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1999 CAS Seminar on Ratemaking

1999 CAS Seminar on Ratemaking. Multiple Uses of Stop Loss Reinsurance. Brian Brown - Milliman & Robertson, Inc. Larry Frank - Pegasus Advisors, Inc. Lisa Walsh - London Life & Casualty Reinsurance Corporation. 1999 CAS Seminar on Ratemaking. Stop Loss Reinsurance. Introduction

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1999 CAS Seminar on Ratemaking

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  1. 1999 CAS Seminar on Ratemaking Multiple Uses of Stop Loss Reinsurance Brian Brown - Milliman & Robertson, Inc. Larry Frank - Pegasus Advisors, Inc. Lisa Walsh - London Life & Casualty Reinsurance Corporation

  2. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance • Introduction • Characteristics • Pros and Cons • Case Studies • Stabilize Results/Reduce Reinsurance Cost • Finance Growth • Adverse Development Protection • Questions and Answers Presentation Overview

  3. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance • What is it? • Who Buys it? • Motivation to Purchase? Introduction

  4. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance • Retention/Attachment • Limits (Sublimits) • Experience Account (Profit Commission) • Margin • Premium Schedule • Term (annual or multiyear) • Funds Transfer/Funds Withheld Characteristics

  5. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Pro Stop loss reinsurance is significantly less expensive than working or low layer traditional reinsurance. Con No immediate cash recovery under stop loss as compared to traditional. Somewhat offsetting this is the ability for buyers to withhold premiums under stop loss (i.e., no large cash outflows). Pros and Cons

  6. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Pro Stop loss reinsurance provides broader reinsurance protection/smoother underwriting results and lower loss ratios than working or low layer traditional reinsurance. Con Some traditional reinsurance coverages provide unlimited coverage whereas stop loss is finite. Pros and Cons

  7. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Pro Stop loss reinsurance profit sharing terms normally provide a contractual device to build off-balance sheet banks including interest on premium funds. Con Traditional reinsurance has less appearance of being financial so it is subject to less regulatory scrutiny for risk transfer. Pros and Cons

  8. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Pro A technical review of the reinsurance income/surplus protection vs. cost will reveal that stop loss is generally a more effective and efficient way to buy reinsurance. Con Stop loss reinsurance is very technical and requires more time to arrange (i.e., CFO or Chief Actuary). Pros and Cons

  9. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Case Study #1 Prospective Accident Year Stop Loss Stabilization of results and reduction of reinsurance costs.

  10. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Company Information

  11. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss • Provide cat protection at a low cost • Stabilize results • Reduce total reinsurance costs • Protect earnings and surplus • Maintain expense ratio • Maintain or improve AM Best rating • Incorporate sufficient risk transfer (timing & u/w risk) for accounting approval Objectives

  12. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Stop Loss Terms

  13. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Stop Loss Terms

  14. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Stop Loss Terms • All other reinsurance purchased inures to the benefit of this cover. • Funds Withheld - F/W. • F/W balance is credited a contractual rate of 7.0% effective annually. • Profit Commission of 100%.

  15. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Stop Loss Terms • F/W balance = All Premium; less Ceding Commission paid; less Reinsurer’s Margin; less UNL Paid by Reinsurer; plus Interest Credit • All FET and LOC costs are paid by the company. • Premium & Loss reporting - Quarterly bordereaux. • UNL Settlements - From F/W account first until depleted, then from reinsurer’s funds.

  16. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Accounting Results 1)Expected - No property cat losses excess of budget SNEP = $500M Subject Losses = $350M (70% L/R) (incl. expected cats) Calculations: Attachment = 65.2% x $500M= 326.0M Limit = 18% x 500M= 90.0M Ceded Losses = 350M - 326M= 24.0M Net Ceded Premium = 4.8%x500M= 24.0M Underwriting Income = 24M - 24M= 0.0M Potential PV Cost = 7.5% x 24M= 1.8M

  17. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Accounting Results 2)Partial Use - $50M cat loss excess of budget SNEP = $500M Subject Losses = $400M (80% L/R) (incl. $50M unplanned cats) Calculations: Attachment = 65.2% x $500M= 326.0M Limit = 18% x 500M= 90.0M Ceded Losses = 400M - 326M= 74.0M Net Ceded Premium = 4.8% x 500M= 24.0M Add’l Premium=52.5%x(400M-376M)= 12.6M Total Premium = 24.0M + 12.6M= 36.6M Underwriting Income=74M - 36.6M= 37.4M Potential PV Cost = 7.5% x 36.6M= 2.7M

  18. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Accounting Results 3)Full Use - $40M cat loss & $26M other xs of budget SNEP = $500M Subject Losses = $416M (83.2% L/R) (incl. $66M unplanned) Calculations: Attachment = 65.2% x $500M= 326.0M Limit = 18% x 500M= 90.0M Ceded Losses = 416M - 326M= 90.0M Net Ceded Premium = 4.8% x 500M= 24.0M Add’l Premium=52.5%x(416M-376M)= 21.0M Total Premium = 24.0M + 21.0M= 45.0M Underwriting Income=90M - 45M= 45.0M Potential PV Cost = 7.5% x 45M= 3.4M

  19. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Accounting Results 4)Favorable - $10M improvement over budget SNEP = $500M Subject Losses = $340M (68% L/R) Calculations: Attachment = 65.2% x $500M= 326.0M Limit = 18% x 500M= 90.0M Ceded Losses = 340M - 326M= 14.0M Ceded Premium = 4.8% x 500M= 24.0M Return Premium Accrual* = 9.8M U/W Income=14M - 24M + 9.8M= -0.2M Potential PV Cost = 7.5% x 24.0M= 1.8M * Accrual = 24M - 1.8M margin + interest credit of 1.6M - 14M losses = 9.8M

  20. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Reinsurer’s Analysis • Client Assessment - Published Rating • Senior Management to communicate objectives • Client Data Requirements • Losses - historical and projected • Payout pattern projections and support • Mix of business - historical and projected • Catastrophe exposure information/modeling

  21. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Reinsurer’s Analysis • Supplementary Data • Industry Losses • Industry Payout Patterns • Other client information • Press releases

  22. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Reinsurer’s Results At expected payout

  23. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Reinsurer’s Results Payout pattern shifted one year forward.

