2022 IABA Annual Meeting: Reinsurance 101 - PowerPoint Presentation

1. 2022 IABA Annual Meeting: Reinsurance 101Tiffany Daley & Eric Dynda | August 12, 2022

2. Basic Overview of ReinsuranceTypes of Reinsurance: Coverages and StructuresActuarial Approaches to Reinsurance PricingReinsurance Placement ProcessAgenda

3. “Insurance for insurance companies”: An agreement between two (re)insurance companies to transfer risk from one to anotherWhat is reinsurance?AutoHomeLife/HealthBusinessInsurance CompanyInsurance CompanyInsurance CompanyReinsurance CompaniesInsured risksPrimary InsuranceReinsuranceThe reinsurer agrees to indemnify the primary insurance company for some, or all, of the financial consequences of certain loss exposures covered by the primary insurer’s policies in return for a reinsurance premium

4. (Re)Insurance Food ChainInsurance PolicyholdersAgents / BrokersInsurance CompaniesReinsurance Entitiese.g. Munich ReReinsurance Intermediariese.g. Gallagher Re

5. The P&C Reinsurance IndustryRankingCompany NameGross Reinsurance Premiums Written (Non-Life Only) $M1Munich Reinsurance Company$30,2372Swiss Re Ltd.$21,5123Hannover Rück S.E.$20,5684Lloyd’s of London$16,5115Berkshire Hathaway Inc.$13,3336SCOR S.E.$8,7957Everest Re Group Ltd.$7,2828China Reinsurance Corporation$6,4229Korean Reinsurance Company$6,42710PartnerRe Ltd.$5,37711General Insurance Corporation of India$6,31012RenaissanceRe Holdings Ltd.$5,80613AXA XL$5,32614Transatlantic Holdings, Inc.$5,23715Arch Capital Group Ltd.$4,201Source: https://www.reinsurancene.ws/top-50-reinsurance-groups/ https://www.reinsurancene.ws/reinsurance-broker-ranking/ Largest P&C ReinsurersLargest Reinsurance BrokersRankingCompany Name2021 Revenue $M1Aon Reinsurance Solutions$1,9972Guy Carpenter$1,8673Gallagher Re$8254Howden Re/TigerRisk Partners$4005Acrisure Re$1156Lockton Re$977BMS Re$958UIB$809Holborn$55Reinsurance is a global industry that plays a vital role in the world economy

6. Benefits of ReinsuranceProvide CatastropheProtectionEnter / Exit Market Segment Increase Policy Limit CapacityAid in Premium GrowthStabilize Loss Experience Knowledge and ExpertiseEnables insurer to provide larger limits of insurance without placing undue strain on the insurer’s financial position. Aids in cedent’s overall premium growth goals.Reduces net retained volatility. Aids insurers in entering a new line of business and can be used to help withdraw from an unprofitable/undesirable market segment.Protects from the financial consequences of a catastrophic event.Reinsurers work with a wide variety of insurers and thus accumulate underwriting expertise. Intermediaries add value through underwriting, financial/loss modeling and rating agency consultation services.Source of CapitalProvides an affordable source of financial and statutory capital that can provide relief from reductions in policyholders surplus.Capital Capacity & ProtectionEarnings Volatility ProtectionPortfolio Management

7. Reinsurance serves three key functions for insurersKey Functions of ReinsuranceWhat reinsurers doBenefits for insurersRisk Transfer FunctionStabilize financial results by smoothing the impact of unexpected major losses and peak risksCompanies become a more attractive investment proposition and benefit from reduced cost of capitalRisk Finance FunctionOffer reinsurance as a cost-effective substitute for equity or debt, allowing clients to take advantage of global diversificationCapital freed up, thereby increasing underwriting capacity and enabling growthInformation FunctionSupport clients in pricing and managing risk, developing new products and expanding their geographical footprintAccelerate profitable growth

8. Types of ReinsuranceCoverages and Structures

9. Typical Reinsurance SolutionsExcess of LossQuota SharePer RiskPer Policy Per Occurrence(Catastrophe) FacultativeProportionalProportionalExcess of LossReinsuranceTreatyAggregate ExcessSurplus Share

