Risk Transfer Risk Transfer In The Real WorldIn The Real World

Presented Presented byby

Jane C. Taylor, FCAS, MAAAJane C. Taylor, FCAS, MAAAJunction Consulting, Inc.Junction Consulting, Inc.

Casualty Loss Reserve SeminarCasualty Loss Reserve SeminarBoston, MABoston, MA

September 12, 2005September 12, 2005

Risk Transfer: History Risk Transfer: History Lesson 1980’s & Lesson 1980’s & 1990’s1990’s Disguised LoansDisguised Loans

– ““Borrow” $50MM Surplus AssistanceBorrow” $50MM Surplus Assistance– ““Pay” $35MM for AssistancePay” $35MM for Assistance– Special Terms Special Terms

Repayments Scheduled, i.e. $5MM per yearRepayments Scheduled, i.e. $5MM per year Funds Withheld – No Assets TransferredFunds Withheld – No Assets Transferred Guaranteed Interest Rate CreditedGuaranteed Interest Rate Credited

Year End Portfolio TradesYear End Portfolio Trades– Benefited both company’s bottom lineBenefited both company’s bottom line– No risk to either companyNo risk to either company

Risk Transfer Risk Transfer RegulationRegulation Began Late 1980’s and Early 1990’sBegan Late 1980’s and Early 1990’s

– Securities & Exchange CommissionSecurities & Exchange Commission– Financial Accounting Standards BoardFinancial Accounting Standards Board

FAS 113FAS 113– National Association of Insurance National Association of Insurance

CommissionersCommissioners Disclosures in Annual StatementsDisclosures in Annual Statements Chapter 22 (Now SSAP 62)Chapter 22 (Now SSAP 62)

Risk Transfer: History Risk Transfer: History Lesson 1990’s & Lesson 1990’s & 2000’s2000’s Finite ReinsuranceFinite Reinsurance

– Little or no risk to reinsurerLittle or no risk to reinsurer– Unusual termsUnusual terms– Year end transactionsYear end transactions– Smoothed or overstated balance Smoothed or overstated balance

sheet / income statementsheet / income statement– Interlocking companies / Interlocking companies /

directorates / ownership / influencedirectorates / ownership / influence

Risk Transfer Risk Transfer RegulationRegulation Began Early 2000’sBegan Early 2000’s

– New York Attorney General SpitzerNew York Attorney General Spitzer Criminal ChargesCriminal Charges Law suitsLaw suits

– National Association of Insurance National Association of Insurance CommissionersCommissioners Changes to Annual StatementChanges to Annual Statement Proposed Changes to SSAP 62Proposed Changes to SSAP 62

What Really Happens?What Really Happens? Pre Contract Effective DatePre Contract Effective Date

– Is there Risk Transfer?Is there Risk Transfer?– Terms FluidTerms Fluid– Internal Data Limited / Data CredibilityInternal Data Limited / Data Credibility– Unusual Policy Form / Terms / ConditionsUnusual Policy Form / Terms / Conditions

Post Contract Effective DatePost Contract Effective Date– Terms SetTerms Set– Same Data Credibility IssuesSame Data Credibility Issues– Same Policy Form / Term / Conditions IssuesSame Policy Form / Term / Conditions Issues– Funds TransferredFunds Transferred– Contract Signed within 9 months?Contract Signed within 9 months?

Now What?Now What? Get a copy of the Cover Slip or ContractGet a copy of the Cover Slip or Contract

– Read itRead it– Read it againRead it again– Ask Questions for Better UnderstandingAsk Questions for Better Understanding– Diagram / Analyze / Write Out TermsDiagram / Analyze / Write Out Terms

Co Reinsurerrr

Agg ReinsurerDed

Retention

Losses Loaded 100 / 85Aggregate Deductible $3MM

Percent of Loss

Reins Rate GNWP RatioMinimum 5.00% 0.45

Provisional 8.00% 0.60

Maximum 15.00% 0.75

Now What?Now What? Is there insurance risk?Is there insurance risk? Reasonable possibility of significant Reasonable possibility of significant

lossloss Effective Date of ContractEffective Date of Contract

– Contract Signed within 9 months?Contract Signed within 9 months? Other contracts (“reinsurance” or Other contracts (“reinsurance” or

otherwise) between same two parties otherwise) between same two parties / subs / affiliates? / subs / affiliates?

