Pricing Strategies for Multi-Line Multi-Year (MLMY) Policies April 12, 1999 CAS Financial Risk...
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Transcript of Pricing Strategies for Multi-Line Multi-Year (MLMY) Policies April 12, 1999 CAS Financial Risk...
Pricing Strategies for Multi-Line Multi-Year
(MLMY) Policies
April 12, 1999
CAS Financial Risk Management Seminar
Denver, Colorado
Nathan J. Babcock, ACAS, MAAADeloitte & Touche LLP
Agenda
I. MLMY Advantages, Disadvantages
II. Pricing Example
III. MLMY Pricing Considerations
IV. Risk Loads
V. Business Dynamics
Insurer/Seller
Extended duration of premium receipts Enhanced market share Relief from market cycles Higher “implied” renewal rates generating a more
“seasoned” book Development of long-term relationships
MLMY Advantages
Insured/Buyers
Lower, more stable premium Lower commission Simplified administration Relief from market cycles Enhanced Corporate Risk Management focus Coverage for traditionally uninsurable risks Guaranteed renewal Customized program
MLMY Advantages
MLMY DisadvantagesInsurer/Seller
Limited ability to react to poor experience by increasing rates
Complex pricing Complex profitability measures Allocation issues (WP, UPR, capital)
MLMY DisadvantagesInsured/Buyer
Possibility of an aberrant line or loss impacting overall coverage for all lines
Opportunity cost of locking-in Lack of focus on traditional risk management “All eggs in one basket”
Pricing Example
Burning cost On-level historical loss ratios Exposure rating Monte Carlo simulation
Traditional Pricing Approaches
Pricing of a layer excess of a self-insured retention SIR applies per occurrence to all lines, with
annual and term aggregates Lines considered: WC, GL, EQ, FX Model output = losses and premiums by layer
Policy ExampleBaseline Assumptions
ExampleLoss Metrics
WCMean = $12 MMStd dev = $1.5 MMCV = 0.125
GLMean = $4 MMStd dev = $1 MMCV = 0.250
EQMean = $2 MMStd dev = $25 MMCV = 12.500
FXMean = $3 MMStd dev = $5 MMCV = 1.667
Scenario I
$25 mm per occ. and ann. agg. SIR
$100 mm annualaggregate limit
Year 1
WC sublimit - $500k per occ. SIR
Scenarios II & III
Prog: $25 mmWC: $500K
Prog: $25 mmWC: $500K
Prog: $25 mmWC: $500K
(implicit $300 mm term aggregate)
Year 1 Year 2 Year 3
$100 mmann aggregate
$100 mmann aggregate
$100 mmann aggregate
Scenario IV
Prog: $25 mmWC: $500K
Prog: $25 mmWC: $500K
Prog: $25 mmWC: $500K
$100 mm term aggregate limit
Year 1 Year 2 Year 3
$100 mmann agg.
$100 mmann agg.
$100 mmann agg.
Scenario I (1 one-year policy) $5 mm
Scenario II (3 one-year policies) $15 mm
Scenario III (1 three-year policy) $12.5 mm
Scenario IV (3-year policy with a term limit) $12 mm
Modeled Premiums
Multi-Line / Multi-YearPricing Considerations
Distribution of Aggregate Losses, Relative to Expected Value
One Two Three Four
Number of Years in Policy Term
5%-50% 50%-75% 75%-95%
Portfolio Effect
Correlation
Among lines of business
Among multiple years
More or less risk?
Impact of Correlation on Risk Loads
-0.50 0.00 0.50
Line of Business Correlation
Pre
miu
m
Loss & Expense Risk Load
Discount Rate Implied risk margin
Paying the “last losses” on aggregate
Appropriate patterns of premium and loss payments
Reinstatements Use Monte Carlo simulation output to determine likelihood of limits
“blown” Or, model likelihood of limits “blown” once a significant loss has
occurred. When would limits be reinstated Very judgmental -- adjust insured’s assumed loss distribution for large
loss that has occurred?
Additional MLMYPricing Considerations
Exposure growth Sublimits/Towers Knockout features Residual Retentions
“THE INSURANCE PREMIUM FORMULA”
P = (expected losses) + (risk load) 1 - (expense ratio)
Risk Loads
Risk Load Considerations
Insured-Specific Attributes Loss distribution - standard deviation Loss distribution - coefficient of variation Confidence level desired
Risk Load Considerations
Insurer-Specific Attributes Return on equity/surplus Expected policyholder deficit Limitations on probability of ruin Probability of surplus declining by xx% Value of RBC or AM Best ratings
Risk Load Considerations
Categories of risk load factors Insured-specific = process risk Insurer-specific = parameter risk
Risk Load as a Percentage of Premium
0.0%
4.0%
8.0%
12.0%
WC WC + EQ WC + GL + EQ WC + GL + EQ + FX
Variance Standard Deviation Coefficient of Variation
Business Dynamics
Opportunity cost of locking in Market cycle Renewal retention pressures Hedges in other areas of insurer’s operations Can risk loads be achieved?
– One risk vs. entire book
– As a cost of liquidity
Ensure no big hits early on in program Dynamic modifications to program Expense allocation/UPR Accounting issues (FAS113)
Business Dynamics