The Actuary In Ceded Reinsurance: Non-Actuarial Considerations CAS Seminar On Reinsurance June 2-4, 2002 Tarrytown, New York Edward P. Lotkowski, FCAS

The Actuary In Ceded The Actuary In Ceded Reinsurance:Reinsurance:

Non-Actuarial ConsiderationsNon-Actuarial Considerations

CAS Seminar On ReinsuranceCAS Seminar On Reinsurance

June 2-4, 2002June 2-4, 2002

Tarrytown, New YorkTarrytown, New York

Edward P. Lotkowski, FCASMain Street America Group

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This discussion is This discussion is notnot……

Actuarial:Actuarial:– Actuarial expertise is assumed, but…Actuarial expertise is assumed, but…– Model everything!Model everything!

• Retention settingRetention setting• PricingPricing• Portfolio – level analysisPortfolio – level analysis

Definitive:Definitive:– Reinsurance buyer’s behavior influenced by specific Reinsurance buyer’s behavior influenced by specific

situationsituation• ConstituenciesConstituencies• Market conditionsMarket conditions

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This discussion This discussion hashas::

General themes:General themes: Who are your customers?Who are your customers? The Actuary-Buyer is also a Broker and a The Actuary-Buyer is also a Broker and a

SellerSeller Pertinent information takes many formsPertinent information takes many forms Buying requires active management, not Buying requires active management, not

passive participationpassive participation Buyer succeeds when he/she leverages Buyer succeeds when he/she leverages

actuarial skills with communication and actuarial skills with communication and people skillspeople skills

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The Buyer’s CustomersThe Buyer’s Customers

Arrows Mean:Arrows Mean:– Reciprocal customer relationshipsReciprocal customer relationships– Reciprocal flows of informationReciprocal flows of information– Reciprocal responsibilitiesReciprocal responsibilities

Company Management

Buyer

Brokers Reinsurers

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Company Management as Company Management as CustomerCustomer

IssuesIssues Ceding company management has several audiencesCeding company management has several audiences

– Board of DirectorsBoard of Directors– Wall StreetWall Street– StockholdersStockholders– Rating AgenciesRating Agencies

What drives corporate risk philosophy?What drives corporate risk philosophy?– Is a philosophy articulated?Is a philosophy articulated?– Is it “robust”?Is it “robust”?– Is it consistent with yours?Is it consistent with yours?

““Hard” vs. “Soft” drivers of risk philosophyHard” vs. “Soft” drivers of risk philosophy

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Company management as Company management as customercustomer

““Hard” DriversHard” Drivers Corporate Form Corporate Form

– Access to capitalAccess to capital

Profile of investment portfolioProfile of investment portfolio– Equity/Fixed income compositionEquity/Fixed income composition

– LiquidityLiquidity

Diversification among businessesDiversification among businesses– Stand-alone P & C vs.Stand-alone P & C vs.

– P & C with Life, Annuities, Asset ManagementP & C with Life, Annuities, Asset Management

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““Soft” DriversSoft” Drivers Management's constituenciesManagement's constituencies

– Removed from reinsurance arenaRemoved from reinsurance arena Need for clear communicationNeed for clear communication

– Can dictate program structureCan dictate program structure• e.g., variable retentionse.g., variable retentions

– May preclude forms of reinsuranceMay preclude forms of reinsurance• e.g., traditional vs. finitee.g., traditional vs. finite

Management’s P & C/Reinsurance backgroundManagement’s P & C/Reinsurance background– Holding company structureHolding company structure

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““Soft” DriversSoft” Drivers, cont’d, cont’d Management’s attitudes towards Management’s attitudes towards

reinsurancereinsurance– Transaction vs. relationshipTransaction vs. relationship– Attitude towards “payback” notionsAttitude towards “payback” notions– Depth of understandingDepth of understanding

• Mean vs. varianceMean vs. variance

Individuals’ risk tolerancesIndividuals’ risk tolerances

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IssueIssue Management’s appetite for analyticsManagement’s appetite for analytics

– Appetite is often low; actuary’s appetite is higherAppetite is often low; actuary’s appetite is higher

– Management’s appetite is often hard to gaugeManagement’s appetite is often hard to gauge

– Actuary-Buyer’s analytical expertise is assumedActuary-Buyer’s analytical expertise is assumed

– Example (amounts are hypothetical):Example (amounts are hypothetical):Retention options considered:Retention options considered:

• Existing $1.5m per occurrenceExisting $1.5m per occurrence

• Existing with $2m AADExisting with $2m AAD

• $2m per occurrence$2m per occurrence

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((ExampleExample))Price/Volatility TradeoffPrice/Volatility Tradeoff

IdeaIdea– Analyze difference among purchasing optionsAnalyze difference among purchasing options– All program differences occur in ($1.5m, All program differences occur in ($1.5m,

$2.5m)$2.5m)– So, model activity in ($1.5m, $2.5m)So, model activity in ($1.5m, $2.5m)

Simulated risk process produces:Simulated risk process produces:

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((ExampleExample))Ceded LossesCeded Losses

Percentiles Percentiles of Annual of Annual

LossLoss

Option 1 Option 1 Annual Loss in Annual Loss in ($1.5m, $2.5m)($1.5m, $2.5m)

