Introduction to Reinsurance Reserving

Introduction toReinsurance Reserving Casualty Loss Reserve Seminar Washington, D.C. September 23, 2002 Bruce D. Fell, FCAS, MAAA Am-Re Consultants, Inc.

Agenda • Reinsurance Contract Types • Data Grouping Dimensions • Differences Between Reinsurance and Primary that affect Loss Reserving • Applications, Complications, and Considerations Am-Re Consultants, Inc.

Reinsurance Contract Types • What Policies Are Insured? • Mechanics of the Cover Am-Re Consultants, Inc.

Reinsurance Contract Types • What Policies Are Insured? • Facultative Reinsurance • Generally covers one insured/policy • The one insured/policy is known to the reinsurer at inception • Treaty Reinsurance • Covers multiple insured/policies which fit treaty specifications • These multiple insured/policies are unknown at inception but become known to the reinsurer during the treaty term Am-Re Consultants, Inc.

Reinsurance Contract Types • Mechanics of the Cover • Proportional Reinsurance • “Follows the Fortunes” of the reinsured company • First-dollar sharing of premium and loss between the parties • Reinsurer’s relative participation is pre-determined • Examples:Quota Share, Surplus Share • Excess Reinsurance • Responds when a loss, group of losses, or a loss ratio exceeds a set figure • Reinsurer’s relative participation is NOT pre-determined, but depends on the size of the loss or loss ratio • Examples:Per Risk, Per Occurrence, Aggregate • Others Am-Re Consultants, Inc.

Data Grouping Dimensions • Accident Year vs Underwriting Year (or “Losses Occurring” vs “Risks Attaching” or “Policies Incepting”) • Casualty vs Property • Treaty vs Facultative • Excess vs Proportional • Broker vs Direct Am-Re Consultants, Inc.

Data Grouping Dimensions • Accident Year vs Underwriting Year (or “Losses Occurring” vs “Risks Attaching” or “Policies Incepting”) • Accident Year allows for easiest application of standard techniques • Premium fixed as of December 31 • Population of claims fixed at December 31 as well, though many may be unknown • May not always be an option for reinsurance Am-Re Consultants, Inc.

Data Grouping Dimensions • Accident Year vs Underwriting Year (or “Losses Occurring” vs “Risks Attaching” or “Policies Incepting”) • Underwriting Year is often used in reinsurance, especially for proportional contracts • This is problematic as an UY can cover two policy years and three calendar years for losses • The current UY as of 12 months is “incomplete” Am-Re Consultants, Inc.

The "Incomplete Underwriting Year" Sample Time Line 1/1/2001 1/1/2002 1/1/2003 1/1/2004 <---Accident Year 2002---> <---Accident Year 2003---> <---Accident Year 2001---> <----------------Underwriting Year 2001------------------> Can cover policies incepting during this period <---------------------------------Underwriting Year 2001---------------------------------> Can cover losses occurring during this period Explanation: Underwriting Year 2001 encompasses any treaties written by the reinsurer in 2001. If these treaties cover "Risks Attaching“ or “Policies Incepting” during the treaty period. Underwriting Year 2001 can theoretically span two years and three accident years (assuming 12-month underlying policies and 12-month treaties, otherwise the exposure period could be even longer). As of December 31, 2001, Underwriting Year 2001 is “incomplete”. Using standard loss development techniques with factors derived from the past underwriting years will overstate the development of Underwriting Year 2001. Historical development after 12 months includes losses on exposures earned after 12 months of an underwriting year. Provision for these losses should not be included in reserves at the December 31, 2001 accounting date. Am-Re Consultants, Inc.

Data Grouping Dimensions • Casualty vs Property • Casualty business generally has a longer development tail • Line of business (LOB) detail is often not available to the reinsurer, but if it is you might want to further subdivide by LOB as different LOBs may develop differently Am-Re Consultants, Inc.

Data Grouping Dimensions • Treaty vs Facultative • These display different development patterns, all else equal Am-Re Consultants, Inc.

