International Reinsurance Pricing and Challenges

1. International Reinsurance Pricing and Challenges Liability Simon Sheaf Tillinghast-Towers Perrin London

2. Agenda • The need for benchmarks • Deriving benchmarks • Index clauses • Changing international liability environments

3. General Issues • Availability of data • Country differences:- • minimum policy limits • inflation • legal environment • social attitude

4. Role of Benchmarking • Lack of company data • Standard to which individual company can be measured • Determine if benchmark is appropriate • Use range of benchmarks

5. Deriving Benchmarks - Methodology • Collect data • Create report year loss development triangles • Select development patterns • Trend losses to common accident date • Develop individual claims to ultimate values • Restate losses to level under current legislative system • Select truncation and censorship points • Fit size of loss curves • Estimate portion below truncation point

6. Deriving Benchmarks - Issues • Credibility of data set • Verify that data is not just comprised of a few companies • Confidentiality concerns • Variations in reporting thresholds • Consider a range of scenarios

7. Results - Size of Loss Curves Note: Before trend, development or filtering

8. Results - Excess Premium/Loss Factors Excess Premium Factor Claim Limit (£) 7.8% 150,000 3.8% 500,000 1.9% 1,000,000 0.7% 2,000,000 0.2% 5,000,000 Illustrative Example Layer £1m xs £1m Rate for layer = EPF (£1m) - EPF (£2m) = 1.2% Simple application, butmust understand origin of figures

9. Results - Loss Development Patterns - Claim Size Comparison

10. Results - Loss Development Patterns - Country Comparison

11. Results - Variability in Claims Development

12. Index Clauses in Excess of Loss Treaties • Fully Indexed: the attachment point and coverage amount are adjusted freely with the index • Franchise Index: the attachment point and coverage amount are adjusted with the index only if the accumulated inflation exceeds a certain level • Severe Inflation Clause (SIC): the attachment point and coverage amount are adjusted with the index only if the accumulated inflation exceeds a certain level, and only to the extent that the accumulated inflation exceeds this level

13. Index Clauses - Example • £1m xs £1m excess of loss reinsurance contract • Contract index: European Expensive Stuff Index • Base Index: EES index value at inception date = 100 • Suppose a loss of £2m (from the ground up, in future nominal pounds) occurs • How reinsurance contract reacts depends on:- • type of index clause • value of index at time of payment

14. Fully Indexed Index Value at Time of Payment Indexing Adjustment Indexed Layer (£m) Reinsurance Payment (£m) 110 110/100 1.10 xs 1.10 0.90 115 115/100 1.15 xs 1.15 0.85 120 120/100 1.20 xs 1.20 0.80 125 125/100 1.25 xs 1.25 0.75 Original loss = £2m Layer = £1m xs £1m Base Index = 100 101 101/100 1.01 xs 1.01 0.99 105 105/100 1.05 xs 1.05 0.95

15. Franchise Index Base Index = 100; Franchise=10% inflation Index Value=110 Index Value at Time of Payment Indexing Adjustment Indexed Layer (£m) Reinsurance Payment (£m) 101 none 1.00 xs 1.00 1.00 105 none 1.00 xs 1.00 1.00 120 120/100 1.20 xs 1.20 0.80 125 125/100 1.25 xs 1.25 0.75 Original loss = £2m Layer = £1m xs £1m 110 110/100 1.10 xs 1.10 0.90 115 115/100 1.15 xs 1.15 0.85

16. Severe Inflation Clause Base Index = 100; SIC = 10% inflation Index Value = 110 Index Value at Time of Payment Indexing Adjustment Indexed Layer (£m) Reinsurance Payment (£m) 101 none 1.000 xs 1.000 1.000 105 none 1.000 xs 1.000 1.000 120 120/110 1.091 xs 1.091 0.909 125 125/110 1.136 xs 1.136 0.864 Original loss = £2m Layer = £1m xs £1m 110 110/110 1.000 xs 1.000 1.000 115 115/110 1.045 xs 1.045 0.955

17. Comments About Index Clauses • Appropriate with long-tail lines of business and inflationary environments • Make the economics of the excess of loss deal fairer • What determines which type of index clause will be used? • market practice • what the broker is used to • what the cedant will accept

18. UK Personal Injury Settlements - The Background • Structured settlements becoming more common • But lump sum payment is the norm in motor TPL claims • How is lump sum calculated? • NPV • allowing for discount • allowing for mortality • using Ogden Tables

19. UK Personal Injury Settlements - Recent Judgement • Historical view: plaintiffs would invest their money “prudently”, including some element of risk • Recent House of Lords judgement: the plaintiff must not be compelled to speculate. Hence, the allowable discount rate is now lower • This may encourage more structured settlements • But lump sum award amounts will rise • Difficult to estimate the effect. Consider:- • new claims handling strategies • changes in reserves for outstanding claims • “as-if” effect on a sample of settled claims

20. The Spanish Baremo • Historically, motor liability awards in the Spanish courts were extremely unpredictable • 1996: The Baremo legislation, to make awards more predictable • A bodily injury reimbursement schedule with a daily living allowance • 1999: Payment levels for the daily living allowance increased

21. Effects of the Baremo • As liability awards are more predictable, plaintiffs are more likely to settle • Loss experience before and after the Baremo is not comparable:- • payment pattern significantly shortened • age-to-age development factors are very different • Difficult to quantify

22. Summary • There are differences between pricing liability reinsurance in the US and in other countries • Examples:- • no market data • different treaty terms • diverse and changing liability environments

23. International Reinsurance Pricing and Challenges Liability Simon Sheaf Tillinghast-Towers Perrin London