Transcript Pitfalls in Common Pricing/Reserving Methodologies David Skurnick Leonard Chung Clive L. Keatinge CARe June 15, 2000

Pitfalls in Common
Pricing/Reserving Methodologies
David Skurnick
Leonard Chung
Clive L. Keatinge
CARe June 15, 2000
Pitfalls in
Common Pricing/Reserving
Methodologies
David Skurnick, St.Paul Re
CARe
June 15, 2000
Pitfalls in...
• Underwriting
• Excess
• Miscellaneous
Pitfalls in Underwriting
• Accuracy and completeness of data
• Understanding of terms
• Local practices
Data Accuracy and Completeness
• How can you verify accuracy?
– Audits
– Consistency
– Agreement with the market
• What’s missing?
– Older cat losses
– rate changes
– experience on discontinued business
Experience on discontinued
business -- my rule of thumb:
• If they have discontinued an entire segment
that ran badly, say a territory or line of
business, then I exclude the experience.
• If they have gotten off some unsuccessful
business, then I include the experience -this is normal underwriting.
Understanding of Terms
• Interlocking clause
• “FCA” (For common account)
• Lloyd’s ‘miscellaneous classes”
Interlocking clause
• E.g., a Worldwide ex. US catastrophe cover
excess of $100m, with interlocking clause.
• If a hurricane hit the Caribbean and the US,
cedant’s combined retention would be $100.
• Must read the contract to see how the
retention is allocated.
• Cannot underwrite this deal without looking
at US exposures.
“FCA” (For Common Account)
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E.g., a cedant has an 80% quota share.
You write 5% of an excess treaty
Is is “5% of net” or “5% of all”?
If you’re covering the Common Account
then you’re limits may be 5 times higher.
• Mandatory or optional?
What are you covering?
• “Miscellaneous Classes” could include
anything, especially at Lloyd’s.
• E.g., Computer Leasing in early 80’s
• E.g., Typical wording is “All policies
written in the Fire Department”, not “All
Fire Policies.”
• You MUST verify what is actually covered.
Local Practices
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Egyptian “catastrophe”
Egyptian personal accident
European commutation
European motor excess
Egypt Re “Catastrophe”
• The Heliopolis Sheraton Hotel burned
down. Was this a cat loss?
• Yes! -- because there were two policies, one
for the floors and one for the elevator shaft!
Egyptian Personal Accident
Question: Treaty limits are :
EGP 50,000 XS 50,000 / $ 20,000 XS 20,000
with 3 reinstatements.
How large is the reinsurer’s maximum loss?
(Assume 1 EGP = $0.40)
Egyptian Personal Accident
(slide 2)
Answer:
EGP 200,000 PLUS $80,000
(The slash meant “and”, not “or”)
European Commutation
• Commutations in Europe are generally
revocable
• The commutation will not apply to
exceptionally large claims or to material
change in claims cost.
European Motor Excess
• Most international motor covers are indexed
for inflation.
Pitfalls in Excess Pricing
• Excess of Aggregate
• Inflation
• Aggregate Deductible
Excess of Aggregate (Stop Loss)
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Buyer knows more than seller
Long-term or short-term relationship?
LR affected by frequency, severity & cats
LR affected by Rate Adequacy
A total loss to the reinsurance layer could be
likely.
Compare the Risk of Specific
Excess Vs Excess of Aggregate
• Look at the impact of an error in estimating
the Expected Loss Ratio
• E.g., suppose that the Expected Frequency
is twice what you thought it was, and all
other estimates are correct.
Specific Excess Example
• Suppose you are receiving 10% of original
premium for a risk layer of $1m Xs $1m
and your expected loss was 7%.
• Due to under-estimate of frequency, the
ELR is 140% rather than 70%
• Note that this 2 to 1 ratio is independent of
the original rate, frequency, severity, etc.
Excess of Aggregate Example
• You receive 6% of original premium to
cover a loss ratio of 30% XS 80%.
• Your primary ELR = 70%.
• Your expected XS loss = 2%.
• Then, your XS ELR = 33%.
• Suppose exp. freq. Is twice what your think
• Then expected FGU LR = 140%
• Expected XS loss might be, say, 24%.
• Correct XS ELR = 400%, not 33%
Excess of Aggregate Example
(slide 2)
• Suppose expected frequency is twice what
your thought it was
• Then expected FGU LR = 140%
• Expected XS loss to the layer 30% XS 80%
might be, say, 24%, not 2%.
• Correct XS ELR = 400%, not 33%
Per Risk Casualty Excess Treaty
with High Inflation
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E.g., Avner -- old Israeli XS motor liability
When Israeli Shekel had 100% inflation
XS claims became routine, not exceptional
The increase in premium (due to a higher
exposure base) did not at all compensate for
the enormous increase in claim frequency in
this layer.
Aggregate Deductible on
Per Risk Property
• E.g., layer of $1m XS $1m XS $4m.
• Reinsurer would would pay only after 4
total losses of $2 million or more (or
equivalent in partial losses to the layer.)
• Assume the treaty limit is $25 million.
• This would protect against a frequency of
losses in a low layer.
Aggregate Deductible on
Per Risk Property (slide 2)
• Key is the average frequency of losses >
$2m (ignoring partial losses to the layer)
• If you think the expected frequency of such
losses = 5, then this treaty would be loss
free more often than not.
• One might guess the expected loss to the
layer as about $1 million (using a Poisson)
Aggregate Deductible on
Per Risk Property (slide 3)
• What if the correct average frequency = 10
• Then expected loss >$5 million
• Doubling the frequency caused the risk
excess expected loss to grow 5X
• Note that frequency might be double
because of unexpected growth in the
underlying premium.
Miscellaneous Pitfalls
• Exchange Rate errors
• Individual company loss development
• Ending a Managing General Agent
relationship
Exchange Rate Errors
Several years ago, one of our underwriters
slipped a decimal point in the exchange rate
and wrote ten times as big a line as he
intended. (Naturally, the deal turned out to
be a big loss!)
Individual company loss
development
• For several years we wrote a quota share of
industrial property business.
• We learned to our sorrow that this property
business took several years to develop.
• Slow development was partly due to the
complex nature of the claims.
• Also, company claims procedures slowed
the reporting and reserving of losses.
Ending an MGA Relationship
• A cedant of ours had a group of Managing
General Agents
• They decided to get out of MGA business
• Several years later they decided to handle
the remaining open claims themselves.
• They discovered that their loss reserve of
$200 m should have been $600 million!
• It turned out that the cancelled MGA’s had
stopped working on the claims.
Next Speaker
Leonard Chung