Option 2 Option 2 Annual Loss Annual Loss

($1.5m, $2.5m)($1.5m, $2.5m) After AADAfter AAD

Option 3Option 3Annual Loss Annual Loss

($1.5m, $2.5m) ($1.5m, $2.5m) Higher RetentionHigher Retention

25%25% $4.0m$4.0m $2.0m$2.0m $1.0m$1.0m

50%50% 5.05.0 3.03.0 1.51.5

75%75% 6.56.5 4.04.0 2.52.5

95%95% 9.09.0 7.07.0 3.53.5

99%99% $11.0m$11.0m $9.0m$9.0m $4.0m$4.0m

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(Example) (Example) Current structure as baselineCurrent structure as baseline

Percentiles of Percentiles of Annual LossAnnual Loss

Option 1Option 1

Current Current StructureStructure

Option 2Option 2

CurrentCurrent

With AADWith AAD

Option 3Option 3

RetentionRetention

25%25% $0m$0m $2m$2m $3.0m$3.0m

50%50% 00 22 3.53.5

75%75% 00 22 4.04.0

95%95% 00 22 5.55.5

99%99% 00 22 7.07.0

Est. PremiumEst. PremiumSaving Saving

$0m$0m $2m$2m $4.5m$4.5m

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Reinsurer as CustomerReinsurer as Customer

Buyer to ReinsurerBuyer to Reinsurer ““Perfect submission”Perfect submission”

– Stable primary Stable primary companycompany

– Well-articulated and Well-articulated and executed business executed business strategystrategy

– Lots of (accurate!) dataLots of (accurate!) data– Timely responseTimely response– Complementary Complementary

exposureexposure– Large “bank”Large “bank”

““Face time” importantFace time” important– MeetingsMeetings

Especially after big lossEspecially after big loss

– AuditsAudits

What does your What does your company have to offer?company have to offer?– Your companyYour company

– YourselfYourself

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Reinsurer to BuyerReinsurer to Buyer Reinsurer’s attitude toward the marketReinsurer’s attitude toward the market

– Where does it write? – e.g. clash vs. working layersWhere does it write? – e.g. clash vs. working layers– Transaction – oriented vs.Transaction – oriented vs.– Relationship – orientedRelationship – oriented

Efficient pricing & termsEfficient pricing & terms– The market is efficient in the long runThe market is efficient in the long run– Not necessarily so in the short runNot necessarily so in the short run

Wide variance in quotes, even in working layersWide variance in quotes, even in working layers Result: e.g., might fill programs by moving money between Result: e.g., might fill programs by moving money between

layerslayers

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SecuritySecurity Spread cover over capital bases:Spread cover over capital bases:

– U.S., London, Bermuda, Europe, otherU.S., London, Bermuda, Europe, other Specific reinsurers/marketsSpecific reinsurers/markets

– Reinsurer eligibility criteriaReinsurer eligibility criteria– Leading indicatorsLeading indicators– Post 9/11…a new gamePost 9/11…a new game

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SecuritySecurity (cont’d) (cont’d) Willingness to payWillingness to pay

– Recent claims payment historyRecent claims payment history

– ReputationReputation

Willingness to playWillingness to play– Do they still want to be in the business?Do they still want to be in the business?

– Reliance on retrocessional capacityReliance on retrocessional capacity

– Corporate structure – who is calling the shots?Corporate structure – who is calling the shots?

– If new, are they “in, hard market”, “out, soft market”?If new, are they “in, hard market”, “out, soft market”?

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Broker as CustomerBroker as Customer

Buyer to brokerBuyer to broker– Company’s needs, risk philosophyCompany’s needs, risk philosophy– Discussion of prospective risk profileDiscussion of prospective risk profile– Best data possibleBest data possible– Frequent and proactive communication – Frequent and proactive communication –

evolving needsevolving needs

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Broker as CustomerBroker as Customer Broker to buyerBroker to buyer

– Advice on risks and Advice on risks and needsneeds

– Current market Current market knowledgeknowledge

– Aggressive Aggressive representationrepresentation ““The market says…” The market says…”

vs. “We should go to vs. “We should go to market with…”market with…”

Advice on specific Advice on specific placements (e.g., sign placements (e.g., sign on /sign down)on /sign down)

– Solid analyticsSolid analytics Actuarial/financial/risk Actuarial/financial/risk

theoretictheoretic PricingPricing Reinsurance as element Reinsurance as element

of DFAof DFA Modeling capabilitiesModeling capabilities Retention & limitsRetention & limits Treaty termsTreaty terms

– Strong back roomStrong back room Security analysisSecurity analysis ClaimsClaims ContractsContracts

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Some Post 9/11 QuestionsSome Post 9/11 Questions

Who is standing (counterparty risk)?Who is standing (counterparty risk)? What is terrorism?What is terrorism?

– What are the dimensions of cyber-terrorism?What are the dimensions of cyber-terrorism? Do relationships matter?Do relationships matter? What is a fair price?What is a fair price?

Documents

The Actuary In Ceded Reinsurance: Non-Actuarial Considerations CAS Seminar On Reinsurance June 2-4, 2002 Tarrytown, New York Edward P. Lotkowski, FCAS