Friedland Flashcards
How are sound estimates unpaid losses important for reinsurers and their stakeholders?
- Internal management of a reinsurer requires sound reserves because they impact pricing, underwriting, strategic planning and financial decision making
- Investors require sound reserves in order to appropriately evaluate a reinsurer’s balance sheet and income statement when making investment decisions
- Regulators require sound reserves in order to appropriately evaluate a reinsurer’s financial health when supervising the reinsurance market
- Rating agencies require sound reserves in order to issue strong financial ratings. If a reinsurer experiences significant adverse development, it risks a rating downgrade. This may make the reinsurer look less attractive to primary insurers
Five primary reasons that ceding companies purchase reinsurance
- Promote stability (reinsurance stabilizes the loss experience of ceding companies from year to ear by retraining smaller, more predictable claims and ceding larger, more unpredictable claims)
- Increase capacity (Reinsurance allows ceding companies to assume more risk by ceding a portion of all of their policies or by ceding their larger policies. By increasing its capacity through reinsurance, cedant may be able to write quality accounts that are otherwise unattainable. It also allows smaller insurers compete with larger insurers who are able to retain more risk)
- Protect against catastrophe (Reinsurance protects ceding companies from a single catastrophic loss event as well as multiple large loss events)
- Manage capital and solvency margin (reinsurance passes risk from the cedant to the reinsurer. With less risk is present, less capital is needed)
- Access technical expertise. (reinsurers can lend their expertise in the area of underwriting, marketing, claims, and pricing to insurers seeking to enter new lines of business or new regions)
What is treaty reinsurance
Cedant enters into a contract with one ore more reinsurers to cede all business from certain lines of business, subject to retentions and attachment points.
The reinsurer is NOT involved in the underwriting of the underlying policies written by the cedant.
What is facultative reinsurance
Reinsurers have the option of rejecting cession submissions from the cedant.
A submission, acceptance, and agreement are required for each individual risk or group of risks that the cedant wants to reinsure.
Underwriting risk for the reinsurer is reduced under facultative reinsurance since the reinsurer can conduct its own underwriting
What’s the primary purpose of facultative reinsurance
To increase a cedant’ s capacity by ceding large risks (typically for high-value and hazardous commercial risks)
2 examples of hybrid contracts
Facultative automatic: a bordereau of risks ceded is submitted to the reinsurer, which has limited rights to decline individual risks
Facultative obligatory treaty: a treaty under which the cedant has the option to cede or not cede individual risks. The reinsurer must accept any risks that are ceded
What is proportional reinsurance typically used for?
- To manage capital and solvency margins (net premium-to-surplus ratios are typically improved)
- To increase capacity
- To protect against catastrophes
What’s the purpose of non-proportional reinsurance
- provides stability by protecting losses above a list for risk ceded
Types of non-proportional reinsurance
- excess per risk (usually to protect property exposure, may include ceding commission)
- Excess per occurrence
- Catastrophe reinsurance (a special case of excess per occurrence)
- Annual aggregate excess of loss (stop-loss) (intent to cover your net results, apply this reinsurance last)
- Clash (casualty reinsurance contract that attaches above all other policy limits, To cover exceptional event)
Components of a clash event
- Loss much have multiple policies by one insured or similar policies held by multiple insureds.
- The losses are traceable to and the direct consequence of a specific event
- The event must take place within a specific timeframe
Reasons that cedant may commute a reinsurance contract
- To exit a line of business or region
- To manage reserves for transfer or sale
- To avoid the credit risk associated with its reinsurer, especially if the reinsurer has experienced a rating downgrade
- To better manage claims and claims-related expenses
Reasons that reinsurers may commute a reinsurance contract
- To end a relationship with a cedant that is in run-off or one with which it no longer conducts business
- To protect itself from the potential insolvency of the cedant
- To avoid disputes when there are significant differences of opinion with respect to future loss development of subject losses
Why understanding commutation is important for the reserving actuary
- Actuaries are often involved in the analysis of reinsurance contracts that are subject to commutation
- Commutations affect the estimation of unpaid ceded losses. Thus, a ceding company’s actuary should be aware of commuted contracts.
