31 st ANNUAL GIRO CONVENTION

1. 31st ANNUAL GIRO CONVENTION 12-15 October 2004, Hotel Europe, Killarney, Ireland

2. Managing Overconfidence Douglas Collins doug.collins@towersperrin.com Tillinghast London (Tel: 44 (0)207 170 2162)

3. THE QUIZ • Take a few minutes, please • . • . • No individual scores will be released • . • . • We will show a graph of results at the end

4. A Fundamental Question • Why do so many underwriters continue to write business at or above historical volumes in soft markets?

5. Some Answers • We have capacity • We need to keep writing if we want to keep the business in the hard market • Management would not accept the certain loss that would result from reduced levels of underwriting • We thought equity profits/investment returns would bale us out • We didn’t realise that we were writing the business on loss-making terms

6. What Needs to Change? • The planning and budgeting process • explicit recognition of the cycle • taking a longer view • breaking the link with capacity • Alignment of interests • design of underwriter compensation packages • Greater flexibility • turn fixed into variable expense • Better management information • sound reserving embedded within pricing framework • monitoring movements in price (including impact of movements in attachment levels, T&C, exposure etc) • Managing overconfidence

7. How has the insurance industry responded? • Hire smart people • Collect lots of data Note: “DATA” ≠ “INFORMATION” ≠ “KNOWLEDGE” • Build complex models … sometimes even use them to guide decisions! • Attend conferences

8. ... and when all else fails … blame someone else • The actuaries…or underwriters…or marketing • Nature • The gods • Lawyers and judges • Competitors • The market • Customers

9. Managing Overconfidence - Origins • Behavioral science • Russo & Shoemaker • Conger & Lowe (’03), Conger & Wolstein (’04) - Emphasis Articles • Pricing & underwriting • Online quiz

10. Managing overconfidence • What do we mean by “overconfidence”?

11. Metaknowledge • An understanding of the limits of our knowledge • What do we know? • What do we NOT know? • What are the implications of not knowing?

12. Overconfidence:Implications for decision making and planning • “Lock in” to a forecast • Insufficient thought about the underlying processes • Variance within models is studied … • But what if we have the wrong parameters? • Or the wrong model? • Insufficient planning for what might vary from plan • And what to do about it • Now • Later

13. Many factors contribute to errors (and bias!) in pricing and underwriting Systemic Sources of Pricing and Underwriting Error/Bias (Macro) Common Sources of Pricing and Underwriting Error/Bias (Micro) • Long feedback loop • No skin in the game • Inadequate internal [historical] data upon which to develop estimates (e.g., old, incomplete or inaccurate data; inadequate/inappropriate sample) • Inability to collect and synthesize all relevant sources of data within the organization • Lack of reliable information about external market conditions and trends (e.g., inflation, tort costs) • Excessive concern for “competitive pressures” • Lack of adequate oversight over pricing decisions • Lack of “metaknowledge” — reinforces inherent overconfidence when making estimates, forecasts and predictions

14. 1. Define/Refine Process 3. MeasurePerformance 2. ImplementProcess The best way to manage overconfidence is to implement a control cycle for pricing and underwriting The Control Cycle: Retrospective Test of Pricing/Underwriting 1.Pricing and Underwriting Process Elements • Data required • Actuarial methods employed • Underwriting policies and rules • Decision authorities and reporting • Quality assurance 3.Formal Retrospective Performance Testing • Data accurate and adequate? • Pricing methods sufficiently robust? • Policies and rules effective? • Decision authorities appropriate? • Variances between projected and actual experience within tolerances? • A control cycle for P/C pricing and underwriting entails identifying, testing and validating all of the assumptions that underlie the projection of future loss costs used to price and underwrite the business

15. Managing overconfidence in pricing and underwriting

16. Respondents to our online Confidence Quiz did not know the limits of their knowledge 0 29 1 67 2 56 3 69 4 44 # of correct responses 44 5 28 6 18 7 12 8 IDEAL RESULT 7 9 10 # of respondents

17. How did you do?

18. The Answers (Q1-5) • £112.6B assets – top 100 UK insurers @12/02 • €13.4B Total insurance premium – new 10 EU countries in ’03 • 108 – New captives in Bermuda in ‘01 • 8,301 – Worldwide passenger deaths in1990s on commercial airline flights • 32,433 - Active Names at Lloyd’s in ‘88

19. The Answers (Q6-10) • $17,300M - New US P/C industry capital in ‘02 • 646 – Authorized General Insurers in UK in ’03 • ¥4,825B – Motor premium of top 10 insurers in Japan in ’01 • £7,356M – WW gross Marine premium in ’00 • 309 – ASTIN delegates in ’03 Berlin

20. Questions??? • Discussion???