1999 CAS Seminar on Ratemaking

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1999 CAS Seminar on Ratemaking
Multiple Uses of Stop Loss Reinsurance
Brian Brown - Milliman Robertson, Inc. Larry
Frank - Pegasus Advisors, Inc. Lisa Walsh -
London Life Casualty Reinsurance Corporation
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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Presentation Overview

• Introduction
• Characteristics
• Pros and Cons
• Case Studies
• Stabilize Results/Reduce Reinsurance Cost
• Finance Growth
• Adverse Development Protection
• Questions and Answers

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Introduction

• What is it?
• Who Buys it?
• Motivation to Purchase?

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Characteristics

• Retention/Attachment
• Limits (Sublimits)
• Experience Account (Profit Commission)
• Margin
• Premium Schedule
• Term (annual or multiyear)
• Funds Transfer/Funds Withheld

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons

• Pro
• Stop loss reinsurance is significantly less
  expensive
• than working or low layer traditional
  reinsurance.
• Con
• No immediate cash recovery under stop loss as
• compared to traditional. Somewhat offsetting
• this is the ability for buyers to withhold
  premiums
• under stop loss (i.e., no large cash outflows).

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons

• Pro
• Stop loss reinsurance provides broader
  reinsurance protection/smoother underwriting
  results and lower loss ratios than working or low
  layer traditional reinsurance.
• Con
• Some traditional reinsurance coverages provide
  unlimited coverage whereas stop loss is finite.

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons

• Pro
• Stop loss reinsurance profit sharing terms
  normally provide a contractual device to build
  off-balance sheet banks including interest on
  premium funds.
• Con
• Traditional reinsurance has less appearance of
  being financial so it is subject to less
  regulatory scrutiny for risk transfer.

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons

• Pro
• A technical review of the reinsurance
  income/surplus protection vs. cost will reveal
  that stop loss is generally a more effective and
  efficient way to buy reinsurance.
• Con
• Stop loss reinsurance is very technical and
  requires more time to arrange (i.e., CFO or Chief
  Actuary).

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance

• Case Study 1
• Prospective Accident Year Stop Loss
• Stabilization of results and reduction of
  reinsurance costs.

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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Company Information
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Objectives

• Provide cat protection at a low cost
• Stabilize results
• Reduce total reinsurance costs
• Protect earnings and surplus
• Maintain expense ratio
• Maintain or improve AM Best rating
• Incorporate sufficient risk transfer (timing
  u/w risk) for accounting approval

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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Stop Loss Terms
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Stop Loss Terms
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Stop Loss Terms

• All other reinsurance purchased inures to
  the benefit of this cover.
• Funds Withheld - F/W.
• F/W balance is credited a contractual rate
  of 7.0 effective annually.
• Profit Commission of 100.

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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Stop Loss Terms

• F/W balance All Premium less
• Ceding Commission
  paid less
• Reinsurers Margin less
• UNL Paid by Reinsurer
  plus
• Interest Credit
• All FET and LOC costs are paid by the company.
• Premium Loss reporting - Quarterly bordereaux.
• UNL Settlements - From F/W account first until
  depleted, then from reinsurers funds.

