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Specialty Lines Pricing

Specialty Lines Pricing. Gerson Smith CARe Seminar Washington, D.C. July 11, 2001. Surety Excess-of-Loss Reinsurance Pricing. Experience Rating Exposure Rating Economic Conditions Market Conditions . Surety Bonding: Estimation of Loss Amounts. Contract Balances (Revenues)

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Specialty Lines Pricing

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  1. Specialty Lines Pricing Gerson Smith CARe Seminar Washington, D.C. July 11, 2001

  2. Surety Excess-of-LossReinsurance Pricing • Experience Rating • Exposure Rating • Economic Conditions • Market Conditions

  3. Surety Bonding: Estimation of Loss Amounts • Contract Balances(Revenues) • Cost to Complete (Liabilities) • Other Costs

  4. Contract Balance = Original Contract Price +/- Change Orders - Cash Payments Made by Obligee to Principal or Surety Surety Bonding: Estimation of Loss Amounts

  5. Cost to Complete: comprised of -Variable Costs: Labor, Materials, Equipment - Fixed Costs: Subcontractors & Suppliers Surety Bonding: Estimation of Loss Amounts

  6. Other Costs: -Liquidated Costs - Unpaid Suppliers - Subcontractors’ Current Payments Due - Contingencies Surety Bonding: Estimation of Loss Amounts

  7. Experience Rating: Loss Data – What to Include? • Contract Balances • Collateral– cash or secured by LOC • Salvage (e.g. indemnities) – only when realized • Anticipated Salvage – no

  8. Surety Bonding Treatment of ALAE • Proportional Treaties – ProRata in addition • Excess-of-Loss – included in definition of loss • SAA - ALAE appr. 5% of aggregate losses (decreasing trend over time)

  9. Experience Rating:Parameter Selection • Loss Development • Trend– Severity / Frequency • Rate Level

  10. Experience Rating: Loss Development – Ground Up

  11. Experience Rating: Loss Development – Excess of Loss

  12. Exposure Rating: Limits Profiles • Per Bond vs. Per Principal • Max Work Program vs. Bonded Work-on-Hand

  13. Exposure Rating: Limits Profile Adjustments • Co-Surety %’s • Bonded/Unbonded Split • Utilization • PML • Benefit of Inuring Reinsurance

  14. Def. - Ratio of bonded work-on-hand to total limits (may be ratio to either bonded or unbonded) Dependent upon: - Amount of Construction Work (esp. public works) - Seasonality - Type of Project - Project Duration Exposure Rating: Utilization

  15. Def. - Probable Maximum Loss as a % of Exposure (may be relative to unbonded, bonded, or utilized work-on-hand) Varies by: - Region - Contractor Size - Contractor Type Exposure Rating: PML’s

  16. 1) Using cessions %’s on a per-bond basis, determine total retained % for portfolio 2) Judgmentally select per-contractor retained %’s by band, making sure to balance back to total retained % 3) Per-contractor retained %’s should decrease with contractor size Exposure Rating: Steps to Estimate Benefit of Inuring

  17. Alternate Method (where available) 1) For each contractor (or limits band), obtain number of bonds, work program limit & max bond limit 2) Assume largest bond ceded according to schedule 3) Calculate average limit excluding largest bond, apply cessions schedule. 4) Add retained amounts from 2) & 3) 5) Other possibilities, e.g. 2x or 3x average Exposure Rating: Steps to Estimate Benefit of Inuring

  18. Exposure Rating Size of Loss Curves • Loss-to-Value (PML) • Derived from coordinated loss & exposure data (preferable: remaining exposure @time of loss) • Alternate Method – Frequency/Severity approach, where severities are derived from loss data and frequencies are based on default rate for implicit contractor ratings

  19. Surety Bonding Commercial (Non-Contract) Surety • Historically low limits and small portion of XS • Gradually including larger and riskier classes • Historical loss ratios ~ 20%

  20. Surety Bonding: Historical Perspective • SAA - 30 year (net) loss ratio result = 40% • Worst Years - 1975/76 (recession) and 1986/87 (expansion) Loss ratios ~ 70%-75% • Best Years - 1989-1999 (recession & expansion) Loss ratios in the 30%’s throughout the period • Conclusion: Surety results not correlated w/economy

  21. Surety Bonding: Profitability • Contractor Profits / ROE’s follow the economy w/ peaks in mid-’80’s and mid to late ’90’s, trough in the early ’90’s • Surety Results stable since late ’80’s • Initial Conclusion: Surety results independent of construction industry profitability • Alternate Conclusion (pending updated results for 2000/2001): Surety results decline in the face of extended periods of profitability and economic prosperity

  22. Surety Bonding: Can We Anticipate the Cycle? • Difficult for High Excess-of-Loss – Random Events • Consecutive Years generally correlated • Underpricing of underlying business not as apparent as in other P/C lines • Enhancements: 1) Improved rate monitoring techniques, 2) Econometric forecasting

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