The Challenges of Medium to Large Sized Commercial Insurance Risks

1. The Challenges of Medium to Large Sized Commercial Insurance Risks July 4, 2007 Presentation for the Ontario Conference of Casualty Actuaries

2. Overview • Medium to Large Sized Commercial Insurance Risks - Definition • Differences from Personal and Small Commercial Risks with respect to: • Risk Characteristics • Insurance Market Environment • Regulatory Environment • Challenges of Medium to Large Sized Commercial Insurance Risks • Conclusion • Questions???

3. Medium to Large Sized Commercial Insurance Risks - Definition • Medium to Large Commercial Risks includes (for the purpose of this presentation): • Commercial Risks with an all-lines insurance premium in excess of $25,000 • Examples:

4. Differences from Personal and Small Commercial Risks - Risk Characteristics • Large Number/Accumulation of Risks • Multiple number of properties • Multiple business transactions • Multiple number of employees • Potential multiple owned companies • Varying Loss Exposures within a Medium-Large Commercial Risk • Property Example • Province Alberta varying properties with different loss exposures such as Gov Offices, Hospitals, Museums, Laboratories, Prisons, Warehouses, Community Housing, Etc… • Liability Example • Aecon Group is involved in various types of construction projects including highways, roads, bridges, high-rises, etc….

5. Differences from Personal and Small Commercial Risks - Risk Characteristics • Loss Exposures may extend outside of Canada • Properties owned outside Canada • Products sold outside Canada • Loss Exposures are potentially unstable over-time • Exposure may change as companies: • Start new business ventures • Sale part of their business or acquire another • Change their products and services • Change management and staff • Etc… • Loss Exposures may be significantly through Risk Management (Loss Control) practices • Larger risks tend to have a Risk Manager on staff

6. Differences from Personal and Small Commercial Risks - Risk Characteristics • Insurance Structure may be complex and involve significant Self-Insured Retention • Self-Insured Retention may take form of large deductible, annual aggregate deductible, captive arrangements, …. • Example: Layered property insurance program with annual deductible: • Primary layer: 25M per claim xs of 2M per year • 1st Layer: 25M xs 25M • 2nd Layer: 50M xs 50M …… • Above characteristics make Medium-Large Commercial Risks somewhat …. unique • Insurance buyers are more sophisticated • In addition to price, often consider insurance company’s: • Quality of services (underwriting, claim and risk management) • Quality of insurance product (matching to coverage needs) • Rating from Credit Rating Agencies • Etc…

7. Differences from Personal and Small Commercial Risks - Risk Characteristics • Historical Loss Experience of the insured may be somewhat credible/reliable to predict future losses • Final/Ultimate value of losses tend to be unknown for a longer period of time • Liability claims, especially for a Medium-Large Commercial Risks, have relatively long reporting and settlement lags • Liability claims tend to be a significant portion of a typical Medium-Large Commercial Risk clam inventory • Typical Payment Pattern:

8. Differences from Personal and Small Commercial Risks – Environment • Brokerage is almost the only distribution channel and has a large role • Medium-Large Commercial Risks require broker’s expertise on: • What coverages and services to purchase to protect their particular loss exposures • Which insurers can provide these coverages and services • Comparing varying insurance offers • Some larger insurance protections require multiple insurers • Insurers in the Medium-Large Commercial Insurance Market are generally specialized in certain sectors only and don’t tend to write personal and small commercial business • Some reasons: Each market require different: • Skills/resources • Risk appetite • Strategy

9. Differences from Personal and Small Commercial Risks – Environment • Very limited rate and form regulation • Automobile risks tend to be fleets (5 or more vehicles…) which are not regulated for rates

10. Challenges of Medium to Large Sized Commercial Insurance Risks • Focus here is on Challenges that are more specific to Medium-Large Commercial Risks Insurers • Many Challenges are common for Personal, Small, Medium or Large Commercial risks insurers • Consistency of profitability during Insurance Market cycles is arguably the biggest challenge…. • Broker has significant influence to the client’s buying decisions • Price is only one consideration in the decision making process, not the only one • Broker may recommend an insurer’s offer over an other based on: • Insurer’s superior products and services • Broker’s relationship with insurer and its representatives • Medium-Large Commercial Risks Insurers will tend to invest significant amount of time and money toward building broker relationships

11. Challenges of Medium to Large Sized Commercial Insurance Risks • Product and Services Development • Is a typically significant part of a Medium-Large Commercial Risks Insurer – due to extensive loss exposures and risks uniqueness • Challenges of Product and Services Development include: • Frequency of development needs as changes occur in the loss exposures, competitors products, … • Significant expertise required from product specialists, underwriting, legal, claims, risk control….. • Acquiring and maintaining that expertise • Many Insurers leverage from parent company’s expertise • Variety of Products and Services available in the market • Challenges brokers and insurers to understand the differences between insurers products. • Challenges insurers’ ability to highlight the advantages of its products • Some insurers provide product comparisons and broker training

