Casualty Actuarial Society Loss Reserving Seminar Washington, D.C. September 18-19, 2008

1. Concurrent Session REI2Impact of Reinsurance and Reinsurers on your FinancialsEvaluating Reinsurance:Different Metrics, Different Perspectives Casualty Actuarial Society Loss Reserving Seminar Washington, D.C. September 18-19, 2008

2. A Typical Reinsurance Analysis • Company entering a new product line • Considering a reinsurance program on the new business to mitigate risk • Used a simulation model to quantify distribution of outcomes • Benefits of these models include: • Ability to consider several metrics • Easy ability to do multiple what-if’s

3. Projected Combined Ratios Gross and Net

4. Projected Combined Ratios Gross and Net

5. Measures of Risk – Reflect the Mean or Not? • Measures of pure volatility, independent of mean • Standard deviation • Percentile-based (VaR or TVar) relative to the mean • Measures that reflect level of mean as well • Percentile-based on absolute result (e.g., underwriting profit or combined ratio) • Probability of ruin or capital impairment

6. Standard Deviation and Percentiles of Underwriting Result Average Outcome – Reinsurance Costs Money Standard Deviation – Reinsurance Reduces Downside Percentile (10%) – About the same across options

7. Risk/Reward Plot – Standard Deviation

8. Risk Reward Plot – Downside Percentiles

9. Measures That Integrate Risk and Reward • When risk/reward plots slope up to the right, they usually do not clearly indicate a “best” option • Economic Value Added (EVA), Return on Risk Adjusted Capital (RORAC), etc. translate the risk measure into a cost of capital, which is measured in the same units as the average outcome, so they can be netted against each other EVA = Avg. Rtn. – (Capital Rqd. x Cost of Capital), where Capital Required is function of risk

10. Sample EVA Calculation • Note that with EVA, zero is a good outcome • Answer often depends crucially on how capital requirement is calculated (could do many sessions on this alone)

11. How to Make a Decision? • Typically several metrics should be considered, as they will emphasize different aspects of risk • Management needs to articulate nature of risk it is most concerned with • Glenn’s PML curve regions gets at this directly • Sensitivity to “middle of distribution” volatility, or extreme downsides? • Willingness to accept greater volatility in pursuit of higher gains? • Focus on company level impact or segment level?

12. Zooming Out - Marginal Impact on Book of Business in Total Average Outcome – Same Marginal Effect Standard Deviation – Reinsurance still reduces, but not as much Downside Percentile (1%) – Marginal impact smaller (Product-level underwriting results from earlier page, for reference)

13. EVA for Whole Book of Business Bottom line: • Much less clear that this reinsurance helps • Final answer requires management to be clear on risk tolerance Capital Based on 1% Downside Capital Based on 0.1% Downside

14. Effects of Volume • If some is good, more is not always better…..

15. Summary • Multiple perspectives, depending on management priorities • Absolute downside • Earnings stability • Appetite for higher reward/aversion to higher risk • Need to consider marginal impact on whole company