Reinsurance

Reinsurance
Presentation Example
2003 CAS Research Working Party:
Executive Level Decision Making using DFA
Raju Bohra, FCAS, ARe
Background
Dynamic Financial Analysis (DFA) Systems Model the
Entire Operations (Liabilities and Assets) of an

Insurance Company
Statistical Simulation Techniques are used to Model
not only Point Estimates, but also the Distribution of
Outcomes
This Provides Answers Conventional Analysis cannot
What Is The Chance Of A Given Financial Result?

How Often Is A Given Alternative Better?
To What Degree?
Under What Circumstances?
2003 CAS Research

Working Party
Outline of Process
Identify Companys Needs and Objectives
Return What is your measure of success?

Usually stated in accounting terms
Risk Why do you buy reinsurance?
Measure of volatility of return, usually downside
Model Underlying Gross Liabilities by Line of Business

Select Reinsurance Options to Compare
How does changing retentions impact net results?

What combination of excess and pro-rata work best?
What is impact of changing covers or inuring structure?
How do loss sensitive and commission terms impact results?
What is effect of combining programs across operating units?
Run Model Several Times with Varying Structures

Create Statistics and Charts to Evaluate Options
2003 CAS Research
Working Party
Outline of Process
Model Insurance
and Asset
Portfolio
Loss distributions
Premiums
Balance Sheet
Define Reins
Structure
Simulate
Results
Gross,
Ceded, and
Net Results,
in Financial
Accounting
Framework
Limits
Retentions
Ceded Rates
2003 CAS Research
Working Party
Benefits of Process
Help you Better Evaluate your Reinsurance Program
Understand the impact of reinsurance

Align reinsurance with your strategy
Analyze your Reinsurance Program as a Whole

Measure Value of Reinsurance Transaction
Go beyond only seeing cost = ceded premium

See risk reduction impact of reinsurance
Quantify risk-return tradeoff (apples to apples measurement)
Analysis is Tailored to Companys Risk Appetite
Tolerance for risk

Current financial condition
What is the Best Reinsurance Program

2003 CAS Research
Working Party
Scope and Limitations

Comprehensively, Insurance Companies face many
Sources of Risk from their Operations:
Asset risk value of investments

Credit risk premium and reinsurance receivables
Liability risk frequency and severity of losses
Pricing risk
Reserving risk
Catastrophes
Large Losses
To do a Reinsurance Analysis we Focus our Modeling
Efforts
Gross prospective losses for lines of business

Ceded reinsurance terms for several reinsurance programs
Yields a Solution with Regard to Reinsurance Strategy
Relatively quick model set up

No data noise from generally unrelated issues, e.g. asset mix
2003 CAS Research

Working Party
Model Setup and Options

Liability Modeling Gross Business
Core losses were modeled aggregate distributions

Large losses were modeled using severity and frequency distributions
Catastrophes were modeled using output from a catastrophe model
Reinsurance Options Net Business
XOL attaching at $1.0m and up

Pro Rata 25% QS with flat 20% ceding comm.
Stop loss attaching at 85% loss and LAE, 10 pts of limit
Modeled Detail Needed to Support Decision Making
Accounting, asset values, reserve balances, and cash flow parameters

were entered using most recent public financial statements
Kept less relevant sources of variation static
Economic variables
Reserve development
2003 CAS Research

Working Party
Model Results
Three Types of Charts were Produced
Distribution graphs
Shows range of outcomes for various options
Distribution statistics table
Shows outcome averages and risk measures
Risk Return graph
Shows risk return trade-off
The Following Criteria were Assumed
Return Maximize SAP Net Income

Risk Standard deviation of Net Income
2003 CAS Research

Working Party
Distribution Graphs
Distribution Graphs
Chart shows probability of return outcomes for each option

Benefit of reinsurance is less volatility (narrower curve) and less
probability of extreme values (smaller tail)
Cost of reinsurance is shown as shifting of average value to the left,
more average total cost
Formal statistics are developed later to quantify risk, for example:
Analytic: Variance/Std Dev., Ruin, EPD, VaR, Tail VaR

