CARE Seminar

Ceding Company Considerations

Elaine Caprio BradyVice President and Manager of Ceded Reinsurance Operations - Liberty Mutual

Gary GanciSecond Vice President and Actuary, Enterprise Risk and Reinsurance - Travelers

Peter Wildman (Moderator), Vice President - Towers Perrin

May 19, 2008

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Topics to be Covered

Panel Discussion Format/questions, audience participation encouraged

Exposure Management

Reinsurance Administration

Underwriting Submission Data

Purchasing Decision

Emerging Claim Issues

Actuarial Involvement/Wrap-up

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CARE SeminarExposure Management

You need to transfer some risk; you’ve run your Cat models, now what?

How do you evaluate the various products offered to assist in the context of Catastrophe management?

Catastrophe Reinsurance

Cat Bonds

Swaps-Exposure PML Hedging

Other Capital Market Products

How can a ceding company evaluate the trade-offs between the above products?

What evaluation criteria are used? Is there a meaningful comparison and what are the administrative implications of the various products?

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Cat Risk Mitigation Alternatives

Traditional Reinsurance, CAT Bonds, Collateralized Reinsurance (Hedge Funds), Swaps

Limits Single Limit vs. One Reinstatement

Term One Year vs. Multi-Year

Security Reinsurance Promise vs. Investor Funds vs. Collateral

Time Value Near immediate collection vs. paid when paid

Basis Risk Non-indemnity triggered CAT Bonds

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CAT Bonds - Basis Risk with Index Triggers

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Why Use Cat Bonds? A Cedant’s Perspective

Diversify suppliers for a key purchase

Reduce reinsurance market disruption risk

Access broader capital base

More capacity at similar prices

Longer-term protection

Multi-year term reduces immediate impact of market price volatility

Minimize credit risk

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Are Your Own Losses the Trigger? Benefits of industry or parametric trigger

Simplify disclosure to investors Relieve investors of worry about the quality of the sponsor’s book

Reinsurance Excess & Surplus Large Commercial Small Commercial Homeowners

More worry

Less worry

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Downside of industry or parametric trigger

“Basis Risk” The risk that your losses exceed what you would have expected based on parametric or industry loss data

You may suffer a large loss, but recover nothing because industry loss is small

Who will bear the basis risk?

Are Your Own Losses the Trigger (Continued)?

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Analyze Your Basis Risk

Compare your losses in past events to (Market Share) x (Industry Loss)

Check exposure maps for “hot spots”

See how your modeled share of industry loss varies among events and among models

Think about non-modeled loss sources

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Other Issues

Multiple events

Beware of multiple-event exposure

More critical given multi-year nature of bonds

Collateral costs important

Termination of coverage

Investors reclaim funds unless event occurs

An event near end of term can present issues

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1. The cedant enters into a reinsurance contract with a Special Purpose Vehicle (SPV)

2. The SPV sells notes to investors in the capital markets

3. Proceeds from the notes offering are invested in high quality securities and held in a collateral trust

4. Investment returns are swapped to a LIBOR -based rate by the Swap Counterparty

SPVCedant Investors

Collateral Trust

Swap Counterparty

Principal& interest

Cash proceeds

Premium

Contingentclaim payment

Notes

Investmentearnings

Scheduledinterest

Investmentearnings

1 2

3

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Typical Cat Bond Structure

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Exposure Management – Credit Risk

How does security evaluation come into play as counterparty credit risk is covered?

What are the counterparty implications of the various products for Availability of reinsurance markets Accessibility of reinsurance/other capital Quality of markets Suitability of markets

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CARE SeminarExposure Management – Credit Risk

Reinsurance Partners – Considerations

Financial Strength Operating Company vs. Group Level

Short or Long-tail Nature of Coverage

Capacity

Quoting Behavior

Level of Engagement, Knowledge of the Business

Aggregation

Claim Payment History

Consideration of Parental Support

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CARE SeminarExposure Management – Credit Risk

Credit for Reinsurance Considerations

Collateral options ranked in order of quality: LOC Reg 114 Trust Individual non-Reg 114 Trust Funds withheld Multi beneficiary trust

New Proposed Rules and State Regulation: NAIC REO Proposal New Fla and NY Collateral Regs

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Exposure Management - Cats

Are Cat management issues difference based on ownership issues? Publicly traded companies Mutual companies Privately held companies [What type of owner?]

Does ceding company size matter?

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Reinsurance Administration

How important is reinsurance administration to the Reinsurance purchasing decision?

What are the hot button decision criteria in contract wording, broker vs. direct placement, claims collection/dispute resolution, casualty vs. property placements?

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Reinsurance Administration

Key Reinsurance Contract Clauses Special Termination: Permits ceding company to terminate and

commute in the event of specified triggers, with reinsurer given option to cure by LOC funding.

Arbitration: Consolidation of claims, streamlined procedures for lower dollar value disputes, applies detailed reinsurance arbitration procedures.

Access to Records: Cedent may reserve rights to provide access to sensitive documents, or all documents if reinsurer does not respond to claim within 90 days.

Assignment, Novation and Transfer: Requires cedent approval before reinsurer liabilities are wholly or partially transferred to affiliates or third parties.

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CARE SeminarReinsurance Administration

Collection and Dispute Resolution Issues

English and US Law implications:

Solvent Schemes of Arrangement:

—a forced commutation by a solvent reinsurer for a fraction of the value of the projected losses.