12. Challenges of Medium to Large Sized Commercial Insurance Risks • Exposure Rates (from rate manuals) can be estimated but are not accurate for any individual risk • Rate manuals do not reflect all the risk characteristics affecting the loss exposure and several Rate manuals’ rating variables are not based on statistical modeling. Reasons include: • Small volume of business relative to the large number of risk characteristics • Some risk characteristics are not captured in the company data • Industry data only captures some characteristics and is reporting is voluntary • Medium-Large Commercial Risks insurers have knowledgeable and experienced underwriters to: • Analyze each risk individually to understand its particular loss exposures (time-consuming process) • Adjust, sometimes very significantly, the risk’s exposure rate accordingly

13. Challenges of Medium to Large Sized Commercial Insurance Risks • Loss Experience Rating can be done but is challenging • Challenges include: • Reconciling various historical claims listings between potentially: • Past insurers listing • Broker’s listing • Claim adjuster’s listing • Client’s listing • Adjustment of historical experience for change in the risks’ exposures and insurance coverage • Typically use an exposure base (insured values, revenues, …) to approximate the change • May require adjustment/elimination of some past losses (examples: change in coverage for sexual abuse claims, change in deductibles, etc…)

14. Challenges of Medium to Large Sized Commercial Insurance Risks • Adjustment of historical claims experience for late reported claims and adequacy of open claims reserves (IBNR) • Typically done using factor from internal statistical analysis but additional challenge of varying adequacy of open claims reserves by company • Judgment and reasonability/benchmarking check is key • Adjustment for appropriate cat and large loss loadings • Adjustment for exposures without past losses • Projecting losses under different and sometimes complex insurance structures (annual aggregate deductibles, etc…) • Aggregate Loss distribution modeling is useful but the data used in the model tend to be limited…. • Overall credibility of the loss experience rating premium indication …after all these adjustments. I.E. What is a reasonable premium range around that indication? • Again, lots of subjectivity requiring excellent judgment!

15. Challenges of Medium to Large Sized Commercial Insurance Risks • True profitability of current portfolio is not accurately known due to the uncertainty surrounding the large amount of unpaid claims • Challenges the management team when deciding on the underwriting actions required on renewal and new business going forward • Increases the importance of reserve reviews and the proper allocation of IBNR by insurance segments within the company

16. Challenges of Medium to Large Sized Commercial Insurance Risks • Claims are more complex to handle. • Often coverage is less certain and requires careful investigation and evaluation. • How do you confirm coverage on a vehicle when the fleet is made up of several hundred vehicles? Do you have a schedule and is it up to date? • How do you evaluate the adequacy of policy limits when stock is moving between 15 locations? How do you assess the value of stock at the various stages of production? • How do you evaluate your exposure for a building loss when there are 200 locations insured on a blanket basis. • How do you estimate your exposure to a class proceeding? • At times the policies are written on “manuscript wordings” which will have specific conditions unique to the insured. How do you price the impact of these changes?

17. Challenges of Medium to Large Sized Commercial Insurance Risks • The policies may involve various forms of retention by the insured. • For example is there a Third Party Deductible or Self Insured Retention (SIR)? We are required to post reserves for third party deductibles. We don’t reserve for SIR amounts. This impacts the amount of capital that we have tied up in reserves. • Does the retention amount include adjusting and legal expenses? If it does, when are these amounts paid, before or after settlement? • Is there an Aggregate limit to the retention? Who will manage the claims with-in the retention and monitor the Aggregate development? Will you need to perform audits to make sure the handling matches your own reserve philosophy? • Will the payment process involve a trust account. Who manages the account and are letters of credit required?

18. Challenges of Medium to Large Sized Commercial Insurance Risks • The insured often has greater choice over the level of claims service they require and how they want that service provided. • Who will do the claims investigation? Does the insured want to use an independent adjuster on all of their losses? Who pays for the additional costs associated with this. • Unlike Personal Lines, Commercial clients are often expected to have a certain number of claims. Who will manage the claims data so everyone is aware of the program development. • Does the insured have a list of preferred vendors they want to use for repairs? How will this impact on your claims costs. • Do they have a good internal risk management process? How can we help them understand the benefits of this? If they don’t have a process how will this impact the losses?

19. Conclusion • Medium-Large Commercial Insurance Market is very challenging for all the competing insurers • In a market where information is available to help determine what the appropriate rate should be,it is often the less informed market that drives the price. • A commercial insurers real strength is in having the knowledge and ability to select the right risk with-in this pricing reality. • Insurers in that market are risk takers as claims can be severe and many decisions are made without complete statistical support • Outperforming the competition requires superior expertise and resources, and collaboration, especially between: • Underwriting • Claims • Actuarial • Management • Questions??