Transcript Download Presentation 2

Capital Allocation
for Reinsurance Pricing
presentation by
Kevin Madigan
Casualty Actuaries in Reinsurance
Seminar on Reinsurance, Boston
May 19-20, 2008
Crawl -> Walk -> Run
At the risk of offending my audience, I want to
spend a few moments talking about some
basics and framing some issues.
Why “allocate” capital?
We need to make decisions under uncertainty
Should we believe our answers?
Why Allocate Capital?
Need a denominator for a return calculation
Context is important. Are we allocating the capital of
the firm, or deriving a method to compare
alternative uses of capacity?
Insurance is not physics – a grand unified theory is
not required
When calculating ROEs for transactions or LOBs or
business units, it isn’t important to get the “right”
one – a reasonable one will do
The Denominator
Returns are extremely important, but they are relative
measures
You give me $x and I will target a return of y%
– Capital markets / “normal” investments
– Capital budgeting (gives me something to write
against, but still exposes more than the allocated
capital)
– Pricing treaties (does this really make sense? I
don’t know, but we need a metric)
How much capital?
Solvency issues are crucial to determining how much
capital a (re)insurer must hold relative to the risk
they already have, or plan to put, on their books
If you want a rating, the rating agencies determine
the lower bound
If you want to be regulated, the regulator also has a
say
How much capital?
We do not need fancy capital methodologies –
the rating agencies and regulators tell us what
we need.
If we want to be unrated and unregulated, we
promise our investors a numerator, and they
give us a denominator.
Are we allocating real capital?
Can this capital be divided into disjoint units
and “allocated” to business units or contracts?
Of course not
Sometimes we behave as if it can (Katrina,
adverse development in long tails)
So why do it?
We have to service the capital we have, or give it
back.
Calculating expected ROEs or ROCs is an
accepted (and pretty good) way to rank order
business opportunities
So we need a denominator
Random thoughts
• Order dependency
– May not matter to cedent, may matter very
much to the reinsurer
– Should it be ignored / avoided / embraced?
• What about rating agency or RDS constraints?
– Can’t be ignored, but how do we
incorporate?
Random thoughts
• Underwriter and management buy-in
– Crucial or time and resources are wasted
• How to deal with parameter risk
– Build into loss pick and fix ROE?
– Build into capital allocated to transaction?
– Don’t bother pretending to know the
impact and target a higher ROE?