Quota Share Quota Share ReinsuranceReinsurance Simple Quota ShareSimple Quota Share Complex Quota ShareComplex Quota Share

– CapsCaps– Corridor / Loss SharingCorridor / Loss Sharing– Sliding Scale CommissionSliding Scale Commission– Profit SharingProfit Sharing

Excess ReinsuranceExcess Reinsurance Simple ExcessSimple Excess Complex Excess such asComplex Excess such as

– Sliding ScaleSliding Scale– Stop LossStop Loss– Cat CoverCat Cover

Complex TermsComplex Terms– CappedCapped– Loss Carry ForwardLoss Carry Forward– CorridorsCorridors– Etcetera, Etcetera, Etcetera Etcetera, Etcetera, Etcetera

IssuesIssues Major Issue – Sufficient DataMajor Issue – Sufficient Data

– InternalInternal May not be credibleMay not be credible Mix may have changedMix may have changed

– Reference CompanyReference Company Match books of businessMatch books of business Specialized policy termsSpecialized policy terms

– IndustryIndustry Special policy termsSpecial policy terms Access to informationAccess to information

AnalysisAnalysis Exception to FAS 113Exception to FAS 113 Focus on maximum lossFocus on maximum loss

– Payment pattern of retentionPayment pattern of retention– Payment pattern of loss to reinsurerPayment pattern of loss to reinsurer

Focus on gross premiumFocus on gross premium– Gross of ceding commissionGross of ceding commission– Receipt of premium patternReceipt of premium pattern– Losses Losses

Determine reasonable rate of returnDetermine reasonable rate of return

Quota ShareQuota Share Same economic position?Same economic position?

– Simple Quota ShareSimple Quota Share Falls in exceptionFalls in exception

– Quota Share with Caps / Corridors / Quota Share with Caps / Corridors / Deductibles / RetentionsDeductibles / Retentions Exception or Full Analysis?Exception or Full Analysis?

Sliding Ceding Sliding Ceding Commission Quota Commission Quota ShareShare Quota Share of General LiabilityQuota Share of General Liability Sliding Scale Ceding CommissionSliding Scale Ceding Commission

Loss Ratio

Ceding Commission

Ratio

Reinsurer Combined

Ratio

0.400 0.3375 0.73750.625 0.2750 0.90000.725 0.1750 0.9000

Cap: 140.0%Cap: 140.0%

Sliding Ceding Sliding Ceding Commission Quota Commission Quota ShareShare Start with 10-10 RuleStart with 10-10 Rule 10% Probability of 10% loss10% Probability of 10% loss Therefore, loss ratio must be Therefore, loss ratio must be

110.0% - 72.5% - 17.5% = 20.0%110.0% - 72.5% - 17.5% = 20.0% Loss Ratio = 72.5% + 20.0% = 92.5%Loss Ratio = 72.5% + 20.0% = 92.5%

Probability of Loss > 92.5% = 4.27%Probability of Loss > 92.5% = 4.27%

Excess “Pass Through”Excess “Pass Through” Same economic position?Same economic position?

– Reinsurer assumes all premium for Reinsurer assumes all premium for layer and all loss for layerlayer and all loss for layer

– Excess Caps / Corridors / Excess Caps / Corridors / Deductibles / Retentions on LayerDeductibles / Retentions on Layer Exception or Full Analysis?Exception or Full Analysis?

All Other ExcessAll Other Excess Same economic position?Same economic position?

– Sliding ScaleSliding Scale– Excess Caps / Corridors / Excess Caps / Corridors /

Deductibles / Retentions on LayerDeductibles / Retentions on Layer Exception or Full Analysis?Exception or Full Analysis?