10. Types of Reinsurance: Treaty vs. FacultativeFacultativeReinsurance of individual policiesWhy Facultative:Unusual risksLarge value risksRestrict liabilityReduce accumulationProtect new businessTreatyReinsurance of multiple policies where a risk falling within the treaty terms is automatically reinsuredWhy Treaty:Simple, automatic and immediate reinsurance protectionEnables insurer to give immediate insurance cover to any insured it writesIndividual office buildingBook of homeowners policies

11. Facultative reinsurance in practiceFacultative Reinsurance: ExampleProblemUnderwriter at primary insurer sees profitable opportunity to insure a $120M buildingBut… corporate risk guidelines dictate a $100M maximum limitSolutionUnderwriter secures a $20M xs $100M facultative cover for the risk and writes the policyResultRisk now conforms to risk appetite of the company. The retained exposure may later be covered by a treaty covering similar risks (i.e. Catastrophe XOL)Retained risk (net of fac)$100M$120MFacultative cover

12. Treaty reinsurance in practiceTreaty Reinsurance: ExampleProblemUnderwriter at primary insurer has written a $600M portfolio of similar commercial buildingsBut… corporate risk team wants to buy reinsurance treaty to cover portfolio to protect against volatility of lossesSolutionCompany secures an XOL treaty to cover the portfolio’s losses above a determined thresholdResultPortfolio is now protected from large losses and now conforms to risk appetite of the company

13. Quota Share is the most common Proportional structureCovers a specific portfolio of businessPremium and loss shared in a fixed proportion for each riskObligatoryCeding commission is provided to compensate cedent for the expenses they incur to write/service the businessCan be applied on a gross account or net account basisReinsurance Structures: ProportionalProportional structures are a type of reinsurance in which the primary insurer and the reinsurer proportionately share the amounts of insurance, policy premiums, and losses (including LAE – loss adjustment expense)70% Retained by the Insurance Company30% Ceded to the Reinsurers25% Ceding Commission30% Quota Share Example$1M

14. Ceding Commissions: Key Concept for Quota SharesA ceding commission is a provision paid from the reinsurer to the insurer (‘cedent’) as part of a proportional structure, and is intended to compensate the insurer for underwriting expenses incurred as a result of writing subject policiesProduction ExpenseTax/License/FeesProportional Premium ProvisionsCedent PerspectiveReinsurer PerspectiveProfitGeneral ExpenseLoss & Loss Adjustment Expense30%5%65%ProfitCeding CommissionLoss & Loss Adjustment Expense5%30%65%Note: For simplicity, in the illustration the ceding commission is set equal to the primary’s underwriting expense provision, but it could differ based on the reinsurer’s view of the profitability of the subject business

15. Reinsurance Structures: Excess of LossExcess of loss (XOL) structures are a type of reinsurance in which the primary insurer is indemnified only for losses that exceed a specified dollar amountInsurance Company RetentionFirst $1MXOL Layer$4M xs $1M(Attachment Point = $1M; Limit = $4M)$4M xs $1M XOL Example$5M$1MKey features common to every XOL:Attachment Point: The specified dollar amount threshold above which losses will be covered by the reinsurer (acts like a deductible on a primary policy)Limit: The specified maximum amount of coverage for a lossReinsurance Premium/Rate: Unlike a quota share, where the original policies’ premium is shared proportionally, XOLs are priced with a non-proportional rate based on expected loss to the reinsurance layer

16. Several ways for XOL structures to define coverageReinsurance Structures: Excess of LossPer Risk XOL: Applies separately to each loss for to each risk (property)Per Occurrence XOL: Applies to the total loss arising from a single event affecting one or more of the primary insurer’s policiesPer Policy XOL: Applies separately to each insurance policy issued by the primary insurer regardless of the number of losses occurring under each policyCatastrophe XOL: Protects the primary insurer from an accumulation of losses that arise from a single catastrophic eventAggregate XOL: Covers the total aggregated losses during the treaty period after exceeding the attachment threshold (a.k.a. Stop Loss)Individual risk levelWhole portfolio level

17. Depends on your goal…Which reinsurance structure is right for my company? Functions of ReinsuranceQuota SharePer Risk XOLCatastrophe XOLPrudent ManagementYesYesYesProvide Catastrophe ProtectionNoNoYesStabilize Loss ExperienceNoYesYesSource of CapitalYesNoNoIncrease Line CapacityYesYesNoEnter / Exit Market SegmentYesNoNoKnowledge & ExpertiseYesNoNo