- Commutations eliminate the corresponding liability to the reinsurer. Thus, a reinsurer’s actuary should also be aware of commuted contracts.
- Loss development patterns for commuted contracts could be different from contracts that remain in-force
4 data requirements
- Sufficiency (data is sufficient if they include the needed information for the work)
- Reliability (data are reliable if they are sufficiently complete, consistent, and accurate for the purposes of work)
- Homogeneity (Homogeneous reinsurance obligations or Homogeneous risk groups are managed together and have similar risk characteristics such as underwriting policies, claims settlement patterns, product features, etc)
- Credibility (a measure of the predictive value in a given application that the actuary attaches to a particular set of data)
Reasons that data may not be sufficient
- Contract terms can vary from one cedant to another and year over year
- Operational and strategic changes implemented at the cedant and the reinsurer can cause significant changes in mix of business, attachment points, policy limits and claim processing
Data validation steps
- reconcile data against audited financial statements, trial balances, or other relevant records
- Test the data for reasonableness against external or independent data
- Test the data for internal consistency and consistency with other relevant information.
- Compare the data to those for a prior period or periods
Data validation for actuaries working for reinsurers may be more difficult than data validation for actuaries for primary insurers for the following reasons
- For each cedant and broker, different IT systems capture different types of data and use different terms for similar types of data
- Bordereau reporting may differ by cedant and broker in the types of data reported, data labels, and the frequency of submission to the insurer
- There may be lags in reporting to the reinsurer
- There may be gaps in reporting critical claims information from the cedant
- The unique nature of reinsurance policies can lead to different coverage for similar loss events with different cedant
- There may be issues related to data coding for the reinsurer
3 reasons why there may be lags reporting to the reinsurer
- Claims must first be reported to the primary insurer before being reported to the reinsurer
- The long-tailed nature of certain types of business
- The use of bordereau reporting, where losses are only reported on a quarterly or more infrequent basis
8 variables that can affect reporting and payment patterns
- LOB
- Type of contract (facultative, treaty, finite)
- Type of reinsurance cover (quota share, surplus share, non-proportional)
- Primary line of business for casualty
- Attachment point for casualty
- Contract terms: flat-rated, retro-rated,
- Type of cedant (small, large, or excess and surplus)
- Broker
Advantage of accident year aggregation for estimating unpaid losses
- easy to achieve
- easy to understand
- become reliably estimable sooner than underwriting year data sine accident year data represents losses occurring over a shorter time frame
- Industry benchmarks, such as Reinsurance Association of America data, are based on accident year losses
- Tracking losses by accident year is valuable when there are changes due to economic or regulatory forces (such as inflation or law amendments) or major loss events that can influence loss experience
Disadvantage of accident year aggregation for estimating unpaid losses
- the potential mismatch between losses and premiums (the matching of calendar earned premium and accident year losses is only approximate)
Advantage of underwriting year aggregation
This is an exact match of losses and premiums. (this is especially important when underwriting or pricing changes occur)
Disadvantage of underwriting year aggregation
- Data takes longer to mature ( this is particularly challenging in the most immature underwriting years where development factors are highly levered and the written premium is not fully earned)
- It can make it difficult to isolate the effect of a single large event
Examples of external sources of data
- Reinsurance association of America (public bi-annual study of loss development triangle)
- Best’s Aggregates & Averages (based on-proportional reinsurance data in schedule P)
- Internet searches (not very useful. It’s highly aggregated)
Selecting age-to-age factors consideration
- smooth progression of individual age-to-age factors and average factors across development periods (want to see steady decreasing incremental development from valuation to next)
- Stability of age-to-age factors for the same development period (down the column, you want to see small range of factors)
- Credibility of experience (when low credibility, may want to use benchmark development factors)
- Changes in patterns and applicability of the historical experience
Issues associated with bordereau reporting
- How data are cumulated by the cedant and absorbed by the reinsurer
- Potential infrequency of bordereau reporting. The more infrequent the reporting, the greater the lag in reporting and the longer the payment pattern.
