Reinsurance Structures Reinsurance Structures and Pricing Pro-Rata and Pricing Pro-Rata

TreatiesTreaties

CARe Pricing Boot CampCARe Pricing Boot CampAugust 10, 2009August 10, 2009

Daniel Kamen, FCAS, MAAADaniel Kamen, FCAS, MAAAVice PresidentVice President

Allied World Reinsurance CompanyAllied World Reinsurance Company

Types of ReinsuranceTypes of Reinsurance

Quota Share (Q/S)Quota Share (Q/S) Excess of Loss (XOL)Excess of Loss (XOL) Combo: Q/S & XOLCombo: Q/S & XOL OtherOther

Q/SQ/S

‘‘Straight’ Q/SStraight’ Q/S Variable Q/SVariable Q/S

‘‘Straight’ Q/S Example Straight’ Q/S Example 70% Ceded 70% Ceded28% Ceding Commission28% Ceding CommissionCedant’s Total Underlying Expenses are 25%Cedant’s Total Underlying Expenses are 25%

Written Written PremiumPremium

Expected Expected Loss RatioLoss Ratio

Expected Expected LossesLosses

Expense Expense RatioRatio ExpensesExpenses

Expected Expected Combined Combined

RatioRatio

GrossGross 100,000,000100,000,000 60%60% 60,000,00060,000,000 25%25%25,000,0025,000,00

00 85%85%

Ceded [to Ceded [to Reinsurer]Reinsurer] 70,000,00070,000,000 60%60% 42,000,00042,000,000 28%28%

19,600,0019,600,0000 88%88%

Net [to Cedant]Net [to Cedant] 30,000,00030,000,000 60%60% 18,000,00018,000,000 18%18% 5,400,0005,400,000 78%78%

# The Combined Ratio displayed for the Reinsurer is prior to brokerage and internal # The Combined Ratio displayed for the Reinsurer is prior to brokerage and internal expenses.expenses.

Types of XOLTypes of XOL

Per ClaimPer Claim Per OccurrencePer Occurrence Per PolicyPer Policy Per RiskPer Risk CombinationCombination

XOL – Premium XOL – Premium DeterminationDetermination

RateRate Cessions RatedCessions Rated

ILFsILFs Cession FactorsCession Factors Pricing of Each PolicyPricing of Each Policy

Combo StructureCombo Structure

VerticalVertical HorizontalHorizontal

Combo Structure: VerticalCombo Structure: Vertical

Underlying Q/SUnderlying Q/S XOL Layers on TopXOL Layers on Top

ExampleExample:: 1M Q/S1M Q/S 4M xs 1M4M xs 1M 5M xs 5M5M xs 5M

Combo Structure: HorizontalCombo Structure: Horizontal

Allocate/Prorate a Policy/LimitAllocate/Prorate a Policy/Limit Each Piece would be subject to different treatiesEach Piece would be subject to different treaties

ExampleExample:: Allocate a 10M policy limit on a 60/40 basisAllocate a 10M policy limit on a 60/40 basis 60% Allocation 60% Allocation 6M Q/S 6M Q/S 40% Allocation 40% Allocation 3M xs 1M XOL *** 3M xs 1M XOL ***

*** This part is equivalent to 40% of a 7.5M xs 2.5M on a ground-up basis.*** This part is equivalent to 40% of a 7.5M xs 2.5M on a ground-up basis.

Other Types of ReinsuranceOther Types of Reinsurance

Example Example Aggregate Stop Loss Aggregate Stop Loss

Motivations for Purchasing Motivations for Purchasing ReinsuranceReinsurance

1)1) Limiting Liability [on specific risks]Limiting Liability [on specific risks]

2)2) Stabilization / Smoothing of ResultsStabilization / Smoothing of Results

3)3) Catastrophe ProtectionCatastrophe Protection

4)4) Increase Capacity / Surplus ReliefIncrease Capacity / Surplus Relief

5)5) Arbitrage of Results / Profit EnterpriseArbitrage of Results / Profit Enterprise

Items 1) – 4) are attributed to RAA|Reference (RAA Fundamentals of Property Items 1) – 4) are attributed to RAA|Reference (RAA Fundamentals of Property Casualty Reinsurance).Casualty Reinsurance).

Item 5) is attributed to the speaker.Item 5) is attributed to the speaker.

Key CalculationKey Calculation

On-Leveled,On-Leveled,

Trended,Trended,

& Developed& Developed

LOSS RATIOLOSS RATIO

** For The Prospective Treaty Structure**** For The Prospective Treaty Structure**

On-Leveling PremiumOn-Leveling Premium

Essentially Same as in Primary Essentially Same as in Primary Pricing AnalysisPricing Analysis Rate Changes (NOT PREMIUM CHANGES)Rate Changes (NOT PREMIUM CHANGES) Exposure TrendExposure Trend

Components of Rate Changes Components of Rate Changes (1)(1)

Base Rate ChangesBase Rate Changes LCM ChangesLCM Changes ILF ChangesILF Changes Schedule Mod ChangesSchedule Mod Changes

Components of Rate Changes Components of Rate Changes (2)(2)

Renewal Rate MonitorRenewal Rate Monitor Monitoring of New BusinessMonitoring of New Business