18. Actuarial Approaches to Reinsurance Pricing

19. Reinsurance Pricing: BasicsIn its simplest form, all reinsurance pricing is made up of two components or variables:Expected LossReinsurers’ load for Expenses, Volatility, and Profit MarginThe way these components are calculated (and transformed into a final price) is dependent on the type of reinsurance structure and the data available for pricingStandard approaches to basic Quota Share and Excess of Loss treaty pricing will be covered in this presentation

20. Actuarial Pricing: Quota Share TreatiesFor quota share treaties, the most important component of pricing is the expected ground up loss ratio (GULR) of the portfolio being reinsuredGiven that reinsurers will proportionally share a % of the primary insurer’s total premium and loss, the reinsurer’s loss ratio will follow the primary insurer’s loss ratioProcess of forecasting the expected GULR for a quota share treaty is the same as a standard loss ratio analysis performed by a primary insurer for a portfolioOn-level historical premium to current levelTrend/develop historical losses to ultimateCalculate an average best estimate forecastProfit5%Ceding Commission30%Ground Up Loss Ratio65%Quota Share: Reinsurer’s PerspectiveThe reinsurer’s view of the GULR (and their level of confidence/certainty) will determine the ceding commission the reinsurer can offer that allows them to achieve their desired profit margin

21. Actuarial Pricing: Excess of Loss TreatiesHistorical Premiums & LossesRisk ProfileIndustry DataExperience RatingExposure RatingCredibility WeightedLoss Cost EstimateReinsurance PriceIncluding Risk / Profit LoadExcess of loss (XOL) treaty pricing is focused on obtaining the expected loss to the layer that is being pricedThere are two methods to find the expected layer loss:Experience Rating – Uses the insurance company’s actual historical loss experience to develop an expected loss Exposure Rating – Uses the insurance company’s current risk profile (policy limits/attachment points, industry/hazard group) to develop an expected loss

22. Both methods are useful in their own wayExperience vs. ExposureExperience RatingExposure RatingProject future loss potential using the client’s actual historical loss experienceProject future loss potential using the client’s current risk profile and industry benchmark severity curvesMost valuable when client has many years of credible historical dataMost valuable when there has been a change to the client’s limit profile or when there is limited historical dataReflective of client’s actual loss experienceReflective of client’s most up-to-date book of businessHighlights how client differs from industry averagesLess valuable if client differs from “average” insurer since it uses industry curvesLess valuable if client’s portfolio has changedCan compute expected losses for layers without historical data

23. This claim is $4.5M in total, which represents a $2.5M layer claimSimilar to ground up loss ratio analysis, but for a specific layer onlyXOL Experience Rating: The BasicsGoal of experience rating is similar to LR analysis:Take historical premium and loss data and “transform” it to current conditions in order to estimate go-forward expected loss$6M xs $2M layerOnly the trended historical losses above the reinsurance layer’s attachment point are relevant for experience ratingTechniques used to “transform” the data are familiar:On-level premiumTrend lossesDevelop losses to ultimateOnly difference: We are analysing a specific layer of loss rather than all losses