Business: Probability key accounting value falls below threshold
Distribution Graphs Cumulative
Chart shows cumulative probability of total cost or less for each retention
option
Can read off percentile values from chart
Lower curve is better at that level
Can quantify how often an option is better than another
2003 CAS Research

Working Party
Value of Reinsurance
Projected Net Income ($000) under Reinsurance
40%
Reinsurance Cost
Drop in Avg Income
Incremental Probability
35%
30%
25%
20%
15%
Loss of Income
Upside Potential
Reduction of Income
Downside Potential
10%
5%
0%
-300
-275
-250
-225
-200
-175
-150
-125
-100
-75
No Reinsurance
-50
-25
25
50
75
100
125
150
175
Net of Excess of Loss
2003 CAS Research

Working Party
10
40%
Reinsurance Cost
Drop in Avg Income
35%
30%
25%
20%
15%
10%
Loss of Income
Upside Potential
Reduction of Income
Downside Potential
5%
0%
- 300 - 275 - 250 - 225 - 200
- 175 - 150
- 125
- 100
- 75
No Reinsurance
- 50
- 25
25
50
75
100
125
150
175
Net of Quota Share
2003 CAS Research

Working Party
11
40%
Reinsurance Cost
Drop in Avg Income
35%
30%
25%
Loss of Income
Upside Potential
20%
15%
10%
Reduction of Income
Downside Potential
5%
0%
- 300 - 275 - 250 - 225 - 200
- 175 - 150
- 125
- 100
- 75
No Reinsurance
- 50
- 25
25
50
75
100
125
150
175
Net of Stop Loss
2003 CAS Research

Working Party
12
40%
Worse off with

Reinsurance 67% of
time (2 out 3 yrs)
Cumulative Probability
35%
30%
25%
20%
Better off with

Reinsurance 33% of
time (1 out 3 yrs)
15%
10%
5%
Reinsurance Benefit
Savings at 95th Percentile
0%
- 300 - 275 - 250 - 225 - 200
- 175 - 150
- 125 - 100
- 75
No Reinsurance
- 50
- 25
25
50
75
100
125
150
175
Net of Excess Cover
2003 CAS Research

Working Party
13
40%
Worse off with

Reinsurance 78% of
time (7 out 9 yrs)
35%
30%
25%
20%
Better off with

Reinsurance 22% of
time (2 out 9 yrs)
15%
10%
5%
Reinsurance Benefit
0%
- 300 - 275 - 250 - 225 - 200
- 175 - 150
- 125 - 100
- 75
No Reinsurance
- 50
- 25
25
50
75
100
125
150
175
Net of Quota Share
2003 CAS Research

Working Party
14
40%
Worse off with

Reinsurance 86% of
time (6 out 7 yrs)
35%
30%
25%
20%
15%
Better off with

Reinsurance 14% of
time (1 out 7 yrs)
10%
5%
Benefit of Reinsurance
0%
- 300 - 275 - 250 - 225 - 200
- 175 - 150
- 125 - 100
- 75
No Reinsurance
- 50
- 25
25
50
75
100
125
150
175
Net of Stop Loss
2003 CAS Research

Working Party
15
Distribution Statistics Table

Summarizes Risk and Return Calculations
Return Measures
Average Net Income under each option

Savings = increase in average Net Income between alternatives
Risk Measures
Percentiles at various levels
Similar to output of a catastrophe model

Select a percentile level selected that reflects risk appetite
A lower percentile level implies a higher risk tolerance
Lower result at that level reflects increased downside risk
Standard deviation
Statistical measure of volatility