Data Grouping Dimensions • Excess vs Proportional • Should be separated from each other • Different development patterns • Possible reserve adequacy mix • Excess case reserves are generally reviewed by reinsurer’s claim department, which may use ACRs to make case reserve adequacy more consistent among the claims • Proportional case reserves are generally booked as reported by the reinsured company without review • Subdivide Excess further, if possible by type of layer - low, high, catastrophe, etc, as these exhibit different development patterns as well Am-Re Consultants, Inc.

Data Grouping Dimensions • Broker vs Direct • Reinsurers obtain business from ceding companies either directly from that company or through a broker • In the case of “broker” business, the data flows through the broker as well - reports are submitted to the reinsurer periodically (monthly, quarterly, or some other increment) • Because of this, there should be less of a reporting lag for “direct” business than for “broker” business - all else equal • Therefore, it should be expected that the development patterns differ Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Reporting Lag/Development Lag • Data • Increased Variability • Tailor-Made or Atypical Contracts or Features • “Accumulation of Issues” Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Reporting Lag/Development Lag • Primary losses develop faster than reinsurance losses if only due to the time it takes for information to reach the reinsurer • Proportional business (“broker”): Accounts are often not due to the reinsurer until 30-90 days after the close of the quarter • It is then possible that losses that the ceding company books in calendar year “X” will be realized and booked by the reinsurer in calendar year “X+1”. The same loss will be in two different triangle “cells” Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Reporting Lag/Development Lag • Excess business: Reporting lag compounds with development lag • The reinsurer is not notified immediately of the loss • The losses do not “hit” the reinsurer’s data until they exceed the threshold established in the Excess reinsurance contract • Example: • Primary company has $400,000 excess of $100,000 per risk reinsurance cover • Loss occurs in Year 1, reserved for $25,000 • Year 3, reserve increased to $50,000, reinsurer is verbally notified that this loss MAY eventually reach their contract • Year 5, reserve increased to $150,000, reinsurer incurs loss, loss “hits” triangles 4 years after it did for the primary company Am-Re Consultants, Inc.

Primary vs. Reinsurer Reproduction of RAA 2001 Historical Loss Development Study Graph Primary Company Data Source: A.M. Best Company Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Reporting Lag/Development Lag • Premium Estimates • Premium estimates are needed in reinsurance more than for primary insurance • Reserves must be set against premium earned/exposed as of the accounting date • Reporting lag can cause large earned premium amounts to be unreported to the reinsurer as of the accounting date • This creates a need for premium to be estimated and for losses to be calculated that are associated with this premium Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Data • Quantity • The “infinite” detail of primary company data is often lost when reported to reinsurers as data gets “collapsed” along several dimensions • Accident dates not reported • Lines of business not reported • Industry benchmarks by line of business or accident year can thus be difficult to use Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Data • Quality • Quality of data affected by “varied quantity”: • Some ceding companies report more detail to reinsurers than do others • As reinsurance data for reserving is organized at the level of common detail in terms of reported data fields, this has an impact on the quality of the analysis Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Increased Variability • Primary insurers purchase reinsurance (among other reasons) to make their results less variable (ie from catastrophes) • Reinsurer data is subject to this reinsured variation • Depending on the type of reinsurance cover, reinsurer data may BE this variation Am-Re Consultants, Inc.

Primary Experience Gross of Reinsurance Am-Re Consultants, Inc.

Primary Experience Net of Reinsurance Am-Re Consultants, Inc.

Reinsurance Experience Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • Tailor-Made or Atypical Contracts or Features • Many (possibly large) reinsurance contracts have features that affect the way their experience will develop vis-à-vis other contracts with which they would otherwise be grouped • Examples: Stop loss arrangements, loss corridors, sunset clauses, etc Am-Re Consultants, Inc.

Differences Between Reinsurance and Primary that affect Loss Reserving • “Accumulation of Issues” • Each primary insurer faces issues such as changing reserve adequacy, changing settlement patterns, etc • These issues affect that company’s loss reserving data, and the primary company reserving analyst has tools to neutralize the effects of these on the reserving data • Reinsurance loss reserving data is an accumulation of the data of primary companies each of which may have these issues • This adds a further complication to the reinsurance loss reserving process Am-Re Consultants, Inc.

Introduction to Reinsurance Reserving