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Slide 1
Reinsurance Structures and On Level Loss Ratios Reinsurance
Boot Camp July 2005
Slide 2
2 Agenda Reinsurance Structures Calculating an On Level Loss
Ratio Adjustments to Premium Adjustments to Losses Adding in a
Catastrophe/Shock load Dealing with a change in mix of business
Filling in the gaps when data is unavailable
Slide 3
3 Reinsurance Structures Standard Structures Pro Rata Excess of
Loss NonStandard Structures Stop Loss Loss Portfolio Transfer
Slide 4
4 What is a Pro Rata Treaty? The cedant agrees to share x% of
the premium and x% of the losses of a book of business. The
reinsurer returns some of the premium to the cedant in the form of
a ceding commission. One Pro Rata Structure, a Quota Share, cedes
the same percentage on all risks. A Variable Quota Share may cede
different percentages for different limits. A Surplus Share allows
the cedant to retain a given amount, called a line, on any one risk
and cede the remaining lines to reinsurers.
Slide 5
5 Variable Quota Share
Slide 6
6 Surplus Share
Slide 7
7 Uses for Pro Rata Treaties Surplus Relief Pro Rata Structures
reduce net premium which improves (decreases) the cedants
net-premium-to surplus ratio The ceding commission increases the
cedants surplus, also improving (decreasing) the
net-premium-to-surplus ratio. Combined Ratio Improvement, in some
cases Although straight Pro Rata Structures do not improve loss
ratios, the cedants actual overall results can improve if the
ceding commission received exceeds the cedants actual expenses (an
override). Cedants overall portfolio results COULD be worse if they
end up ceding out very profitable business instead of keeping it
net.
Slide 8
8 What would I care about if I were pricing a Pro Rata Treaty?
Expected Loss Ratio for the covered business Volatility of Loss
Ratio/Loss Sensitive Features Cedants actual expenses Alignment of
Interests
Slide 9
9 Other concerns - Variable QS Do I have the appropriate data
to estimate a loss ratio by limit? Surplus Share Do I have surplus
share data that represents the current line guide?
Slide 10
10 What is an Excess of Loss Treaty? For any loss, the cedant
retains the first x dollars and cedes out the next y dollars, in
exchange for premium. Per Risk Per Occurrence Example: 9M x 1M per
occurrence For a loss sustained on any given occurrence, the cedant
keeps the first 1M and the reinsurer picks up the next 9M.
Slide 11
11 Uses for Excess of Loss Treaties Stabilize loss experience
Catastrophe Protection Increased Risk Capacity
Slide 12
12 What would I care about if I were pricing an Excess of Loss
Treaty? Frequency of Layer Losses Severity of Layer Losses
Volatility of Loss Ratio/Loss Sensitive Features Alignment of
Interests
Slide 13
13 What is a Stop Loss Treaty and what is it used for? The
cedant retains the first x of aggregate losses and cedes out the
next y of aggregate losses to a reinsurer in exchange for premium.
X can either be a percentage or a fixed dollar amount Stabilizes
net results Example: 10% excess of a 70% net loss ratio in exchange
for 3% premium.
Slide 14
14 What would I care about if I were pricing a Stop Loss
Treaty? Expected Loss Ratio for the covered business Volatility
around the Loss Ratio Special Funding features Alignment of
Interests Accounting considerations
Slide 15
15 What is a Loss Portfolio Transfer and what is it used for?
The cedant gives a block of loss reserves to a reinsurer in
exchange for premium. Premium considers the discounted value of
those reserves along with a risk charge. Enables the cedant to
cleanly exit a line of business and focus on their going concern
portfolio.
Slide 16
16 What would I care about if I were pricing a Loss Portfolio
Transfer? Loss Reserve Adequacy Latent Liabilities Interest Rate
Assumptions Alignment of Interests
Slide 17
17 Calculating an On Level Loss Ratio Essential for pricing
almost any prospective reinsurance structure. Historical years of
premium are adjusted to the prospective periods rate and dollar
levels. Historical years of losses are adjusted to an ultimate
settled basis and trended to the prospective periods dollar levels.
Adjusted losses are ratio-ed to adjusted premium for an on level
loss ratio.
Slide 18
18 Data Needs - Premium Historical Premium Earned Premium if
Losses Occurring treaty Written Premium if Risks Attaching treaty
Historical Rate Changes Premium/Exposure Trend if Exposure Base is
Inflation Sensitive
Slide 19
19 Data Needs - Losses Historical Paid a/o Incurred Losses and
ALAE Accident Year if Losses Occurring treaty Policy Year if Risks
Attaching treaty Loss Development Triangle Loss Trend
Catastrophe/Shock losses separately
Slide 20
20 Adjustments to Premium Rate On Level Factors Parallelogram
method Premium at Present Rates Premium/Exposure Trend Yes if
exposure base is insured value, sales, revenues, etc. No if
exposure base is square feet, per vehicle, per employee, per
doctor, etc.
Slide 21
21 Rate On Level Factors Rate Changes should consider changes
to base rates, schedule credits and debits, tier rating, LCMs. They
should also be adjusted for changes in limits and attachment points
on the underlying policies. Parallelogram method uses geometry to
calculate on level factors. Premium at Present Rates re-rates all
historical policies using prospective rates.
Slide 22
22 Rate On Level Factors
Slide 23
23 Premium/Exposure Trend Trend from: Average Earned Date of
experience period for Losses Occurring Average Written Date of
experience period for Risks Attaching Trend to: Average Earned Date
of prospective period for Losses Occurring Average Written Date of
prospective period for Risks Attaching
Slide 24
24 Adjustments to Losses Catastrophe/Shock losses should be
separated out. NonCat Incurred Losses need to be adjusted to
ultimate, settled basis. Use cedants own loss development triangle
Supplement with industry/peer data if necessary Ultimate, settled
noncat losses need to be trended to prospective period. Trend from
average date of loss of experience period Trend to average date of
loss of prospective period
Slide 25
25 Incurred Loss Development Triangle (in thousands)
Slide 26
26 Loss Development (contd)
Slide 27
27 Developing Incurred Losses
Slide 28
28 Loss Trend
Slide 29
29 On Level Loss Ratios: Making a Selection Select for
Stability? Select for Responsiveness? Somewhere in the middle?
Slide 30
30 Stability versus Responsiveness
Slide 31
31 Adding a Catastrophe Load Catastrophe Load By definition,
catastrophes are low frequency, high severity. Your experience
period may not even have had such a lossyet There are plenty of
catastrophe exposure models available for property however.
Catastrophe experience should be reviewed, but given little weight
due to its inherently volatile nature.
Slide 32
32 Adding a Shock Load Loss Experience versus Loss Exposure
Calculate a limited loss ratio at low stable level. Add a load for
larger losses that you are exposed to, but havent experienced yet.
Use exposure curves to add an excess charge above that limited
level Amortize in some large but possible loss
Slide 33
33 Dealing with a Shift in Business Mix A loss ratio analysis
done on an all lines combined basis will miss shifts in the
business mix. Should analyze each line of business separately and
then weight results on prospective premium by line.
Slide 34
34 Dealing with Start-Ups and No Data New line of business for
a company New company altogether
Slide 35
35 What to think about in no data situations Competitor
experience or rate comparisons, but consider: Growing
pains/distractions in new line Competitive advantage? Position in
the market cycle? Burning your way in Track record at prior
carriers Rating of current carrier/current paper Company
infrastructure established? Smaller but growing book and
volatility