Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt...
-
Upload
lee-porter -
Category
Documents
-
view
236 -
download
0
Transcript of Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt...
Ratemaking: An ERM Function
CAS Ratemaking Seminar
March 13 & 14, 2006
Russ Bingham, Hartford
Curt Parker, Grange Mutual
John Kollar, ISO
CAS ERM Definition• Process
– Assess,– Control,– Exploit,– Finance,– Monitor risk
• Holistic treatment of risk
• Senior management function
• Upside and downside
ERM “Drivers”• Improved corporate governance
– Sarbanes Oxley Act
• Consolidation • Financial services convergence• Globalization – International Association of
Insurance Supervisors (IAIS)• International insurance accounting standards
– Solvency II – International Accounting Standards Board (IASB)
• Risk management evolution
Some OTHER Ratemaking Questions(Outline)
• Adequacy of reserve estimates?
• Capital adequacy?
• Risk measurement by line, state, etc.?
• Reinsurance? Amount? Cost? Risk transfer?
• Marketing program?
• Underwriting guidelines?
• Underwriting cycle position?
• Predictive modeling? Adverse selection?
Loss Reserve AdequacyShort-Tailed vs. Long-Tailed Lines
Short-Tailed Lines
Release most capital at the end of 1st year.
Long-Tailed Lines
Release a portion of capital at the end of each year.
Year 1 Year 2 Year 3 Year 4 Y1 Y2 Y3 Y4
Reserve Risk:Average Size and Volatility of GL
Open Claims Increases Over TimeBig Claims Settle Slowly
0 1 2 3 4 5 6
Open After n Years
Cla
im A
mo
un
t
95th %Mean
Capital RequirementsLoss Volatility
} }Less Capital
More Capital
Expected costs
Insurer A Insurer B
Years Years
Correlation = More Volatility
LineA
LineB
LineC
LineD
Total
{Capital}Capital
Low Correlation
HighCorrelation
Total
Insurer A Insurer B
Correlation increases with volume
Correlation and Risk Size
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
Size of Risk
Co
rre
lati
on
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9
Cumulative Probability
Lo
ss A
mo
un
t
Aggregate Loss Distribution& Implied Economic Capital
Value at Risk
TVaR
Different measures of risk imply different amounts of economic capital
Implied Capital
2xStd. Dev. VaR@99% TVaR@99%
Am
ou
nt
CapitalLiabilities
Risk Measurement & (Cost of) Capital Allocation by Line, etc.
CMP HO Auto Cat Multiline
Am
ou
nt
Diversification Benefit
Standalone
Note capital isallocated to loss reserves
Cost of Financing Risk = Cost of Capital + Net Cost of Reinsurance • Cost of capital reflects:
– Release of capital as claims are resolved– Discounted at the target rate of return on capital– Rate of return on invested assets
• Net cost of reinsurance is the difference of the ceded premium and the expected reinsurance recovery after it has been reduced for:– Discounted cash flows– Federal income taxes
• Minimize the cost of financing risk.
Optimize reinsurance by minimizing the cost of financing
Cost of Financing Insurance
No Re Cat Re All Re
Am
ou
nt
Net Cost of ReinsCost of Capital
Reinsurance Risk Transfer Testing
Aggregate Loss Reserve Distribution
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800
Loss Reserves ($Millions)
Cu
mu
lati
ve
Pro
ba
bil
ity
Expected losses
Marketing/Underwriting StrategyReflect Risk in Planning Change
Growing the Business
Standalone Standalone Standalone Total Total
Req
uir
ed C
apit
al
Prospect 1Prospect 2Existing
RatemakingSetting Combined Ratio
Targets by Line
• Expected losses
• Expected expenses
• Investment income
• Cost of financing– Cost of reinsurance– Cost of capital (risk)
Standard RatemakingExhibit Scroll to end –>
Cost of Financing
Target Combined
Ratio
Set combined ratio targets by line and overall
Target Combined Ratios
96%
98%
100%
102%
104%
106%
108%
CMP HO Auto Cats Total
Underwriting CyclePricing Risk
• Develop a number of pricing scenarios reflecting marketplace conditions (cycle).
• For each pricing scenario:– Adjust premiums.– Calculate (projected) combined ratio.– Calculate (projected) return on capital.
Predictive ModelingRisk of Adverse Selection
• Use of other information (beyond rating variables) to more accurately rate a policy– Increased profits– Reduced risk– Lower economic capital
• Inability to select better policies and compete with other insurers results in adverse selection– Losses or reduced profits– Increased downside risk– Higher economic capital
Confidence Interval Around the Target Combined Ratio
0
0.2
0.4
0.6
0.8
1
0 20 40 60 80 100 120 140 160 180
Combined Ratio (%)
Cu
mu
lati
ve
Pro
ba
bili
ty
CDFTarget Combined
Ratio (104%)
Robust Analysis of an Enterprise’s Risks (ERM) is
Essential to Sound Ratemaking!