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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Accounting Results
1) Expected - No property cat losses excess of
budget SNEP 500M Subject Losses 350M (70
L/R) (incl. expected cats)
Calculations Attachment 65.2 x
500M 326.0M Limit 18 x 500M
90.0M Ceded Losses 350M - 326M 24.0M Net
Ceded Premium 4.8x500M 24.0M Underwriting
Income 24M - 24M 0.0M Potential PV Cost
7.5 x 24M 1.8M
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Accounting Results
2) Partial Use - 50M cat loss excess of
budget SNEP 500M Subject Losses 400M (80
L/R) (incl. 50M unplanned cats)
Calculations Attachment 65.2 x
500M 326.0M Limit 18 x 500M
90.0M Ceded Losses 400M - 326M 74.0M Net
Ceded Premium 4.8 x 500M 24.0M Addl
Premium52.5x(400M-376M) 12.6M Total Premium
24.0M 12.6M 36.6M Underwriting Income74M
- 36.6M 37.4M Potential PV Cost 7.5 x
36.6M 2.7M
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Accounting Results
3) Full Use - 40M cat loss 26M other xs of
budget SNEP 500M Subject Losses 416M
(83.2 L/R) (incl. 66M
unplanned) Calculations Attachment
65.2 x 500M 326.0M Limit 18 x 500M
90.0M Ceded Losses 416M - 326M 90.0M Net
Ceded Premium 4.8 x 500M 24.0M Addl
Premium52.5x(416M-376M) 21.0M Total Premium
24.0M 21.0M 45.0M Underwriting Income90M
- 45M 45.0M Potential PV Cost 7.5 x 45M
3.4M
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Accounting Results
4) Favorable - 10M improvement over budget SNEP
500M Subject Losses 340M (68 L/R)
Calculations Attachment 65.2 x
500M 326.0M Limit 18 x 500M
90.0M Ceded Losses 340M - 326M
14.0M Ceded Premium 4.8 x 500M
24.0M Return Premium Accrual 9.8M U/W
Income14M - 24M 9.8M -0.2M Potential PV
Cost 7.5 x 24.0M 1.8M Accrual 24M -
1.8M margin interest credit of 1.6M - 14M
losses 9.8M
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Reinsurers Analysis

• Client Assessment - Published Rating
• Senior Management to communicate objectives
• Client Data Requirements
• Losses - historical and projected
• Payout pattern projections and support
• Mix of business - historical and projected
• Catastrophe exposure information/modeling

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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Reinsurers Analysis

• Supplementary Data
• Industry Losses
• Industry Payout Patterns
• Other client information
• Press releases

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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Reinsurers Results
At expected payout
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Reinsurers Results
Payout pattern shifted one year forward.
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Companys Results with Stop Loss
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1999 CAS Seminar on Ratemaking
Case Study 1Prospective Accident Year Stop Loss
Stop Loss versus a Traditional Cover
Scenario 2 with 50M catastrophe
Traditional cover with 50M in limits for a 20
rate of line. Reinstatement premium of 1 at 100
as to time, prorata as to amount. Reinsurers
PV cost 1.8 million _at_ expected level..
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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance

• Case Study 2
• Financing Growth

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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Company Information
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Company Objectives

• To expand premium writings.
• To increase Statutory Surplus
• Reduce gross and net leverage tests
• (Premiums and Liabilities)
• Maintain or improve AM Best ratings
• Improve RBC test results

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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Stop Loss Terms
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Stop Loss Terms
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Stop Loss Terms

• All other reinsurance purchased inures to the
  benefit of this cover.
• Funds Withheld (F/W).
• F/W balance is credited a contractual rate of
  7.0 effective annually.
• Profit Commission of 100.

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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Stop Loss Terms

• F/W balance All Premium less
• Ceding
  Commission paid less
• Reinsurers Margin less
• UNL Paid by Reinsurer
  plus
• Interest Credit
• All FET and LOC costs are paid by the company.
• Premium Loss reporting - Quarterly bordereaux.
• UNL Settlements - From F/W account first until
  depleted, then from reinsurers funds.

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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Accounting Results
1) Expected SNEP 75M Subject Losses 63.8M
(85 L/R) Calculations Attachment
70.0 x 75M 52.5M Limit 30 x 75M
22.5M Ceded Losses 63.8M - 52.5M
11.3M Net Ceded Premium 5.25x75M
3.9M Underwriting Income 11.3M - 3.9M
7.4M Potential PV Cost 12.0 x 3.9M
0.5M
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Accounting Results
2) Full Use SNEP 75M Subject Losses 75M
(100 L/R) Calculations Attachment
70.0 x 75M 52.5M Limit 30 x 75M
22.5M Ceded Losses 75M -52.5M 22.5M Net
Ceded Premium 5.25 x 75M 3.9M Addl
Premium20x(75M-63.8M) 2.3M Total Premium
3.9M 2.3M 6.2M Underwriting Income22.5M -
6.2M 16.3M Potential PV Cost 12.0 x 6.2M
0.7M
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Accounting Results
3) Only 25 Growth in Premium - Expected
Losses SNEP 62.5M Subject Losses 53.1M
(85 L/R) Calculations Attachment
70.0 x 62.5M 43.8M Limit 30 x 62.5M
18.8M Ceded Losses 53.1M -43.8M
9.3M Net Ceded Premium MD
3.9M Underwriting Income9.3M - 3.9M
5.4M Potential PV Cost 12.0 x 3.9M
0.5M
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Reinsurers Analysis

