Pricing Strategies for Multi-Line Multi-Year (MLMY) Policies

1. Pricing Strategies for Multi-Line Multi-Year (MLMY) Policies April 12, 1999 CAS Financial Risk Management Seminar Denver, Colorado Nathan J. Babcock, ACAS, MAAA Deloitte & Touche LLP

2. Agenda I. MLMY Advantages, Disadvantages II. Pricing Example III. MLMY Pricing Considerations IV. Risk Loads V. Business Dynamics

3. MLMY Advantages • Insurer/Seller • Extended duration of premium receipts • Enhanced market share • Relief from market cycles • Higher “implied” renewal rates generating a more “seasoned” book • Development of long-term relationships

4. MLMY Advantages • Insured/Buyers • Lower, more stable premium • Lower commission • Simplified administration • Relief from market cycles • Enhanced Corporate Risk Management focus • Coverage for traditionally uninsurable risks • Guaranteed renewal • Customized program

5. Insurer/Seller Limited ability to react to poor experience by increasing rates Complex pricing Complex profitability measures Allocation issues (WP, UPR, capital) MLMY Disadvantages

6. MLMY Disadvantages • Insured/Buyer • Possibility of an aberrant line or loss impacting overall coverage for all lines • Opportunity cost of locking-in • Lack of focus on traditional risk management • “All eggs in one basket”

7. Pricing Example

8. Traditional Pricing Approaches • Burning cost • On-level historical loss ratios • Exposure rating • Monte Carlo simulation

9. Policy Example Baseline Assumptions • Pricing of a layer excess of a self-insured retention • SIR applies per occurrence to all lines, with annual and term aggregates • Lines considered: WC, GL, EQ, FX • Model output = losses and premiums by layer

10. Example Loss Metrics WC Mean = $12 MM Std dev = $1.5 MM CV = 0.125 GL Mean = $4 MM Std dev = $1 MM CV = 0.250 EQ Mean = $2 MM Std dev = $25 MM CV = 12.500 FX Mean = $3 MM Std dev = $5 MM CV = 1.667

11. Scenario I $100 mm annualaggregate limit $25 mm per occ. and ann. agg. SIR WC sublimit - $500k per occ. SIR Year 1

12. Scenarios II & III (implicit $300 mm term aggregate) $100 mm ann aggregate $100 mm ann aggregate $100 mm ann aggregate Prog: $25 mmWC: $500K Prog: $25 mmWC: $500K Prog: $25 mmWC: $500K Year 1 Year 2 Year 3

13. Scenario IV $100 mm term aggregate limit $100 mm ann agg. $100 mm ann agg. $100 mm ann agg. Prog: $25 mmWC: $500K Prog: $25 mmWC: $500K Prog: $25 mmWC: $500K Year 1 Year 2 Year 3

14. Modeled Premiums • Scenario I (1 one-year policy) $5 mm • Scenario II (3 one-year policies) $15 mm • Scenario III (1 three-year policy) $12.5 mm • Scenario IV (3-year policy with a term limit) $12 mm

15. Multi-Line / Multi-YearPricing Considerations

16. Portfolio Effect

17. Correlation • Among lines of business • Among multiple years • More or less risk?

19. Discount Rate • Implied risk margin • Paying the “last losses” on aggregate • Appropriate patterns of premium and loss payments

20. Reinstatements • Use Monte Carlo simulation output to determine likelihood of limits “blown” • Or, model likelihood of limits “blown” once a significant loss has occurred. • When would limits be reinstated • Very judgmental -- adjust insured’s assumed loss distribution for large loss that has occurred?

21. Additional MLMYPricing Considerations • Exposure growth • Sublimits/Towers • Knockout features • Residual Retentions

22. “THE INSURANCE PREMIUM FORMULA” P = (expected losses) + (risk load) 1 - (expense ratio)

23. Risk Loads

24. Risk Load Considerations Insured-Specific Attributes • Loss distribution - standard deviation • Loss distribution - coefficient of variation • Confidence level desired

25. Risk Load Considerations Insurer-Specific Attributes • Return on equity/surplus • Expected policyholder deficit • Limitations on probability of ruin • Probability of surplus declining by xx% • Value of RBC or AM Best ratings

26. Risk Load Considerations Categories of risk load factors • Insured-specific = process risk • Insurer-specific = parameter risk

28. Business Dynamics • Opportunity cost of locking in • Market cycle • Renewal retention pressures • Hedges in other areas of insurer’s operations • Can risk loads be achieved? • One risk vs. entire book • As a cost of liquidity

29. Business Dynamics • Ensure no big hits early on in program • Dynamic modifications to program • Expense allocation/UPR • Accounting issues (FAS113)