Deviation from ‘Manual’Deviation from ‘Manual’ Comparison to Rates Charged on Comparison to Rates Charged on

RenewalsRenewals

LossesLosses

Essentially Same as in Primary Essentially Same as in Primary Pricing AnalysisPricing Analysis Develop Losses to UltimateDevelop Losses to Ultimate Trend Losses from Average Accident in Trend Losses from Average Accident in

Experience Period to Average Accident Experience Period to Average Accident Date in Treaty PeriodDate in Treaty Period

Premium and Losses – Types of Premium and Losses – Types of DataData

Experience PeriodExperience Period Policy Year Policy Year Accident YearAccident Year

Treaty PeriodTreaty Period Risks AttachingRisks Attaching Losses OccurringLosses Occurring

Experience Period and Treaty Period Experience Period and Treaty Period 12 12 Month BlockMonth Block 1/1 – 12/311/1 – 12/31 Other (e.g., 4/1 – 3/31, 9/1 – 8/31, etc.)Other (e.g., 4/1 – 3/31, 9/1 – 8/31, etc.)

Mix of Business ChangesMix of Business Changes

Subdivide Historical Experience into Subdivide Historical Experience into Relevant Homogeneous Segments Relevant Homogeneous Segments (e.g., by state, class, business unit, (e.g., by state, class, business unit, etc.)etc.)

Project Loss Ratios for each SegmentProject Loss Ratios for each Segment Weight Projections on Prospective Weight Projections on Prospective

Treaty Year PremiumTreaty Year Premium

Responsiveness vs. StabilityResponsiveness vs. Stability

Not an Exact ScienceNot an Exact Science Need to Consider the Following:Need to Consider the Following:

Premium Volume by YearPremium Volume by Year Magnitude of the LDFsMagnitude of the LDFs Limits and Attachment Points of the Limits and Attachment Points of the

BusinessBusiness Any Changes in the BookAny Changes in the Book

(with respect to the items above, other types of (with respect to the items above, other types of mix changes, and changes in management)mix changes, and changes in management)

Quality of the InformationQuality of the Information

Catastrophes and Large Catastrophes and Large LossesLosses

Two Potential SituationsTwo Potential Situations NoNo Catastrophes or Abnormally Large Catastrophes or Abnormally Large

Losses [Relative to the Limit] Have Losses [Relative to the Limit] Have Occurred in the Experience PeriodOccurred in the Experience Period

Catastrophes or Large Losses Occurred Catastrophes or Large Losses Occurred During the Experience PeriodDuring the Experience Period

Large Loss Load ProcedureLarge Loss Load Procedure

Limit Large Losses or Remove Cats from Limit Large Losses or Remove Cats from the Experience (if they are present)the Experience (if they are present)

Model the LoadModel the Load For Property Cat business, use one of the For Property Cat business, use one of the

Cat Models (e.g., RMS).Cat Models (e.g., RMS). For Other Lines, Model it via an Exposure For Other Lines, Model it via an Exposure

Rating ModelRating Model Compare Experience Load to Modeled Compare Experience Load to Modeled

Load and Make a SelectionLoad and Make a Selection

Start-ups and Limited DataStart-ups and Limited Data

Potential Items to Assess:Potential Items to Assess:1)1) Analyze Experience from Management’s Analyze Experience from Management’s

Former CompanyFormer Company2)2) Assess Rating Plan and Rating Factors as well Assess Rating Plan and Rating Factors as well

as their Business Planas their Business Plan3)3) Compare Rates to Similar CompaniesCompare Rates to Similar Companies4)4) Assess Pricing via an AuditAssess Pricing via an Audit

*** For items 1) and 3), any comparison to another company should *** For items 1) and 3), any comparison to another company should make an attempt to convert the benchmark company to an make an attempt to convert the benchmark company to an apples-to-apples basis (with respect to rate level, class mix, etc.).apples-to-apples basis (with respect to rate level, class mix, etc.).

Start-ups: Other Start-ups: Other ConsiderationsConsiderations

Current State of the Underwriting CycleCurrent State of the Underwriting Cycle Business Plan vs. Realistic Likelihood of Business Plan vs. Realistic Likelihood of

SuccessSuccess Amount of Risk Being Retained by Amount of Risk Being Retained by

CedantCedant Number and Size of CompetitorsNumber and Size of Competitors Ability/Plan to Obtain Business from Ability/Plan to Obtain Business from

Competitors Other Than Based on PriceCompetitors Other Than Based on Price

Final ThoughtsFinal Thoughts

Prior to Pricing Analysis, Make Sure Deal Prior to Pricing Analysis, Make Sure Deal Makes Sense From an Underwriting Makes Sense From an Underwriting PerspectivePerspective

Make Sure You Understand the StructureMake Sure You Understand the Structure Make Sure All of the Data is Clear and Make Sure All of the Data is Clear and

Complete; If Not, Make the Necessary Complete; If Not, Make the Necessary RequestsRequests

Compare Your Projections to Other Similar Compare Your Projections to Other Similar Treaties; If the Results Differ Significantly, Treaties; If the Results Differ Significantly, Make Sure You Understand WhyMake Sure You Understand Why