Transcript Download Presentation 1

Impact of Financial Crisis on D&O
15 September 2009
2
Lessons Learned
We need to improve risk management practices for D&O insurance exposure
We need better models and better understanding of models, particularly
understanding of limitations of models
3
Is D&O the same type of risk as Property Cat?
4
Is D&O the same type of risk as Property Cat?
Property Cat
Frequency
Low
D&O
Low
5
Is D&O the same type of risk as Property Cat?
Property Cat
D&O
Frequency
Low
Low
Severity
High
High
6
Is D&O the same type of risk as Property Cat?
Property Cat
D&O
Frequency
Low
Low
Severity
High
High
Accumulation Risk
High
High
7
Is D&O the same type of risk as Property Cat?
Property Cat
D&O
Frequency
Low
Low
Severity
High
High
Accumulation Risk
High
High
Consistency of Risk
over time
Low
Low
8
Is D&O the same type of risk as Property Cat?
Property Cat
D&O
Frequency
Low
Low
Severity
High
High
Accumulation Risk
High
High
Consistency of Risk
over time
Low
Low
Available Historical Data
About 100 yrs
Limited
9
Low Frequency/High Severity Business
What is an Actuary to Do?
Lack of a complete historical catalogue of events
 We have difficulty estimating the expected loss. It is even more difficult to estimate the
tail
 There are many black swans.
Risk is enormously complex to model
 Hurricane – wind speed, central pressure, sea surface temperature, landscape, etc.
 D&O – legal climate, complexity of corporate structure, etc.
Exposure changes over time
 Property cat – climate change, improvements in building codes, improvements in
engineering, improvement in loss mitigation
 D&O – M&A, judicial rulings, Sarbanes-Oxley
10
Uncertainty
What does this mean?
 Model risk and parameter risk are huge
ￚ We don’t fully understand the risk
ￚ No model can reflect every aspect of the risk, even if we understood it perfectly
ￚ Model and parameter risk far outweigh the process risk
 Pricing estimates have enormous uncertainty; i.e. you can not calculate the price
precisely
What do you do?
 Create models but don’t over-rely on them
ￚ Unbiased, consistent benchmark for risk selection – which risks are better than
others?
ￚ Sensitivity test to try to understand uncertainty
ￚ Create decision rules to go with the model – but be flexible
ￚ Don’t forget to use judgment
 Understand correlations within the portfolio and with other portfolios
ￚ Measure accumulations
ￚ Management must set risk tolerances for accumulations
11
Putting it to Work
12
Portfolio Management
Monitoring Accumulations
Hypothetical D&O Portfolio
Underwriting Review
Combined All Coverages
Industry
Type
(1)
Industry Group
(2)
Policy Count
(4)
Limit
(5)
Side A - D & O
Policy
Count
Limit
(7)
(8)
Full - D & O
Policy
Count
Limit
(9)
(10)
Fiduciary Liability
Policy
Count
Limit
(11)
(12)
E&O
Policy
Count
Limit
(13)
(14)
EPL
Policy
Count
Limit
(15)
(16)
Financial
Asset Mangers
16
290.0
0
0.0
10
175.0
0
0.0
5
100.0
1
15.0
Financial
Banks
12
201.5
4
86.5
3
60.0
2
20.0
1
10.0
2
25.0
Financial
Finance Companies
0
-
0
0.0
0
0.0
0
0.0
0
0.0
0
0.0
Financial
Insurance
1
10.0
1
10.0
0
0.0
0
0.0
0
0.0
0
0.0
Financial
Professionals
0
-
0
0.0
0
0.0
0
0.0
0
0.0
0
0.0
29
501.5
5
96.5
13
235.0
2
20.0
6
110.0
3
40.0
13
Portfolio Management Tool
 An exposure model simulating industry losses based on financial data
 Company loss based on in-force portfolio
 Model captures:
ￚ
ￚ
ￚ
ￚ
Endurance loss and alae for each category, and in total
Industry claim frequency above various attachments for each category
Average severity of industry losses in various layers for each category
Industry increased limits curves
Uses for Model




Enterprise Risk Management
Verification of pricing model parameters
Reserving
Strategy
14
Warren Says It Best
15
Warren Buffet’s 2001 Letter to Shareholders
“What counts in this business is underwriting discipline. The winners are those that
unfailingly stick to three key principles:
 They accept only those risks that they are able to properly evaluate (staying within their
circle of competence) and that, after they have evaluated all relevant factors, including
remote scenarios, carry the expectancy of profit. These insurers ignore market-share
considerations and are sanguine about losing business to competitors that are offering
foolish pricing or policy conditions.
 They limit the business they accept in a manner that guarantees they will suffer no
aggregation in losses from a single event or from related events that will threaten their
solvency. They ceaselessly search for possible correlations among seemingly unrelated
risks.
 They avoid business involving moral risk: No matter what the rate, trying to write good
contracts with bad people doesn’t work. While most policyholders and clients are
honorable and ethical, doing business with the few exceptions is usually expensive,
sometimes extraordinarily so.”