Higher standard deviation implied greater risk
2003 CAS Research

Working Party
16
Distribution Statistics Table

Distribution Statistics
Risk and Return Calculations
No Rein
Excess
Pro Rata
Stop Loss
34,363
27,254
16,823
29,891
Return Measure
Expected SAP Net Income
Risk - Percentile
0.1%
0.5%
1.0%
5.0%
10.0%
25.0%
Median
75.0%
90.0%
95.0%
99.0%
99.5%
99.9%
Return Period
1 in 1000 years
1 in 200 years
1 in 100 years
1 in 20 years
1 in 10 years
1 in 4 years
1 in 2 years
(242,192)
(186,566)
(160,426)
(92,804)
(54,908)
2,951
43,762
80,073
105,540
120,938
146,225
153,964
171,059
(129,969)
(104,641)
(90,626)
(49,559)
(28,407)
6,295
31,847
55,801
73,932
83,846
101,075
105,850
118,382
(121,579)
(93,766)
(80,696)
(46,885)
(27,937)
1,156
21,562
39,718
52,451
60,150
72,794
76,663
85,211
(161,392)
(105,766)
(79,627)
(25,746)
(25,745)
(16,062)
30,211
66,522
91,989
107,386
132,673
140,412
157,507
Risk - Volatility Statistics

Standard Deviation
64,886
40,494
2003 CAS Research

Working Party
32,498
48,202
17
Risk Return Graph

Graphs Risk and Return Statistics for each Option
Generally, Increased Return Requires Additional Risk
Running Multiple Options will trace out Efficient Frontier
Identifies inefficient options that provide a lower level of return for the
same or more risk as another option
Identifies unfavorable options that provide insufficient return for level of
risk (convex points on curve)
Identifies options that have most attractive risk return trade-offs
Chart is the Intersection of three Key Views of Risk
Underlying risk in portfolio

Reinsurers risk appetite (reflected in ceded premiums)
Companys measure and tolerance for risk
2003 CAS Research
Working Party
18
Risk Return Graph

R e tu rn - E x p e c te d S A P N e t In c o m e (a fte r-ta x )
Risk Return Tradeoff Chart

40,000
35,000
NO REIN
30,000
STOP LOSS
EXCESS
25,000
20,000
PRO RATA
15,000
10,000
30,000
35,000
40,000
45,000
50,000
55,000
60,000
65,000
70,000
Risk - Standard Deviation of Net Income (after-tax)
2003 CAS Research

Working Party
19
Observations
All Options are Efficient based on a Linear Risk
Preference
No option provides less return for the same or greater risk than
another option
If a lines was drawn through the points, no option is clearly on a
convex point
Ranking may Change given an Alternate Risk
Preference Function (use Alexs iso-line Graphics)

Ranking may also Change using an Alternate Risk
Measure
The Stop Loss option will probably perform very well using a risk
measure that reflects downside risk only
2003 CAS Research
Working Party
20

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Entire Operations (Liabilities and Assets) of an

What Is The Chance Of A Given Financial Result?

2003 CAS Research

Return What is your measure of success?

Model Underlying Gross Liabilities by Line of Business

How does changing retentions impact net results?

Run Model Several Times with Varying Structures

Understand the impact of reinsurance

Analyze your Reinsurance Program as a Whole

Go beyond only seeing cost = ceded premium

Analysis is Tailored to Companys Risk Appetite

Tolerance for risk

What is the Best Reinsurance Program

Scope and Limitations

Sources of Risk from their Operations:

Asset risk value of investments

To do a Reinsurance Analysis we Focus our Modeling

Gross prospective losses for lines of business

Yields a Solution with Regard to Reinsurance Strategy

Relatively quick model set up

2003 CAS Research

Model Setup and Options

Core losses were modeled aggregate distributions

Reinsurance Options Net Business

XOL attaching at $1.0m and up

Stop loss attaching at 85% loss and LAE, 10 pts of limit

Modeled Detail Needed to Support Decision Making

Accounting, asset values, reserve balances, and cash flow parameters

2003 CAS Research

Return Maximize SAP Net Income

2003 CAS Research

Chart shows probability of return outcomes for each option

Analytic: Variance/Std Dev., Ruin, EPD, VaR, Tail VaR

Distribution Graphs Cumulative

2003 CAS Research

Net of Excess of Loss

2003 CAS Research

Net of Quota Share

2003 CAS Research

Net of Stop Loss

2003 CAS Research

Worse off with

Better off with

Net of Excess Cover

2003 CAS Research

Worse off with

Better off with

Net of Quota Share

2003 CAS Research

Worse off with

Better off with

Net of Stop Loss

2003 CAS Research

Distribution Statistics Table

Average Net Income under each option

Percentiles at various levels

Similar to output of a catastrophe model

Statistical measure of volatility