Beruflich Dokumente
Kultur Dokumente
Case Study
1999 CAS Seminar on Financial Risk Management April 12-13, 1999 Denver, Colorado
Presented by: Robert F. Conger, FCAS Tillinghast Towers Perrin
Discussion Outline
The Challenge: How Much Reinsurance to Buy, and What Mix? Conceptual Framework Methodological Approach Case Study: XYZ Insurance Key Issues
The Challenge:
Given the behavior of todays insurance and financial markets, many property/casualty insurers are re-evaluating their reinsurance programs
We have excess capital Keep net premiums up Eliminate unnecessary expenses and transaction costs Why share profits? Maximize investable assets
pressure
Its cheap Everyone else is grabbing this
deal
Let the reinsurers share the
selling
We cant lose on this latest
reinsurance proposal
Better safe than sorry
Chief Financial Officer
The design of a reinsurance program involves complex issues, and is material to most insurers bottom lines
Despite favorable market conditions, reinsurance is still a significant cost item for
many insurers
Reinsurance decisions are becoming more challenging Benefits have always been difficult to evaluate in relation to costs
requirements? Decisions are often made at the program level, but need to be placed in overall enterprise context Need to avoid inefficient reinsurance activity Proliferation of reinsurance products expands alternatives to consider Alternatives to reinsurance products are becoming available, but add further to complexity of analysis Securitization of risk Contingent debt/equity capital
Reinsurance price volatility creates short-term tactical opportunities that can be
Conceptual Framework
The answers to reinsurance questions must be specific to XYZ Insurance Compared to XYZ Insurance, no other insurance company has exactly the same
Volume and mix of business Profitability history and outlook Exposure to large claims, mass torts, and catastrophes Investment strategy and performance Capital amount and structure Loss reserve adequacy Reinsurance choices Risk appetite/aversion Corporate affiliates Corporate structure Stakeholder expectations Rating agency and regulatory considerations
Therefore, the right choice of reinsurance for XYZ Insurance will be different than for any other company . . . And may be different next year than this year.
Components of a reinsurance program can be compared to each other, and to other alternatives, by viewing reinsurance as rented capital
Reduction in Required Capital
Cost of Reinsurance Expected Ceded Premium Ceding Commission Expected Ceded Losses
Is reinsurance a cost effective source of capital? It adds value when this cost of
Reinsurance strategy alternatives can be compared using an Asset/Liability Efficient Frontier (ALEF) framework
50%
Q
O P B
N A
M 10%
10
variability in these future results? Gross of reinsurance Net of reinsurance (for each alternative reinsurance program)
How to measure the Cost of a Reinsurance program and its effect on an insurers
Expected Returns?
How to translate the potential for variability in future results into a usable and
11
Methodological Approach
Income Statement
Analyzer
Measures of Risk
Return
Capital Requirements
13
Modeled financial outcomes are translated into Risk Measures specific to the insurer Identify Key Reasons to Buy Reinsurance
Control variability of reported financial
results
Reduce capital needs
Long-term Finance growth Satisfy regulatory or rating agency
constraints
Support pricing of primary products
Offer new insurance products Allow discounting of reserves Current reinsurance price is below
Define Risk Measures that capture the key objectives of the reinsurance program
cost
Etc.
14
We have explored several illustrative alternatives to traditional statistical measures of risk and variability
Probability of Operating Result = X$
Below Target Return measure
15
The advantage of Below Target Risk over standard deviation can be illustrated by an example
These two return probability
(roughly equivalent to a zero real return), the top distribution has a BTR of 17.6%; the bottom distribution has a BTR of 27.7%
The top return distribution is
Probability
distributions have the same expected return of 13%, and the same standard deviation
Rate of Return
13%
16
The choice of methods will depend on the objectives of the analysis, the expected duration of the reinsurance arrangement, and the nature of information available.
In the current market, where reinsurers are aggressively seeking top-line growth,
short term tactical opportunities may lead to different reinsurance buying decisions than in the long run
17
The definition of Required Capital likewise will vary depending on company perspective
Illustrative definitions of required capital with current reinsurance program Current capital Estimated capital at threshold of specified A.M. Best rating
Multiple of RBC
Capital that keeps Expected Policyholder Deficit < x% With alternative reinsurance programs, we can Model the different amount of Required Capital that would produce the same
level of risk, or Determine the change in level of risk, given the same amount of capital
18
While probability of ruin is the simplest form of risk-capital constraint, more complex constraints can be defined
Dimensions of Risk-Capital Constraints
Probability Metric
Measurement Basis
Perspective
Examples:
Less than a 1% chance of GAAP operating loss equal to or greater than 25% of reported equity Economic capital sufficient to reduce expected unfunded policyholder obligations to less than .25%
19
As a first step, XYZ identified the highest cost components of the reinsurance program
Top 15 Programs by Normative Net Annual Cost
Casualty Working XS Property First Cat Special Property Fac E&O Program XS Work Comp Working XS Property High Cat Umbrella QS Std Property Risk XS Surety QS
Casualty High XS
Marine XS Aviation XS Prof Liab XS Special Property QS Casualty Clash
10
12
14
16
$ Millions
21
XYZ measured each components contribution to reducing insolvency risk, and translated that into a reduction in required capital
20
40
60
80
100
120
140
$ Millions
22
Some program elements appear to add significant value; others may be inefficient
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
23
In evaluating strategy alternatives, the focus was narrowed to the three least efficient programs
Strategy A B C D E
Casualty Working XS
Work Comp Working XS No Change No Change Double Retention Double Retention Double Retention Treble Retention Treble Retention
Aviation XS No Change No Change No Change Double Retention Double Retention Double Retention
No Change
Double Retention Double Retention Double Retention Treble Retention Treble Retention Treble Retention
F
G
Treble Retention
24
Each strategy was evaluated in terms of its impact on risk and return
12%
Expected Return
11% E D C B A 10% F
0.9%
1.1%
25
Key Issues
An essential feature of the model is the interaction between its components and across time Correlations between lines of business Runs of good or bad years Relationships between historical and future results Macro-economic trends over time Correlations between inflation, equity returns, and interest rates Relationships between underwriting results and investment results Relationship between gross-of-reinsurance results and recoveries Patterns of reserve inadequacy/redundancy Patterns of variation in cash flow Influence of past results on future management strategies and actions Investment strategy dependent on yield curve and/or asset duration Shareholder dividends dependent on operating results
27
The model is run in a wide variety of scenarios over multiple future years Future inflation rates Future interest rates and investment returns Catastrophes Random large losses Loss ratio movement Long term patterns Shocks Year-to-year variability As with the company model itself, inter-relationships between elements are an essential feature of the modeling
28
Parameters used to model reinsurable losses (e.g., size-of-loss distribution) Degree of correlation of results across lines of business and across years Base level of company profitability and growth Different combinations of reinsurance components The objective of the sensitivity testing is to satisfy ourselves that the results are
29
of Risk Measure
The final trade-off between risk and return is a matter of preference
But this modeling approach provides strong support to allow making the key decisions in a well-informed manner.
30