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Reinsurance Analysis: Strategies for Make Believe Inc.

Explore reinsurance strategies to optimize risk and financial performance for Make Believe Inc. with practical examples and considerations. Analyze key factors influencing cost, exposure, and business impact. Evaluate different scenarios, account balances, and asset allocation to achieve company goals.

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Reinsurance Analysis: Strategies for Make Believe Inc.

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  1. C O N N I N G A S S E T M A N A G E M E N T Analyzing Reinsurance with DFA Practical Examples Daniel Isaac Washington, D.C. July 28-30, 2003

  2. Key Considerations • Why are we changing? - Cost of current program - Rating agencies -Regulatory capital - Change in business mix/philosophy

  3. Key Considerations • How long do we need protection? - Impacts potential reinsurers - Impacts types of covers considered • How long will benefits last? - Will that change if there is a claim?

  4. Key Considerations • What other changes can we make? - Asset strategy - Capital structure - Business mix • How do these fit together? - Mitigate cost - Enhance benefits

  5. General Rules • Use several different measures - We prefer Economic Value as primary • Just considers cash flows • Eliminates accounting “noise” - Also evaluate financial metrics • Statutory Surplus • GAAP Equity • RBC Ratio

  6. Company Profile • Name: Make Believe Inc. (MBI) • Size: $150 MM Net Premium • Growth: 10 - 15% per year • Mix 60/40 Commercial/Personal 60/40 Liability/Property • Time Horizon: 5 years

  7. MBI Concerns • Recently went public - Very concerned about GAAP Income - Also very concerned about volatility • Wants to increase equity exposure - Very conservative asset portfolio - 98% bonds - Mostly high quality (A or better) and short-term - Expect higher returns long-term

  8. Option #1 • Buy traditional coverage - 10 x 70 accident year loss ratio coverage - 2% of earned premium - 1 year cover which is annually renewed • Increase equity allocation - Consider 10 and 20% allocations

  9. Results Option #1

  10. Results Option #1

  11. Summary - Option #1 • Reinsurance - Successfully reduces risk • 25% lower standard deviation • less downside - Negatively impacts income • Equities - Further drop in GAAP Income - Little additional risk • Overall - Hit to income is too great

  12. Option #2 • Add experience account balance to Option #1 - Same coverage 10 x 70 accident year loss ratio - Increase price from 2% to 5% - 5 year cover with separate limits by accident year • Experience account balance - 80% of reinsurance premium added for each accident year - Positive balances earn equity returns - Any time after the end of the fifth calendar year, MBI can commute the treaty and claim the positive balance • No change in asset allocation

  13. Results - Option #2

  14. Results - Option #2

  15. Summary - Option #2 (cont.)

  16. Summary - Option #2 • Achieves company’s goals - Improves average GAAP income - Increases equity exposure • Other benefits - Lock in the price and coverage for five years - Commutation provision allows company flexibility - Lower RBC charge for reinsurance recoverable than equity

  17. Summary - Option #2 • Disadvantages - Makes stock returns currently taxable • Normally, stock returns are only taxed when realized • Changes in experience account balance flow through income • Hurts ending shareholder equity • No reduction in volatility

  18. Summary - Option #2 • Disadvantages - In good scenarios, experience account balance would become a large (-20%) portion of assets • May concern regulators • Muted, to some extent, by commutation provision

  19. How Many Scenarios? • Most DFA models create large number of scenarios - Monte Carlo simulation - Allows “complete” scenarios - Other methods are available • Simulation creates the possibility of sampling error - Large samples reduce this possibility - Can be very time and resource consuming

  20. How Many Scenarios? • The “right” number of scenarios is based on: - Volatility of results - Metrics being used - Simulation methodology - Independent vs Dependent

  21. How Many Scenarios? Definitions: Reward: Average ending Economic Value Risk: Mean - 1st percentile

  22. How Many Scenarios? Sample Size based on: Reward: Net cost under $6 million Risk: Reduced at least $40 million

  23. How Many Scenarios? • Different strategies are highly correlated - Same gross underwriting - Same economy • Maintaining correlation in modeling process reduces sampling error - Still have to consider parameter risk

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