Stop Loss Transaction: Stop Loss Transaction: TermsTerms

Ceding Company protection for Ceding Company protection for potential under reservingpotential under reserving– Aggregate Adverse Loss Development Aggregate Adverse Loss Development

Ceded: $500 millionCeded: $500 million Cap: $600 millionCap: $600 million Max Loss to reinsurer: $100 millionMax Loss to reinsurer: $100 million Reinsurers Margin: $10 millionReinsurers Margin: $10 million

Stop Loss Transaction: Stop Loss Transaction: TermsTerms Funds withheld: 98.0%Funds withheld: 98.0% Experience Account: 3.0% Experience Account: 3.0%

InterestInterest Usual reporting requirements, Usual reporting requirements,

definitions, etc.definitions, etc. Contains regulatory terms such as Contains regulatory terms such as

Insolvency ClauseInsolvency Clause

Stop Loss Transaction: Stop Loss Transaction: AnalysisAnalysis

Prospective or retrospective Prospective or retrospective reserves?reserves?

Funds withheld: 98.0% ($10 million)Funds withheld: 98.0% ($10 million) Experience Account: 3.0% InterestExperience Account: 3.0% Interest

– Assume no payments from Experience Assume no payments from Experience Account Account

– Approximately 7 years to make up Approximately 7 years to make up $100 million of total funds$100 million of total funds

– What is payout pattern?What is payout pattern?

Stop Loss Transaction: Stop Loss Transaction: AnalysisAnalysis

Transaction effective fourth quarter 2000.Transaction effective fourth quarter 2000. In a draft memo dated December 12, In a draft memo dated December 12,

2000 and actually sent December 17, 2000 and actually sent December 17, 2000 from ceding company to reinsurer:2000 from ceding company to reinsurer:

Exhibit 1

Stop Loss Transaction: Stop Loss Transaction: AnalysisAnalysisIn an internal memo dated October 17, In an internal memo dated October 17,

2000, the ceding company makes the 2000, the ceding company makes the following comments:following comments:

Exhibit 6, GR1_0126245

Stop Loss Transaction: Stop Loss Transaction: The Final AnalysisThe Final Analysis

March 30, 2005

Loss Ratio Stop Loss Loss Ratio Stop Loss Transaction: TermsTransaction: Terms Attachment Point: 69.5% Loss RatioAttachment Point: 69.5% Loss Ratio Subject Premium: $180 MillionSubject Premium: $180 Million Initial Premium: $1 millionInitial Premium: $1 million Added Premium: Added Premium:

Loss Level RateAll Losses 0.500

Greater than 4,000,000 0.100 Greater than 8,000,000 0.050 Greater than 12,000,000 0.025

Max Added Premium: $14 millionMax Added Premium: $14 million Reinsurance Aggregate Max: $15 MillionReinsurance Aggregate Max: $15 Million

Loss Ratio Stop Loss Loss Ratio Stop Loss Transaction: TermsTransaction: Terms Funds Withheld AccountFunds Withheld Account Interest: Interest:

– 2.05% per quarter, ~8.5% per year2.05% per quarter, ~8.5% per year– Credited to inception dateCredited to inception date

Loss Ratio Stop Loss Loss Ratio Stop Loss Transaction: AnalysisTransaction: Analysis Next StepsNext Steps

– Determine maximum premiumDetermine maximum premium– Determine maximum subject lossDetermine maximum subject loss– Determine probability of maximum Determine probability of maximum

lossloss– Answer question as to when maximum Answer question as to when maximum

premium will be achievedpremium will be achieved

Risk Transfer Risk Transfer In The Real WorldIn The Real World

Presented Presented byby

Jane C. Taylor, FCAS, MAAAJane C. Taylor, FCAS, MAAAJunction Consulting, Inc.Junction Consulting, Inc.

Casualty Loss Reserve SeminarCasualty Loss Reserve SeminarBoston, MABoston, MA

September 12, 2005September 12, 2005