volatility of return, usually downside
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Modeling work
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Analyze model output
Presentation
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Select and define alternatives to compare
Interpret and discuss output
Create statistics and charts to evaluate
options with respect to objectives
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Typical DFA Process
Preliminary Work

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Must work closely with company
Understand company’s objectives
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Return – What is their measure of success?
Answers could be: long term SAP surplus
growth, smooth or increase GAAP earnings,
increase economic value, grow premiums, etc.
Usually stated in accounting terms.
Risk – Why do they buy reinsurance?
Answers could be: catastrophe potential,
frequency of smaller events, volatility of
results, leverage issues, support growth, etc.
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Typical DFA Process
Preliminary Work – Definition of “Risk”

Formal statistics
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•
•
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•
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Probability of ruin
Expected policyholder
deficit
Tail VAR
Variance, standard
deviation
Number of others
Difficult for
management to
interpret
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Business related
measures
•
Probability of unfavorable
operating result
–
–
–
–

U/W Loss > $X
Surplus decline > X%
Rating downgrade
Regulatory IRIS test
failure
Shows reinsurance
program’s impact on
management objectives
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Typical DFA Process
Modeling Work

Identify reinsurance alternatives
•

Reinsurance premiums
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Financials, reinsurance submission, Loss
reserve study, catastrophe study, etc.
Create a consistent U/W model
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Reinsurer or broker quote
Technical pricing
Gather data
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Terms, inuring, rates and commissions
Direct results by line
Net results by line
Ceded results by cover
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Typical DFA Process
Modeling Work Diagram
Model Insurance
and Asset
Portfolio
Loss distributions
Premiums
Balance Sheet
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Define Reins
Structure
Simulate
Results
Gross,
Ceded, and
Net Results,
in Financial
Accounting
Framework
Limits
Retentions
Ceded Rates
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Typical DFA Process
Modeling Considerations
Loss Modeling






Flexible LOB’s
Claim level
Policy limits
Correlation
Events
Occurrences
Reinsurance
Modeling
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Complex
terms
Inuring
structures
Loss sensitive
features
Commissions
Profit share
Accounting

Detailed pro
forma’s
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•
•


Balance sheet
Income stmt
Cash flow
Tax impacts
Regulatory and
Rating ratios
•
•
BCAR
IRIS
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Typical DFA Process
Analysis Work

Meet with company to discuss and
interpret model results
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What were the drivers of the model results?
How did the various structures/covers respond
under the simulated conditions?
What results are not intuitive? Why?
Were the company’s objectives addressed?
Which structures make the most sense?
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Hypothetical
Case Study
InsureMetricsTM – Description
Graphical User Interface
Flexible detail level supports different needs – simple or complex
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Reinsurance Alternatives
XOL
Retention
CAT
Retention
Acc Year
Stop Loss
Current
Structure
Higher
Retention
Stop
Loss
$250k
$1.0m
$1.0m
$5.0m
None
$10.0m $10.0m
10% xs
None 72.5%
AASKL
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11/6/2015
345,000
315,000
285,000
255,000
225,000
195,000
165,000
135,000
105,000
75,000
45,000
15,000
-15,000
-45,000
-75,000
-105,000
-135,000
-165,000
-195,000
-225,000
-255,000
Probability
Comparison of Reinsurance Alternatives
Net Income - Incremental Probability
30%
25%
20%
15%
10%
5%
0%
CURRENT PROGRAM
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345,000
315,000
285,000
255,000
225,000
195,000
165,000
135,000
105,000
75,000
45,000
15,000
-15,000
-45,000
-75,000
-105,000
-135,000
-165,000
-195,000
-225,000
-255,000
Probability
Comparison of Reinsurance Alternatives
Net Income - Incremental Probability
30%
25%
20%
15%
10%
5%
0%
HIGHER RETENTION
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11/6/2015
345,000
315,000
285,000
255,000
225,000
195,000
165,000
135,000
105,000
75,000
45,000
15,000
-15,000
-45,000
-75,000
-105,000
-135,000
-165,000
-195,000
-225,000
-255,000
Probability
Comparison of Reinsurance Alternatives
Net Income - Incremental Probability
30%
25%
20%
15%
10%
5%
0%
AGG STOP LOSS
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CURRENT PROGRAM
HIGHER RETENTION
345,000
315,000
285,000
255,000
225,000
195,000
165,000
135,000
105,000
75,000
45,000
15,000
-15,000
-45,000
-75,000
-105,000
-135,000
-165,000
-195,000
-225,000
-255,000
Probability
Comparison of Reinsurance Alternatives
Net Income - Incremental Probability
30%
25%
20%
15%
10%
5%
0%
AGG STOP LOSS
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Red Green Chart - Higher Retention vs Current
$50,000
$40,000
NET INCOME Differential
$30,000
$20,000
$10,000
$0
-$10,000
-$20,000
-$30,000
-$40,000
-$50,000
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
GROSS INCURRED LOSS
HIGHER RETENTION Better 875 times than CURRENT PROGRAM
HIGHER RETENTION Worse 125 times than CURRENT PROGRAM
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Red Green Chart - AYSL vs Higher Retention
$200,000
NET INCOME Differential
$150,000
$100,000
$50,000
$0
-$50,000
-$100,000
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
GROSS INCURRED LOSS
AGG STOP LOSS Better 134 times than HIGHER RETENTION
AGG STOP LOSS Worse 866 times than HIGHER RETENTION
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Reinsurance Alternatives - Risk Reward Chart
120000
110000
Mean - Net Income
HIGHER
RETENTION
100000
CURRENT
PROGRAM
90000
80000
AGG STOP LOSS
70000
60000
20000
30000
40000
50000
60000
70000
80000
90000
100000
110000
120000
Standard Deviation - Net Income
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