Mix of Business Review Example

1. Mix of Business Review Example Executive Level Decision Making Using DFA Patrick J. Crowe, FCAS, MAAA

2. Goals of Study • Review Mix of Business Options • Evaluate Optimal Growth Patterns using simulation model results

3. Mix of Business Options • Base Model WC+5%, HO+5% • Increase Base Model, HO+10% • Increase Base Model, WC+10% • Decrease Base Model, HO-10% • Decrease Base Model, WC-10%

4. Financial Measures • Earned Premium • Net Loss Ratio • Premium to Surplus Ratio • Expected Return\Standard Deviation • Cash Flow • Net Operating Results

5. Underwriting operations and investment • strategy are not affected by change in policy growth • assumptions. • The DFA model assumes there is a tradeoff • between growth and profitability. Model / Assumptions Assumptions Behind Simulation

6. Corporate Elements Reinsurance Investment Underwriting Taxes DRM Flow Starting Policy Holder Surplus $40 million Workers Compensation Financial Calculator Homeowners Financial Measures • Net Earned Premium • Net Loss Ratio • Premium to Surplus Ratio • Return on Surplus • Cash Flow • Net Operating Results • Financial Results • Simulated over Five Years • Balance Sheet • Income Statement Analyze Results

7. Caveats • Effect on expense ratios has not been modeled • Reducing exposures could result in higher expense ratios and thus may not result in the best alternative • Effect of change in investment strategies has not been modeled • Reducing exposures will most likely result in a change in investment strategies • Not considered as significant as the effect on company expenses

8. Initial Balance Sheet Bonds = 91% of Assets Loss & loss expense reserves = 64% of Surplus

9. Net Earned PremiumFifth Year Projection

10. Net Loss RatioFifth Year Projection

11. Net Loss RatioFifth Year Projection

12. Premium to Surplus RatiosFifth Year Projection

13. Premium to Surplus RatioFifth Year Projection

14. Return on SurplusFifth Year Projection Less rewarding Less risky

15. Return on SurplusFifth Year Projection Better

16. Cash FlowFifth Year Projection

17. Net Operating ResultsFifth Year Projection

18. Net Operating ResultsFifth Year Projection

19. P Conclusion – Risk vs. Return Expected Standard OptionReturnDeviation HO (-10%) +6.1% ± 12.0% WC (-10%) +5.4% ± 12.3% Base +3.9% ± 12.8% WC (+10%) -1.1% ± 18.5% HO (+10%) -3.9% ± 19.7% Decreasing Homeowners exposures (10)% results in: • Higher expected return and • Lower standard deviation … vs. the current and other strategies.

20. P Conclusion – Cash Flow Cash OptionFlow HO (-10%) 0.0167% Base 0.0163% HO (+10%) 0.0157% WC (-10%) 0.0137% WC (+10%) 0.0136% Decreasing Homeowners exposures (10)% also results in: • Higher cash flow … vs. the current and other strategies.

21. P O O Conclusion – P:S Ratio at the 50% Percentile Decreasing HO & WC exposures (10)% results in: • Lowest premium to surplus ratios … vs. the current and other strategies. Premium to OptionSurplus Ratio HO (-10%) 1.26 WC (-10%) 1.33 Base 1.81 WC (+10%) 2.91 HO (+10%) 3.14

22. P Conclusion – Net Operating Ratio Probability of OptionOperating Ratio < 100% HO (-10%) 79.4% WC (-10%) 61.7% Base 45.2% WC (+10%) 27.6% HO (+10%) 14.8% Decreasing HO exposures (10)% results in: • Highest probability of operating ratio < 100% … vs. the current and other strategies.

23. P Conclusion – Net Loss Ratio Net OptionLoss Ratio WC (-10%) 71.4% HO (-10%) 71.5% Base 71.5% HO (+10%) 71.7% WC (+10%) 72.9% Decreasing HO & WC exposures (10)% results in: • Lowest net loss ratio … vs. the growth strategies.

24. P Conclusion – Rankings Risk vs. Cash P:S Net Net OptionReturnFlowRatioOp RatioLoss Ratio HO (-10%) # 1 # 1 Tied # 1 # 1 Tied # 1 WC (-10%) # 2 # 4 Tied # 1 # 2 Tied # 1 Base # 3 # 2 # 3 # 3 Tied # 1 WC (+10%) # 4 # 5 # 4 # 4 # 5 HO (+10%) # 5 # 3 # 5 # 5 # 4 Decreasing HO exposures (10)% results in: • Most return and least risk • Greatest cash flow • Lowest P:S Ratio • Lowest Operating Ratio • Lowest Net Loss Ratio

25. Conclusion • Although decreasing Homeowners exposures is the best option, neither the current U/W strategy nor the alternatives are expected to result in an adequate return or a sufficient financial position to support the company’s business!