- The creation of a bordereau is often manual and time intensive
- The loss detail on a bordereau is not nearly as detailed as the claim files of the cedant
Limitations of Schedule P data
- An experience period of only 10 years, which is not typically long enough for excess of loss reinsurance
- The segmentation is not granular enough
- The combined experience may not reflect the experience of an individual reinsurer
Shortcoming of external data for a reinsurer
- Reinsurance contract terms and conditions
- Mix of assumed business
- Types of reinsurance
- underwriting processes
- Claims management processes
- IT systems
What is finite risk reinsurance
this type of reinsurance takes the time value of money into account
What are some features of finite risk reinsurance
- Risk transfer and risk financing in a multi-year contract
- Incorporates the time value of money and investment income
- Limited assumption of risk by the reinsurer
- Reinsurer and ceding company share results
Reasons for run off
- corporate restructuring
- mergers & acquisitions
- discontinuation of lines of business
- erratic changes in the valuation/cost of a liability
What is loss portfolio transfers
Transfers all (or a portion) of liability for future loss payments on losses already incurred.
Relieves cedant of uncertainty in loss reserves and relieves capital
What is adverse development cover
Ceding company is reimbursed for losses excess a retention, but there is no transfer of the loss reserves to the reinsurer.
Often used for Mergers & Acquisition to transfer the risks of timing an adverse reserve development
What is loss-occurring-during basis
Reinsurance coverage for all losses that occur between the inception and expiration of the reinsurance contract, regardless of when the underlying policy was issued
What is risks-attaching basis
Reinsurance coverage for losses on underlying policies with inception dates during the reinsurance contract’s effective period
This takes longer for data to mature
What is subscription policy
A reinsurance policy where risk is shared by multiple reinsurers. Each reinsurer has a subscription percentage to the contract
Reasons for subscription policies
- When coverage is more than one reinsurer is willing to assume
- allows the cedant to diversify credit risk (the risk that one reinsurer cannot pay reinsurance recoveries)
Two approaches to deal with multiple currencies
- Separate data by currency, then combine the data after translating to a common currency using the exchange rate at a single point in time
- Aggregate losses are based on the ceding company’s currency of origin
Differences in method assumptions for reinsurance vs. primary insurance
- For a similar line: LDFs at immature ages are often higher (more leveraged) for reinsurance due to reporting lags.
- Loss trend factors are often higher for excess of loss reinsurance than primary insurance.
- Less precision in premium on-level factors for rate-changes for reinsurance vs. primary insurance
- Limited use of adjustment factors for tort/product reform for reinsurance vs. primary insurance
Comparing the development factors and patterns for reinsurance vs. primary insurance for similar types of business
- More volatility in age-to-age factors at earlier maturities for reinsurance compared to primary insurance. and also for paid losses compared to reported losses
- Greater volatility means more uncertainty in age-to-age factor selection and projected ultimate losses.
- Longer reporting/payment patterns for reinsurance due to lags in reporting to the reinsurer
Comparing the development factors and patterns for proportional vs. non-proportional reinsurance for same line of business
- Significantly more volatility in age-to-age factors for non-proportional treaty and facultative reinsurance than for proportional treaty reinsurance.
- CDFs are greater for non-proportional treaty and facultative reinsurance (longer development patterns)
- More volatility in ratios of paid-to-reported losses for non-proportional and facultative.
The key difference is that proportional reinsurance is ground-up and non-proportional is excess of loss.
Comparing the development factors and patterns for property reinsurance excluding CAT and property reinsurance CAT
- Reinsurer carried reserves for CAT losses are usually based on ground-up exposure-based assessments using information from ceding companies by contract (NOT the development method)
- The impact of CAT events at different times of the year impacts development and age-to-age factors for different years
- Volatility is much higher for CAT compared to excluding CAT reinsurance.
Takeaway: Methods using age-to-age factors are often not appropriate for property CAT
Implications of volatility in loss development
Greater volatility in age-to-age factors can lead to greater uncertainty in projections of ultimate losses because: development methods and other methods rely on the factors that have greater volatility. Greater volatility in indicated ultimate loss ratios is often used to select ELRs.