• Client Assessment - Financial Statements
• Client Data Requirements
• Losses - historical and projected
• Payout pattern projections
• Paid and incurred data triangles
• Pricing history (Rate filings, deviations)
• Marketing strategy and support

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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Reinsurers Analysis

• Supplementary Data
• Industry Losses
• Industry Payout Patterns
• Other client information
• Press releases

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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Reinsurers Results
With 75M SNEP and expected payout
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Reinsurers Results
With 75M SNEP and payout pattern shifted one year
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1999 CAS Seminar on Ratemaking
Case Study 2Financing Growth
Companys Results with Stop Loss
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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance

• Case Study 3
• Facilitating a Sale
• Adverse Development Cover

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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Company A (to be Acquired) Information
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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Company B (Buyer) Information
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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Adverse Development Coverage (ADC)

• Company B requires Company A to arrange at least
  150M of limit above the year end carried loss
  and alae (LALAE) reserves.
• Cover must be placed contemporaneously with the
  sale of the company (EITF D 54-Accounting).
• Retention to be set to equal carried LALAE
  reserves less premium expense of coverage (u/w
  income neutral).

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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Accounting Implications

• Company A at Closing
• Purchase of ADC is u/w neutral.
• Federal Income Tax benefits (discount of
  reserves).
• Surplus is maintained.
• Combined Companies
• Future earnings reduced by lost investment income
  on expensed premium by A for the ADC.
• Future earnings protected by the offset of any
  direct LALAE development with up to 150M of
  reinsurance recovery.

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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
ADC Key Terms
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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Combined Companys Annual Results
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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Reinsurers Analysis

• Client Assessment - Published Rating
• Client Data Requirements
• Independent Actuarial Review
• Internal Projections
• Confidence Intervals
• Incurred Loss Triangles
• Paid Loss Triangles

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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Reinsurers Analysis

• Client Data Requirements (continued)
• Historical pricing of business
• Historical inuring reinsurances
• Claims audits
• Reserving policies
• Changes to claims handling

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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Reinsurers Analysis

• Supplementary Data
• Industry Losses
• Industry Payout Patterns
• Peer company information
• Press releases

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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Reinsurers Results
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1999 CAS Seminar on Ratemaking
Case Study 3Facilitating a Sale
Reinsurers Analysis

• Expected Results based upon actuarial
  projected probabilities is 16.5 million.
• Upside to downside is 1.0 1.8
• Return on Equity (Capital allocation)
• LOC usage
• Underwriting constraints
• Relationship implications - historical/prospectiv
  e
• Subject Loss Limitations (Asbestos/EIL, Y2K caps)

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Conclusions

• Addresses multiple reinsurance needs
• Customizable
• Cost Effective
• Efficient
• Offers considerable advantages over traditional
  approaches

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1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Speakers

• Lisa Walsh is Vice President of London Life and
  Casualty Reinsurance Corporation domiciled in
  Barbados, West Indies. Lisa is a Fellow of the
  Casualty Actuarial Society, Member of the
  American Academy of Actuaries and a Chartered
  Property and Casualty Underwriter. Lisa was
  previously employed with The St. Paul Companies
  in St. Paul, MN primarily in the medical
  malpractice area.
• Larry Frank is Vice President of Pegasus
  Advisors, Inc.. Larry is a New York Certified
  Public Accountant and a member of the American
  Institute of Certified Public Accountants. Larry
  is a summa cum laude graduate of Long Island
  University, C.W. Post College, where he earned a
  B.S. degree in accounting. Larry was previously
  employed with G.L. Hodson and Son, Inc., a member
  of the Willis Corroon family, and Price
  Waterhouse.