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INTRODUCTION TO
REINSURANCE
NOLAN ASCH
CAS RATEMAKING SEMINAR
MARCH 8-9, 2007
INT-4
INSURANCE
The insurer insures the individual or
the corporation
REINSURANCE
The REINSURER insures the
insurance company
REINSURANCE
PLACEMENT MECHANISMS

DIRECT

BROKER
INSURANCE
vs.
REINSURANCE
BOTH concerned with future contingencies
 BOTH require underwriting skills (risk)
 BOTH involve transfer of risk
 BOTH require payment of premium
 BOTH provide protection
 BOTH subject to (some) regulation

REINSURANCE
Buyers assumed to be knowledgeable
 Responds to actual loss
 Provides indemnification only
 Reimburses for payments already made
 Usually Global

FUNCTIONS OF
REINSURANCE

CAPACITY
CAPACITY
Single Risk (Fac - Sears Tower)
 PORTFOLIO (Treaty)

CAPACITY MECHANISMS
Excess-of-Loss
 Quota Share

FUNCTIONS OF REINSURANCE
CAPACITY
 CATASTROPHE

CATASTROPHE
QUOTA SHARE
 EXCESS OF LOSS
 SECURITIZATION

CATASTROPHE
They are Cat Models not magic
 Was AIR client #4 in 1987
 User tips

CATASTROPHE
 Outputs
are probabilistic
 The “1 in 100 year event”
– Is really a scenario with a 1% chance of
occurring in any calendar year.
 Look
at the range of loss outcomes.
CATASTROPHE
GIGO
Garbage-In
Garbage-out
Cat Models NEED VERY detailed
and accurate data input
FUNCTIONS OF REINSURANCE
CAPACITY
 CATASTROPHE
 STABILIZATION

STABILIZATION
Reduction in Variance (swings)
STABILIZATION
Extreme contractual case
“STOP-LOSS”
Aggregate Excess
FUNCTIONS OF REINSURANCE
CAPACITY
 CATASTROPHE
 STABILIZATION
 FINANCING

FINANCING
Reducing Liabilities
Ceding Commissions
“Overrides”
FINANCING
May increase PHS due to transaction
FINANCING
Finite Reinsurance......
Pre-Elliott Spitzer
ALL Reinsurance is Financial
Post Elliott Spitzer
I don’t think so….
FUNCTIONS OF
REINSURANCE





CAPACITY
CATASTROPHE
STABILIZATION
FINANCING
ENTER AND EXIT
MARKETS
ENTER OR EXIT MARKETS
Lessens risk as you learn
With 100% Q/S you exit
FUNCTIONS OF REINSURANCE
CAPACITY
 CATASTROPHE
 STABILIZATION
 FINANCING
 ENTER AND EXIT MARKETS
 UTILIZE REINSURER EXPERTISE

USING REINSURER
EXPERTISE
Large or unusual claims
 Large or unusual risks
 Special relationships and/or
knowledge

LIMITATIONS OF
REINSURANCE
Will NOT make bad business profitable
 Transaction Costs
 Rating Agency Impacts (Gross/Net)

How Reinsurance Is Priced
in Practice
Hypothetical
Examples
NO PRICE REGULATION

(virtually)
CASE BY CASE
NEGOTIATION
FLEXIBILITY IN STRUCTURE
Contractual
EXCESS OF LOSS
LAYERING
$19.75 Mill xs $0.25 Mill
(sounds like a wide layer)
TYPICAL LAYERING
10M xs 10M
5M xs 5M
3M xs 2M
1M xs 1M
500 xs 500
250 xs 250
Price
Price
Price
Price
Price
Price
F
E
D
C
B
A
High Frequency/ Low Severity
Buffer layers
ie 250 xs 250
Price A
250 xs 250
Low Frequency/ High Severity
10M xs 10M
Price F
Capacity Layers
i.e. 10m xs 10m
CLIENT/BROKER
NEGOTIATION
Change or re-subdivide
the layering
LAYER TRAP
MANY PERMUTATIONS

Pricing for 500 xs 500

Later, request the 250 xs 250
LAYER TRAP

at “last minute”
Ask for 150 xs 100
--Requires more data
PRICING TRAPS

AGGREGATE ANNUAL DEDUCTIBLES
ASSUME A 10% RATE
Request a 1% AAD
 Request a 2% AAD
 Request an 8% AAD
 NOW the risk/variance
 becomes LARGE vs a 2% rate

INFORMATION FOR PRICING
NO standards
WHAT THE REINSURER
WANTS
EVERYTHING
WHAT THE BROKER/CLIENT
MAY WISH TO SUPPLY
NOTHING
POSSIBLE
OUTCOMES
GIGO
Garbage-In
Garbage-out
NINO
Nothing-in
Nothing-out
EXPERIENCE RATING
Using losses of the risk
to price the risk.
HISTORIC
STANDARD
All losses at half the
attachment point & up
ACTUARIAL APPROACH
DETRENDED LOSSES
Varies with age of claim
BEGINS to show ACTUAL
CLAIMS as a sample outcome
EXPOSURE RATING
Attempt to rate Reinsurance based upon the
TRUE underlying exposures
Proxies for TRUE exposures:
Limits Profiles = Subject Premium by policy limit
Exposures by policy limit (still not the TRUE exposure)
LIMITS PROFILE
$100,000 Policy Limit
Yr 2002 10% of exposures at $100,000
 Yr 2003 25% of exposures at $100,000
 Yr 2004 90% of exposures at $100,000

loss was atypical in 2002
 layer is effective 7/1/07

Include ‘02 and ‘03 losses at $100,000
LIMIT LOSS
limit loss to 2002 policy limits
or
trend and develop loss
beyond policy limits
“WE DON’T DO THIS
ANYMORE”
“Throw out “ claims from
MGA’s, classes or states
we no longer write
QUOTA SHARE ISSUES
Moral hazard and Retention - 1% net
 Ceding Commission
 Overrides
 Sliding Scales
 Loss Corridors
