Transcript Program Design and Pricing Options for Integrated Risk Policies Will Dove, Centre Group

Program Design and Pricing
Options for Integrated Risk
Policies
Will Dove, Centre Group
Casualty Actuarial Society
Financial Risk Management Seminar
April 12-13, 1999 – Denver, CO
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What is Integrated Risk?
• Single contract covering both
traditional insurance risks and other
risks
- Insurance policy
- Surety bond
- Corporate guarantee
- Put option
- Contingent equity/liquidity contract
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What is Integrated Risk?
• Examples of other risks
- Business risk
- Credit risk
- Liquidity risk
- Market risk
• Foreign exchange rates
• Commodity prices
• Asset prices
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What is Integrated Risk?
• How is coverage provided?
- Coverage part
- Indexed retention or limit
- Investment credit to experience account
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Coverage Trigger
• Accounting: goal is to stabilize
accounting results (income statement,
balance sheet)
• Economic/Cash Flow: goal is to
stabilize future cash flows/asset values
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Advantages of Integrated Risk
•
Can allow customer to purchase less coverage on
more flexible terms
- Single limit available to cover a broad collection of risks can
be superior to a collection of smaller limits each covering a
single risks
•
Administrative efficiency: fewer pieces of paper
to manage
•
Can facilitate transactions, reduce equity
requirements and/or cost of debt in some
circumstances
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Disadvantages of Integrated Risk
• Soft insurance markets can provide
insurance at less than cost for some
period of time
• Contracts must be individually
structured: lot of work, can involve
significant costs
• May require changes to traditional risk
management practices
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How can economies be achieved?
• Total risk management
- Insurer and customer must take a holistic risk
management approach instead of stapling
together multiple policies that are separately
priced
• Customer
- Must integrate risk management and other
financial management functions (e.g. treasury)
to evaluate pricing and coverage terms
• Insurer
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How can economies be achieved?
•
Insurer
- Must integrate underwriting/pricing/reserving for
insurance and other risks: risk premium example
•
Assume that risk premium is proportional to variance of
losses
•
Let A denote traditional insurance losses, B denote other
losses covered by an integrated contract
•
Expected losses E(A+B)=E(A)+E(B)
•
Risk premium kVar(A+B)=k[Var(A)+Var(B)+2Cov(A,B)]
•
If Cov(A,B)<0 then insurer can pass benefit on to the
customer through reduced risk premium only if it retains
both risks A and B on the same balance sheet
•
Insurer must consider correlation of new contract with its
existing risk portfolio as part of the underwriting process
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Accounting Issues
• FAS 133: Hedge vs investment vs
insurance accounting
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Examples of Integrated Risk
Transactions
•
Basket Aggregate program for US-based
multinational: multiple property and casualty
coverage, foreign exchange risks
•
USAir: Collateral substitution program covering
WC loss payments contingent on airline’s credit
worthiness and asset value risk
•
Lan Chile: Credit enhancement of notes
supported by credit card receivables
•
Canadian Airlines: Senior debt put option
combining credit risk and asset value risk