Pitfalls in CommonPricing/Reserving Methodologies

David Skurnick

Leonard Chung

Clive L. Keatinge

CARe June 15, 2000

Pitfalls in Common Pricing/Reserving

Methodologies

David Skurnick, St.Paul Re

CARe

June 15, 2000

Pitfalls in...

• Underwriting

• Excess

• Miscellaneous

Pitfalls in Underwriting

• Accuracy and completeness of data

• Understanding of terms

• Local practices

Data Accuracy and Completeness

• How can you verify accuracy? – Audits– Consistency– Agreement with the market

• What’s missing?– Older cat losses– rate changes– experience on discontinued business

Experience on discontinued business -- my rule of thumb:

• If they have discontinued an entire segment that ran badly, say a territory or line of business, then I exclude the experience.

• If they have gotten off some unsuccessful business, then I include the experience -- this is normal underwriting.

Understanding of Terms

• Interlocking clause

• “FCA” (For common account)

• Lloyd’s ‘miscellaneous classes”

Interlocking clause

• E.g., a Worldwide ex. US catastrophe cover excess of $100m, with interlocking clause.

• If a hurricane hit the Caribbean and the US, cedant’s combined retention would be $100.

• Must read the contract to see how the retention is allocated.

• Cannot underwrite this deal without looking at US exposures.

“FCA” (For Common Account)

• E.g., a cedant has an 80% quota share.

• You write 5% of an excess treaty

• Is is “5% of net” or “5% of all”?

• If you’re covering the Common Account then you’re limits may be 5 times higher.

• Mandatory or optional?

What are you covering?

• “Miscellaneous Classes” could include anything, especially at Lloyd’s.

• E.g., Computer Leasing in early 80’s

• E.g., Typical wording is “All policies written in the Fire Department”, not “All Fire Policies.”

• You MUST verify what is actually covered.

Local Practices

• Egyptian “catastrophe”

• Egyptian personal accident

• European commutation

• European motor excess

Egypt Re “Catastrophe”

• The Heliopolis Sheraton Hotel burned down. Was this a cat loss?

• Yes! -- because there were two policies, one for the floors and one for the elevator shaft!

Egyptian Personal Accident

Question: Treaty limits are :

EGP 50,000 XS 50,000 / $ 20,000 XS 20,000

with 3 reinstatements.

How large is the reinsurer’s maximum loss?

(Assume 1 EGP = $0.40)

Egyptian Personal Accident(slide 2)

Answer:

EGP 200,000 PLUS $80,000

(The slash meant “and”, not “or”)

European Commutation

• Commutations in Europe are generally revocable

• The commutation will not apply to exceptionally large claims or to material change in claims cost.

European Motor Excess

• Most international motor covers are indexed for inflation.

Pitfalls in Excess Pricing

• Excess of Aggregate

• Inflation

• Aggregate Deductible

Excess of Aggregate (Stop Loss)

• Buyer knows more than seller

• Long-term or short-term relationship?

• LR affected by frequency, severity & cats

• LR affected by Rate Adequacy

• A total loss to the reinsurance layer could be likely.

Compare the Risk of Specific Excess Vs Excess of Aggregate

• Look at the impact of an error in estimating the Expected Loss Ratio

• E.g., suppose that the Expected Frequency is twice what you thought it was, and all other estimates are correct.

Specific Excess Example

• Suppose you are receiving 10% of original premium for a risk layer of $1m Xs $1m and your expected loss was 7%.

• Due to under-estimate of frequency, the ELR is 140% rather than 70%

• Note that this 2 to 1 ratio is independent of the original rate, frequency, severity, etc.

Excess of Aggregate Example

• You receive 6% of original premium to cover a loss ratio of 30% XS 80%.

• Your primary ELR = 70%.

• Your expected XS loss = 2%.

• Then, your XS ELR = 33%.

• Suppose exp. freq. Is twice what your think

• Then expected FGU LR = 140%

• Expected XS loss might be, say, 24%.

• Correct XS ELR = 400%, not 33%

Excess of Aggregate Example(slide 2)

• Suppose expected frequency is twice what your thought it was

• Then expected FGU LR = 140%

• Expected XS loss to the layer 30% XS 80% might be, say, 24%, not 2%.

• Correct XS ELR = 400%, not 33%

Per Risk Casualty Excess Treatywith High Inflation

• E.g., Avner -- old Israeli XS motor liability

• When Israeli Shekel had 100% inflation

• XS claims became routine, not exceptional

• The increase in premium (due to a higher exposure base) did not at all compensate for the enormous increase in claim frequency in this layer.

Aggregate Deductible on Per Risk Property

• E.g., layer of $1m XS $1m XS $4m.

• Reinsurer would would pay only after 4 total losses of $2 million or more (or equivalent in partial losses to the layer.)

• Assume the treaty limit is $25 million.

• This would protect against a frequency of losses in a low layer.

Aggregate Deductible on Per Risk Property (slide 2)

• Key is the average frequency of losses > $2m (ignoring partial losses to the layer)

• If you think the expected frequency of such losses = 5, then this treaty would be loss free more often than not.

• One might guess the expected loss to the layer as about $1 million (using a Poisson)

Aggregate Deductible on Per Risk Property (slide 3)

• What if the correct average frequency = 10

• Then expected loss >$5 million

• Doubling the frequency caused the risk excess expected loss to grow 5X

• Note that frequency might be double because of unexpected growth in the underlying premium.

Miscellaneous Pitfalls

• Exchange Rate errors

• Individual company loss development

• Ending a Managing General Agent relationship

Exchange Rate Errors

Several years ago, one of our underwriters slipped a decimal point in the exchange rate and wrote ten times as big a line as he intended. (Naturally, the deal turned out to be a big loss!)

Individual company loss development

• For several years we wrote a quota share of industrial property business.

• We learned to our sorrow that this property business took several years to develop.

• Slow development was partly due to the complex nature of the claims.

• Also, company claims procedures slowed the reporting and reserving of losses.

Ending an MGA Relationship• A cedant of ours had a group of Managing General

Agents

• They decided to get out of MGA business

• Several years later they decided to handle the remaining open claims themselves.

• They discovered that their loss reserve of $200 m should have been $600 million!

• It turned out that the cancelled MGA’s had stopped working on the claims.

Next Speaker

Leonard Chung