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

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Specialty Lines PricingSpecialty Lines Pricing

Gerson SmithCARe Seminar

Washington, D.C.July 11, 2001

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Surety Excess-of-LossReinsurance Pricing

Surety Excess-of-LossReinsurance Pricing

Experience Rating

Exposure Rating

Economic Conditions

Market Conditions

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Surety Bonding: Estimation of Loss Amounts


Contract Balances (Revenues)

Cost to Complete (Liabilities)

Other Costs

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Contract Balance = Original Contract Price +/- Change Orders

- Cash Payments Made by Obligee to Principal or

Surety



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Cost to Complete: comprised of

- Variable Costs: Labor, Materials, Equipment

- Fixed Costs: Subcontractors & Suppliers



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Other Costs: - Liquidated Costs - Unpaid Suppliers - Subcontractors’ Current Payments Due - Contingencies



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Experience Rating: Loss Data – What to Include?

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

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Surety Bonding Treatment of ALAESurety 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)

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Experience Rating:Parameter SelectionExperience Rating:

Parameter Selection

Loss Development

Trend – Severity / Frequency

Rate Level

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Experience Rating: Loss Development – Ground

Up

Experience Rating: Loss Development – Ground

Up Age ATA ATU

12 2.500 3.26924 1.250 1.30736 1.050 1.04648 1.025 0.99660 0.993 0.97272 0.999 0.97984 0.999 0.98096 0.996 0.981108 0.992 0.985120 0.995 0.993

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Experience Rating: Loss Development – Excess

of Loss

Experience Rating: Loss Development – Excess

of Loss Age ATA ATU

12 1.950 1.62324 0.990 0.83336 0.973 0.84148 0.982 0.86460 0.995 0.88072 1.001 0.88584 0.960 0.88496 0.985 0.920108 0.978 0.934120 0.980 0.956

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Exposure Rating: Limits Profiles

Exposure Rating: Limits Profiles

Per Bond vs. Per Principal

Max Work Program vs. Bonded Work-on-Hand

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Exposure Rating: Limits Profile Adjustments

Exposure Rating: Limits Profile Adjustments

Co-Surety %’s

Bonded/Unbonded Split

Utilization

PML

Benefit of Inuring Reinsurance

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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

Exposure Rating: Utilization

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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

Exposure Rating: PML’s

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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


Inuring

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Alternate Method (where available)1) For each contractor (or limits band), obtain number

of bonds, work program limit & max bond limit2) Assume largest bond ceded according to schedule3) 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


Inuring


Inuring

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Exposure Rating Size of Loss Curves

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

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Surety Bonding Commercial (Non-Contract)

Surety

Surety Bonding Commercial (Non-Contract)

Surety Historically low limits and small portion of XS

Gradually including larger and riskier classes

Historical loss ratios ~ 20%

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Surety Bonding: Historical Perspective

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

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Surety Bonding: Profitability

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

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Surety Bonding: Can We Anticipate the

Cycle?

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

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

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