  24. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Company’s Results with Stop Loss

  25. 1999 CAS Seminar on Ratemaking Case Study #1Prospective Accident Year Stop Loss Stop Loss versus a Traditional Cover Scenario 2 with $50M catastrophe * Traditional cover with $50M in limits for a 20% rate of line. Reinstatement premium of 1 at 100% as to time, prorata as to amount. ** Reinsurer’s PV cost = $1.8 million @ expected level..

  26. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Case Study #2 Financing Growth

  27. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Company Information

  28. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Company Objectives • To expand premium writings. • To increase Statutory Surplus • Reduce gross and net leverage tests (Premiums and Liabilities) • Maintain or improve AM Best ratings • Improve RBC test results

  29. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Stop Loss Terms

  30. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Stop Loss Terms

  31. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Stop Loss Terms • All other reinsurance purchased inures to the benefit of this cover. • Funds Withheld (F/W). • F/W balance is credited a contractual rate of 7.0% effective annually. • Profit Commission of 100%.

  32. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Stop Loss Terms • F/W balance = All Premium; less Ceding Commission paid; less Reinsurer’s Margin; less UNL Paid by Reinsurer; plus Interest Credit • All FET and LOC costs are paid by the company. • Premium & Loss reporting - Quarterly bordereaux. • UNL Settlements - From F/W account first until depleted, then from reinsurer’s funds.

  33. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Accounting Results 1)Expected SNEP = $75M Subject Losses = $63.8M (85% L/R) Calculations: Attachment = 70.0% x $75M= 52.5M Limit = 30% x 75M= 22.5M Ceded Losses = 63.8M - 52.5M= 11.3M Net Ceded Premium = 5.25%x75M= 3.9M Underwriting Income = 11.3M - 3.9M= 7.4M Potential PV Cost = 12.0% x 3.9M= 0.5M

  34. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Accounting Results 2)Full Use SNEP = $75M Subject Losses = $75M (100% L/R) Calculations: Attachment = 70.0% x $75M= 52.5M Limit = 30% x 75M= 22.5M Ceded Losses = 75M -52.5M= 22.5M Net Ceded Premium = 5.25% x 75M= 3.9M Add’l Premium=20%x(75M-63.8M)= 2.3M Total Premium = 3.9M + 2.3M= 6.2M Underwriting Income=22.5M - 6.2M= 16.3M Potential PV Cost = 12.0% x 6.2M= 0.7M

  35. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Accounting Results 3)Only 25% Growth in Premium - Expected Losses SNEP = $62.5M Subject Losses = $53.1M (85% L/R) Calculations: Attachment = 70.0% x $62.5M= 43.8M Limit = 30% x 62.5M= 18.8M Ceded Losses = 53.1M -43.8M= 9.3M Net Ceded Premium = M&D = 3.9M Underwriting Income=9.3M - 3.9M= 5.4M Potential PV Cost = 12.0% x 3.9M= 0.5M

  36. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Reinsurer’s Analysis • Client Assessment - Financial Statements • Client Data Requirements • Losses - historical and projected • Payout pattern projections • Paid and incurred data triangles • Pricing history (Rate filings, deviations) • Marketing strategy and support

  37. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Reinsurer’s Analysis • Supplementary Data • Industry Losses • Industry Payout Patterns • Other client information • Press releases

  38. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Reinsurer’s Results With $75M SNEP and expected payout

  39. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Reinsurer’s Results With $75M SNEP and payout pattern shifted one year

  40. 1999 CAS Seminar on Ratemaking Case Study #2Financing Growth Company’s Results with Stop Loss

  41. 1999 CAS Seminar on Ratemaking Stop Loss Reinsurance Case Study #3 Facilitating a Sale Adverse Development Cover

  42. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Company A (to be Acquired) Information

  43. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Company B (Buyer) Information

  44. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale • Company B requires Company A to arrange at least $150M of limit above the year end carried loss and alae (L&ALAE) reserves. • Cover must be placed contemporaneously with the sale of the company (EITF D 54-Accounting). • Retention to be set to equal carried L&ALAE reserves less premium expense of coverage (u/w income neutral). Adverse Development Coverage (ADC)

  45. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Company A at Closing: • Purchase of ADC is u/w neutral. • Federal Income Tax benefits (discount of reserves). • Surplus is maintained. Combined Companies: • Future earnings reduced by lost investment income on expensed premium by A for the ADC. • Future earnings protected by the offset of any direct L&ALAE development with up to $150M of reinsurance recovery. Accounting Implications

  46. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale ADC Key Terms

  47. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Combined Company’s Annual Results

  48. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Reinsurer’s Analysis • Client Assessment - Published Rating • Client Data Requirements • Independent Actuarial Review • Internal Projections • Confidence Intervals • Incurred Loss Triangles • Paid Loss Triangles

  49. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Reinsurer’s Analysis • Client Data Requirements (continued) • Historical pricing of business • Historical inuring reinsurances • Claims audits • Reserving policies • Changes to claims handling

  50. 1999 CAS Seminar on Ratemaking Case Study #3Facilitating a Sale Reinsurer’s Analysis • Supplementary Data • Industry Losses • Industry Payout Patterns • Peer company information • Press releases

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