24. XOL Experience Rating: ExampleStandard experience rating procedure:Trend individual claims from ground-up;Cap claims at historical policy limit;Slot into reinsurance layerCalculate experience rate as trended/capped layer loss divided by sum of on-level historical premiumKey assumptions in experience rating:Trend: Trend can have a leveraged effect on layer claims (see next slide).LDFs: Layer LDFs are more uncertain/volatile than ground up. Typically more heavy than ground up.Experience period: E.g. 5-years vs. 10-years, more years is better because higher LDFs and higher volatility in layer vs. ground up.500K xs 500K Layer Analysis ($M)      AccidentSubjectOn-LevelOn-LevelReported IncurredTrended IncurredExcess LossUltimate TrendedUltimate TrendedYearPremiumPremium FactorPremium Layer Loss & ALAELayer Loss & ALAEDevelopment FactorLayer Loss & ALAELayer Loss & ALAE Ratio(1)(2)(3)(4) = (2) * (3)(5)(6)(7)(8)(9) = (8) / (4)201649.6 1.610 79.9 -5.3 1.20 7.1 8.9%201760.1 1.524 91.6 5.6 7.2 1.30 10.1 11.0%201863.2 1.406 88.8 5.6 7.9 1.50 11.9 13.4%201974.0 1.329 98.3 3.5 4.2 2.00 10.5 10.7%202080.6 1.249 100.7 .1 .4 5.00 8.8 8.7%202187.1 1.147 99.8 --10.00 10.0 10.0%All Years xlast327.5  459.4 14.8 25.0  48.4 10.5%5 Year xlast327.5  459.4 14.8 25.0  48.4 10.5%3 Year xlast217.8  287.9 9.2 12.5  31.2 10.9%         Premium is on-leveled exactly like a LR AnalysisIndividual claims may trend into the layer from below XS LDFs specific to the layerLayer loss cost %s are averaged into final selection

25. Similar to loss ratio analysis but differences exist because we are focused on loss to the layerTrend & XOL Experience RatingTrending large losses has a greater effect on excess layersA 20% ground-up loss trend = 300% implied layer loss trendDepends on many factors: loss size, number of years, ground up trend factorXS Layer Trend = 300%20% Trend20% Trend

26. This insurer writes a range of policy limits from $1M-$10M, with mostly $1M and $5M limit policiesUse the portfolio’s current risk profile to estimate expected lossXOL Exposure Rating: The BasicsGoal of exposure rating:Use in-force policy risk profile and factors based on Line of Business/Industry to allocate total expected loss to reinsurance layersIn-force = All policies on the books at a particular point in timeUsed as a proxy to project the exposures for the upcoming treatyComponents of exposure rating:Policy limits and attachment pointsWritten premiumIncreased limit factors (ILFs)Ground up loss ratioIn-force Limits ProfileLimit# of PoliciesTotal Written Premium$1,000,000 200 $500,234 $2,000,000 50 $200,355 $5,000,000 100 $743,923 $10,000,000 25 $253,540

27. XOL Exposure Rating: Increased Limit FactorsLimit ILF$1M1.00$2M1.20$5M1.40$10M1.50)Increased Limits Factors (ILFs) describe the relative premium between limitsIn primary insurance pricing, ILFs are used to calculate premiums for policies with different limitsIn XOL reinsurance pricing, ILFs are used to figure out the % of a policy’s premium that lies within the reinsurance layer (known as the cessions premium or ILF premium)Note: ILFs are specifically used for Casualty business, but other LOBs have similar concepts:Property: “FLS” curves (first loss scales)Workers Comp: “ELF” curves (excess loss factors)Here, $1M is the “basic limit”, with an ILF of 1.00 ILF at $2M is 1.20, which means if a $1M limit policy costs $100, then a $2M limit policy should cost $120Sources of ILFs:Industry sources (ISO classes, NCCI hazard groups, etc.)Company-specific dataPareto distribution curves

28. XOL Exposure Rating: Increased Limit Factors Pt. 2Limit ILF$1M1.00$2M1.20$5M1.40$10M1.50Calculating Layer Cessions %Excess ratio for 1M xs 1M layer = ILF(2M) – ILF(1M) = 1.2 – 1.0 = 0.2% of $2M limit policy in 1x1 layer = 0.2 / 1.2 = 16.6%% of $5M limit policy in 1x1 layer = 0.2 / 1.4 = 14.3%% of $10M limit policy in 1x1 layer = 0.2 / 1.5 = 13.3%First $1M:83.4% of total$2M$3M xs $2M: 14.3% of totalFirst $1M: 71.4% of total$1M xs $1M: 14.3% of total$5M$2M$1M$3M$4M$1M$1M xs $1M:16.6% of total$2M Limit Policy$5M Limit PolicyExposure rating aims to figure out: What portion of the policy’s expected loss should be allocated to the reinsurance layer being analyzed?Example with $1M xs $1M reinsurance layer(layer cessions %)

