Risk Transfer In The Real World

1. Risk Transfer In The Real World Presented by Jane C. Taylor, FCAS, MAAA Junction Consulting, Inc. Casualty Loss Reserve Seminar Boston, MA September 12, 2005

2. Risk Transfer: History Lesson 1980’s & 1990’s • Disguised Loans • “Borrow” $50MM Surplus Assistance • “Pay” $35MM for Assistance • Special Terms • Repayments Scheduled, i.e. $5MM per year • Funds Withheld – No Assets Transferred • Guaranteed Interest Rate Credited • Year End Portfolio Trades • Benefited both company’s bottom line • No risk to either company

3. Risk Transfer Regulation • Began Late 1980’s and Early 1990’s • Securities & Exchange Commission • Financial Accounting Standards Board • FAS 113 • National Association of Insurance Commissioners • Disclosures in Annual Statements • Chapter 22 (Now SSAP 62)

4. Risk Transfer: History Lesson 1990’s & 2000’s • Finite Reinsurance • Little or no risk to reinsurer • Unusual terms • Year end transactions • Smoothed or overstated balance sheet / income statement • Interlocking companies / directorates / ownership / influence

5. Risk Transfer Regulation • Began Early 2000’s • New York Attorney General Spitzer • Criminal Charges • Law suits • National Association of Insurance Commissioners • Changes to Annual Statement • Proposed Changes to SSAP 62

6. What Really Happens? • Pre Contract Effective Date • Is there Risk Transfer? • Terms Fluid • Internal Data Limited / Data Credibility • Unusual Policy Form / Terms / Conditions • Post Contract Effective Date • Terms Set • Same Data Credibility Issues • Same Policy Form / Term / Conditions Issues • Funds Transferred • Contract Signed within 9 months?

7. Now What? • Get a copy of the Cover Slip or Contract • Read it • Read it again • Ask Questions for Better Understanding • Diagram / Analyze / Write Out Terms

8. Now What? • Is there insurance risk? • Reasonable possibility of significant loss • Effective Date of Contract • Contract Signed within 9 months? • Other contracts (“reinsurance” or otherwise) between same two parties / subs / affiliates?

9. Quota Share Reinsurance • Simple Quota Share • Complex Quota Share • Caps • Corridor / Loss Sharing • Sliding Scale Commission • Profit Sharing

10. Excess Reinsurance • Simple Excess • Complex Excess such as • Sliding Scale • Stop Loss • Cat Cover • Complex Terms • Capped • Loss Carry Forward • Corridors • Etcetera, Etcetera, Etcetera

11. Issues • Major Issue – Sufficient Data • Internal • May not be credible • Mix may have changed • Reference Company • Match books of business • Specialized policy terms • Industry • Special policy terms • Access to information

12. Analysis • Exception to FAS 113 • Focus on maximum loss • Payment pattern of retention • Payment pattern of loss to reinsurer • Focus on gross premium • Gross of ceding commission • Receipt of premium pattern • Losses • Determine reasonable rate of return

13. Quota Share • Same economic position? • Simple Quota Share • Falls in exception • Quota Share with Caps / Corridors / Deductibles / Retentions • Exception or Full Analysis?

14. Sliding Ceding Commission Quota Share • Quota Share of General Liability • Sliding Scale Ceding Commission • Cap: 140.0%

15. Sliding Ceding Commission Quota Share • Start with 10-10 Rule • 10% Probability of 10% loss • Therefore, loss ratio must be 110.0% - 72.5% - 17.5% = 20.0% Loss Ratio = 72.5% + 20.0% = 92.5% • Probability of Loss > 92.5% = 4.27%

16. Excess “Pass Through” • Same economic position? • Reinsurer assumes all premium for layer and all loss for layer • Excess Caps / Corridors / Deductibles / Retentions on Layer • Exception or Full Analysis?

17. All Other Excess • Same economic position? • Sliding Scale • Excess Caps / Corridors / Deductibles / Retentions on Layer • Exception or Full Analysis?

18. Stop Loss Transaction: Terms • Ceding Company protection for potential under reserving • Aggregate Adverse Loss Development • Ceded: $500 million • Cap: $600 million • Max Loss to reinsurer: $100 million • Reinsurers Margin: $10 million

19. Stop Loss Transaction: Terms • Funds withheld: 98.0% • Experience Account: 3.0% Interest • Usual reporting requirements, definitions, etc. • Contains regulatory terms such as Insolvency Clause

20. Stop Loss Transaction: Analysis • Prospective or retrospective reserves? • Funds withheld: 98.0% ($10 million) • Experience Account: 3.0% Interest • Assume no payments from Experience Account • Approximately 7 years to make up $100 million of total funds • What is payout pattern?

21. Transaction effective fourth quarter 2000. In a draft memo dated December 12, 2000 and actually sent December 17, 2000 from ceding company to reinsurer: Stop Loss Transaction: Analysis Exhibit 1

22. In an internal memo dated October 17, 2000, the ceding company makes the following comments: Stop Loss Transaction: Analysis Exhibit 6, GR1_0126245

23. Stop Loss Transaction: The Final Analysis March 30, 2005

24. Loss Ratio Stop Loss Transaction: Terms • Attachment Point: 69.5% Loss Ratio • Subject Premium: $180 Million • Initial Premium: $1 million • Added Premium: • Max Added Premium: $14 million • Reinsurance Aggregate Max: $15 Million

25. Loss Ratio Stop Loss Transaction: Terms • Funds Withheld Account • Interest: • 2.05% per quarter, ~8.5% per year • Credited to inception date

26. Loss Ratio Stop Loss Transaction: Analysis • Next Steps • Determine maximum premium • Determine maximum subject loss • Determine probability of maximum loss • Answer question as to when maximum premium will be achieved

27. Risk Transfer In The Real World Presented by Jane C. Taylor, FCAS, MAAA Junction Consulting, Inc. Casualty Loss Reserve Seminar Boston, MA September 12, 2005