Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt...
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Transcript of Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt...
![Page 1: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/1.jpg)
Ratemaking: An ERM Function
CAS Ratemaking Seminar
March 13 & 14, 2006
Russ Bingham, Hartford
Curt Parker, Grange Mutual
John Kollar, ISO
![Page 2: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/2.jpg)
CAS ERM Definition• Process
– Assess,– Control,– Exploit,– Finance,– Monitor risk
• Holistic treatment of risk
• Senior management function
• Upside and downside
![Page 3: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/3.jpg)
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
![Page 4: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/4.jpg)
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?
![Page 5: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/5.jpg)
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
![Page 6: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/6.jpg)
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
![Page 7: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/7.jpg)
Capital RequirementsLoss Volatility
} }Less Capital
More Capital
Expected costs
Insurer A Insurer B
Years Years
![Page 8: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/8.jpg)
Correlation = More Volatility
LineA
LineB
LineC
LineD
Total
{Capital}Capital
Low Correlation
HighCorrelation
Total
Insurer A Insurer B
![Page 9: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/9.jpg)
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
![Page 10: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/10.jpg)
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
![Page 11: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/11.jpg)
Different measures of risk imply different amounts of economic capital
Implied Capital
2xStd. Dev. VaR@99% TVaR@99%
Am
ou
nt
CapitalLiabilities
![Page 12: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/12.jpg)
Risk Measurement & (Cost of) Capital Allocation by Line, etc.
CMP HO Auto Cat Multiline
Am
ou
nt
Diversification Benefit
Standalone
![Page 13: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/13.jpg)
Note capital isallocated to loss reserves
![Page 14: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/14.jpg)
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.
![Page 15: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/15.jpg)
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
![Page 16: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/16.jpg)
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
![Page 17: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/17.jpg)
Marketing/Underwriting StrategyReflect Risk in Planning Change
Growing the Business
Standalone Standalone Standalone Total Total
Req
uir
ed C
apit
al
Prospect 1Prospect 2Existing
![Page 18: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/18.jpg)
RatemakingSetting Combined Ratio
Targets by Line
• Expected losses
• Expected expenses
• Investment income
• Cost of financing– Cost of reinsurance– Cost of capital (risk)
![Page 19: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/19.jpg)
Standard RatemakingExhibit Scroll to end –>
![Page 20: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/20.jpg)
Cost of Financing
Target Combined
Ratio
![Page 21: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/21.jpg)
Set combined ratio targets by line and overall
Target Combined Ratios
96%
98%
100%
102%
104%
106%
108%
CMP HO Auto Cats Total
![Page 22: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/22.jpg)
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.
![Page 23: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/23.jpg)
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
![Page 24: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/24.jpg)
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%)
![Page 25: Ratemaking: An ERM Function CAS Ratemaking Seminar March 13 & 14, 2006 Russ Bingham, Hartford Curt Parker, Grange Mutual John Kollar, ISO.](https://reader036.fdocuments.in/reader036/viewer/2022081503/56649ea15503460f94ba419f/html5/thumbnails/25.jpg)
Robust Analysis of an Enterprise’s Risks (ERM) is
Essential to Sound Ratemaking!