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Severity Exposed - October 2010

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Severity Exposed - Putting the jacket back on

October 2010

3Guy Carpenter

Instant vs Homemade – Single Claimant Severity

Severity can arrive a couple of different ways, kind of like oatmeal

– Instant in the form of a serious catastrophic claim – Burns / Brains– Homemade / slow cooked via deterioration of reserves and

additional health problems of injured workers “in the system”– Unlike oatmeal, unforeseen severity to a portfolio can be unhealthy

A long-term, broad market view of losses will provide some severity indicators

AASCIF provides a great environment for non-competing companies to exchange data, experience and strategies to identify and attempt to mitigate severity volatility

Intermediary and Consultant have tools to help to reveal severity volatility

4Guy Carpenter

Guy CarpenterSeverity Indicator / Portfolio Management Tool - Reveal™

Others may have similar tools. Some of you may have created your own severity tool / index

Reveal™, by Guy Carpenter was created to provide a refined, class code level look at severity beyond Hazard Groupings– What was originally a four tiered system is now seven tiered

system – better but still contains some gaps– Computer power and actuarial science have been combined to

produce a more refined view of severity

Created with industry data by state

For class codes without the volume to produce credibility, algorithms were created using other state and/or similar class code experience

5Guy Carpenter

Plotting the Class CodesRelative Frequency by Class Code

• Individual Class Codes

Lower than Hazard Group

Higher than Hazard Group

A point plotted near “1” represents a class code that has historically had an “average” number of observed Permanent Total claims, compared to the Hazard Group average. A point significantly above or below has had a disproportionate number of PT claims, compared to the class’s HG average.

0.1

1

10

These Class Codes have a higher relative frequency of 5-7 times the hazard group

Ratio of Permanent Total Claims to Temporary Total Claims

6Guy Carpenter

Guy CarpenterSeverity Indicator / Portfolio Management Tool - Reveal™

Both ceding companies and reinsurers tend to rely on Hazard Groups for their severity indicators.– With severity driven class code data on your side you can refine….

…Underwriting / Loss Control / Claims handling to address severity classes

…/enhance chances of profitability when reviewing growth initiatives

…(change) reinsurer opinions of severity within a portfolio, reduce reinsurance pricing

…indentify pockets of exposure, policies which may warrant strategic reinsurance purchasing (facultative reinsurance)

Using Reinsurance to Mitigate Severity Volatility -

8Guy Carpenter

Reinsurance as a backstopSingle Claimant vs Multiple Claimant losses

Lots of “two’s” in the reinsurance discussion today– Two types of reinsurance Treaty and Facultative

Treaty – reinsurance to cover a portfolio of policies Facultative – reinsurance to cover losses from a single policy*

– Two forms of reinsurance Pro-Rata and Excess of Loss Pro-rata – first dollar sharing of premium and losses Excess of Loss – reinsurance pays once a deductible has been

exceeded– Two forms of Excess of Loss reinsurance

Multiple claimant coverage – industrial accident, natural perils, terrorism. Also called Catastrophe reinsurance

Single claimant coverage – also called working layer

9Guy Carpenter

Reinsurance as a backstopSingle Claimant vs Multiple Claimant losses

Multiple Claimant (Catastrophe) Reinsurance

Several products, ample reinsurance capacity and price flexibility for multi-claimant, Catastrophe reinsurance.– Steady price decreases 2003– Third-party catastrophe models for earthquake and terrorism create

common ground for evaluating loss possibilities Price is market driven by the market’s cost of capital to cover

limits offered – Terms and Conditions typically allow for loss from a single claimant

of up to $10M. More is available, but at a price

10Guy Carpenter

Reinsurance as a backstopSingle Claimant Coverage

Single Claimant severity exposure is typically mitigated with Working layer reinsurance coverage.

Two typical tranches (if purchased)– Single claimant coverage in layers up to $5M per occurrence– Single claimant losses between $5M and $10M– Very few buy reinsurance excess of $10M although there is

capacity available. (watch this space !) Strength of Ceding company balance sheet, Hazard Group mix,

historical losses and risk appetite of Executives and Board usually factor into the decision for working layers structures.

Instant severity and developed (homemade) severity volatility can be covered by the same structures

11Guy Carpenter

Reinsurance as a backstopSingle Claimant Coverage

Typical terms and conditions for a working layer providing single claimant coverage– Per Occurrence – determined by the date of loss– Typically a fixed aggregate limits either…

…purchased in advance …limited by a number of reinstatements, which may result in

some additional premium– Usually a sunset provision of seven or ten years

Requires that a claim be reported to reinsurers within the sunset date.

– Limits to $10M available

As a part of an overall Enterprise Risk Management strategy, conservative accident year strategies create good calendar year strategies.

12Guy Carpenter

Reinsurance as a backstopSingle Claimant Coverage – higher limits

More inquiries from clients for limits greater than $10M

Tough to find middle ground for ceding companies and reinsurers

Possible strategies– Pooling of risk by more than one company to purchase reinsurance– Multi-year agreements for reduced annual limits – Change layering. Update current $5M xs $5M layers to $10M xs

$5M– Modify the multi-claimant catastrophe coverages to allow for a

single claimant loss greater than $10M (which is typically the cap)

Intermediaries and reinsurers can provide a valuable view of the risk (and mitigating structures) to complement a company’s internal view of the risk of severity volatility

13Guy Carpenter

Closing

Additional client stories

– 15+ year client – One historical loss greater than $5M. Within three weeks in 2010, one claim $9M one claim $6M. Both single claimant losses

– We have a client with a single claimant incurred loss greater than $30M.

Few believe a company can eliminate the possibility of severity loss volatility. However, there are tools and strategies which can reduce dependency on “good luck”

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Questions / Discussion

Aaron Bueler, Workers Compensation Specialty Practice Leader, Managing Director – Guy Carpenter, Seattle

Jason Denechaud, Director of Accident, Health & Workers Compensation Underwriting, Catlin US

www.guycarp.com

www.guycarp.com

Severity Exposed - Putting the jacket back on

October 2010