29. XOL Exposure Rating: Example*Because the $1M policy limit is not above the reinsurance layer attachment point, the $1M limit policies are not exposed to the 1x1 reinsurance layerPolicy LimitTotal Written Premium1M xs 1M Cessions %1M xs 1M Cessions $$1M $500,234 0.0%*$0 $2M $200,355 16.6%$33,259 $5M $743,923 14.3%$106,381 $10M $253,540 13.3%$33,721 Total$1,698,052 10.2%$173,361 Apply Ground Up Loss Ratio (60% in this example)1M xs 1M Loss Cost %1M xs 1M Loss Cost $0.0%$0 10.0%$19,955 8.6%$63,829 8.0%$20,232 6.1%$104,016 Comes from ILF calculations on previous slideCessions represents % of policy’s premium allocated to the layerApplying ground up loss ratio converts the cessions premium into expected layer loss costStandard exposure rating procedure:Group policies into premium buckets by limit (and attachment point if relevant)Use ILFs to calculate % of each policy’s premium exposed to layer (cessions)Convert layer cessions to expected layer loss by applying ground up loss ratioKey assumptions in exposure rating:Policy limit profile: Should be representative of exposure that will be subject to the reinsurance treaty; usually in-force bookILF Curve: LOBs that are more risky/hazardous with greater large loss potential should have heavier ILF curves, which will allocate more loss to higher reinsurance layersGround up loss ratio: Calculated separately, key component of final layer loss cost

30. Experience vs. Exposure RatingWhich is Correct??After performing experience rating and exposure rating, we now have two separate estimates of expected loss cost for our reinsurance treatyBoth estimates have their pros and cons, but how do we know which one to use?Credibility!

31. Overall ConceptCredibility RatingCredibility weighting = A measure of how much weight to give to experience rating vs. exposure rating when choosing a final loss costFinal Loss CostExperience Loss CostExposure Loss Cost1 - CredibilityCredibility

32. Methods of MeasureCredibilityMathematical CredibilityActuarial methodologies used to formulaically calculate appropriate credibility weights depending on different characteristics of the bookPro: More scientific; unbiasedCon: Difficult to explainJudgmental selectionSelect credibility based on expertise or judgmentPro: Easier to understand and explain Con: Judgmental nature of it may bias the results and selections may vary significantly from one actuary to another; more “art than science”There is no single “right” measure of credibility

33. Actuarial models allow us to estimate pricing of reinsurance alternativesReinsurance Pricing ExampleReinsurer’s load for risk/profit

34. Modeling Losses – Reinsurance StructuresLoss TrianglesHist PremiumHist Rate ChangePolicy BordereauLimit ProfilesILFsLarge Loss ListingGround-Up Loss RatioExposure analysisLoss curve selectionCredibility weightingFrequency/severity distributionExperienceanalysisQSXOLComplexStructures

35. Deterministic vs. Stochastic ModelsDeterministic: Output of model is a point estimate of a single valueWhat’s the “average”?Stochastic: Possess some inherent randomness and output is a distribution of valuesWhat’s the “variability”?Simulations produce percentiles of lossesFull actuarial analyses blends both processesDeterministic models can be used to develop parameters for large stochastic simulations of client portfolios

36. Reinsurance Placement Process

37. How a Treaty Reinsurance Placement gets done

38. Thank you! Questions?Contact us:Tiffany Daley (tiffany_daley@ajgre.com)Eric Dynda (eric_dynda@ajgre.com)

39. Appendix

40. Structuring an XOL Program: LayeringAn excess of loss treaty is often structured in layersEach layer will attract reinsurers depending on their underwriting policy, which is driven by their appetite for risk vs. returnLayer 3The top (or third) layer operates in excess of the second layerThe top layer is much further from the ground and has the lowest chance of a loss, but it carries a smaller premium in relation to the liability assumed and is the most unpredictable/volatileLayer 2The second layer will operate in excess of the first layer, and therefore the second layer’s retention will equal the sum of the first layer’s retention plus the limit (size) of the first layerLayer 1:The bottom (or first) layer gives protection immediately in excess of the reinsured’s chosen retention Closest to the ground and has the highest chance of a loss, but also carries a high premium relative to liability assumed and is more predictable01M2M5M10M$1M RetentionLayer 2: 3M xs 2MLayer 3:5M xs 5MLayer 1: 1M xs 1MEach layer operates on the same principle – i.e. liability only commences in excess of the layer’s retention

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