—English law

—RI Legislation

Part 7 Transfers: Reinsurer domiciled under English law may transfer its reinsurance liabilities to a lesser capitalized affiliate.

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CARE SeminarReinsurance Administration

Collection and Dispute Resolution Issues

“Run off” Reinsurers may avoid paying valid claims delay collections for over 90 days after billing Press for commutation of treaties

Arbitration vs. Litigation: Consolidation issues Cost Length of Proceeding Claim Preclusion

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CARE SeminarUnderwriting Submission Data

Information for Reinsurance Pricing

Historical Written and/or Earned premium Current and Historical In-force Premium & Policy Profile

(what’s available) Limits profile by line of business – distribution of premiums,

policies, and exposures For AL/GL provide breakdown by Increased Limits Factor

category ILF’s for non-ISO lines or Distribution by class/hazard group, by state for WC For Excess/Umbrella, SIR, and large deductible business –

subject premiums mapped to a grid of policy limit by underlying limit (deductible/SIR)

Deductible profile

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CARE SeminarUnderwriting Submission Data

Information for Reinsurance Pricing

Projected Written and/or Earned Premium – by line of business (subject premium for upcoming year)

Large Loss Listing Claims over $100,000 (or half of desired retention, whichever is less) Last ten years, where available

Excess (or Large Loss) Loss Triangles Individual losses at periodic valuation dates (preferably same loss threshold as above) Paid and incurred, where available Any changes in Claims Dept. philosophy

Historical effective rate level changes – if available (or rough estimates if possible) Provide breakdown of base rate and schedule credit/debit changes if available Explanation of schedule credit/debit methodology Most recent Annual Statement (note: for U.S. Companies, we usually have this on-line)

Proposed reinsurance contract (will identify any unusual features)

Catastrophe Submission data Exposure profiles, RMS, AIR, EQE (Cat modeling) files output

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CARE SeminarUnderwriting Submission Data (continued)

Observations

1. Introductory narrative important, Underwriting plans

2. Organize information

3. Index info, categorize what is most important!

4. Recognize various party incentives

5. Insurer questions, Reinsurer request for information (early and often)

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CARE SeminarPurchasing Decisions

How do ceding companies view purchasing decisions?

Are they centralized or decentralized?

How are profit centers, different companies within same group, different lines of business treated?

Are any internal reinsurance solutions considered?

What are some of the recipes for placing metrics on the Go/no go purchase decision?

To what extent are the unknown unknowns considered? (What is value of Casualty Reinsurance for latent, unanticipated exposures?)

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CARE SeminarPurchasing Decisions

Types of Reinsurance Buyers

Large, Well Capitalized, Publicly Traded Insurers

Peak Exposures Only Objective: long term growth in absolute book value Potential Metric: compare theoretical cost of capital savings

(reduction in pricing risk load) versus expected cost of reinsurance

Buy Retentions Down to Reduce Volatility Objective: achieve consistency in book value growth at the

cost of lesser absolute value. Believe in to the doctrine of multiple expansion

Potential Metric: compare reduction in modeled variance to expected cost of reinsurance (have some equation that relates CV of earnings to P/B multiple)

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Types of Reinsurance Buyers

Company A Company BPeak Exposures Only Buy Down Retentions

Mult = 1.8Mult = 1.5

Mult = 1.5 Mult = 1.5

Value

Current 5 Yr Plan Current 5 Yr Plan

- book value- market premium over book value- frictional cost of additional reinsurance

Fundamental Question : Does reduced earnings volatility lead to a higher price/book multiple?

Mult=1.7

Mult=1.5

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Emerging Claims Issues

What do you see as emerging issues in the industries you represent?

Will the sub-prime crisis result in reinsurance disputes?

Industry reports often state that disputes are rising between cedents and reinsurers, do you think this is true? If so, why have the disputes in the reinsurance industry increased?

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CARE SeminarEmerging Claims Issues (continued)

Global warming effects Impact on weather modeling Secondary issue to producers of green house gas vis-à-vis pollution exclusion

Nanotechnology Will be widely adopted Marathon man issue (Is it safe?)

Fear of illness from products under GL coverage Benzine, mercury, avian flu, etc. Does increased anxiety constitute bodily injury or not

Identity Theft Have purveyors of individual data “negligently” published the information by

having inadequate safeguards? Coverage B issues

Aging Public Infrastructure Inspection and Replacement procedures

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Actuarial Involvement/Wrap Up

What are some of the various roles actuaries can play to assist the reinsurance purchasing process being optimized? Risk Transfer Documentation

— should be more than simply audit fodder

— Should be natural extension of internal pricing work Need to be responsive to reinsurers’ actuarial questions –

develop rapport with broker/reinsurer actuaries Should be in a position to discuss reasonableness of quotes –

alternative pricing methodologies

Can there be an optimal reinsurance decision? Need to develop buying strategy first

— Use quiet periods to define strategy

— Consistently apply metrics to support strategy

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Actuarial Involvement

Reinsurance Decision Making

Understand decision dynamics of company

What is management’s appetite for analytics? Actuarial desire is often greater than management (Rating Agency

metrics are requiring more analytical metrics) What is ceding company analytical level of expertise (in-house actuary,

committee, CFO is purchaser, etc.)? Who is the decision maker? Management appetite hard to gauge (do they think numerically,

graphically, or intuitively)

What is management attitude towards reinsurance? Relationship oriented, transaction oriented, mix of both Is payback a common notion? What level of understanding or complexity is desired?

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