Price Monitoring: A Governance Issue Isaac Mashitz - Swiss Re CAS Seminar on Ratemaking March 8,...

Price Monitoring: A Governance IssueIsaac Mashitz - Swiss Re

CAS Seminar on Ratemaking

March 8, 2007

Price MonitoringA Governance IssueCAS Ratemaking Seminar3/8/200

Slide 2

Governance

Aggregate Accumulations

Policy Wordings

Underwriting

Operations

Outward cessions

Price Adequacy

etc.

Price Monitoring:A Governance IssueCAS Ratemaking Seminar 3/8/07

Slide 3

Price Adequacy

Understand and measure past and current profitability

Understand and measure changing exposure environment

Identify or create usable benchmark

Monitor each pricing judgement

Monitor External Rates/Prices

Monitor Internal Rates/Prices

Price Monitoring:A Governance IssueCAS Ratemaking Seminar3/8/07

Slide 4

Why is Price Monitoring So Important??


Slide 5

Accident Gross Earned Estimated Estimated Smoothed RestatedYear Premium Ultimate Loss Ultimate LR Premium Loss Ratio1984 $9.43 $19.81 210%1985 $14.55 $19.40 133%1986 $25.49 $15.16 59%1987 $26.15 $13.59 52% $26.15 52%1988 $23.64 $13.93 59% $26.96 52%1989 $21.58 $14.36 67% $27.78 52%1990 $21.12 $14.83 70% $28.63 52%1991 $20.18 $14.45 72% $29.51 49%1992 $19.64 $14.17 72% $30.42 47%1993 $19.66 $14.75 75% $31.35 47%1994 $20.82 $15.97 77% $32.31 49%1995 $19.77 $15.72 79% $33.30 47%1996 $19.16 $16.32 85% $34.32 48%1997 $19.53 $18.42 94% $35.37 52%1998 $20.64 $22.05 107% $36.46 60%1999 $21.68 $25.66 118% $37.58 68%2000 $22.03 $26.38 120% $38.73 68%2001 $27.57 $27.05 98% $39.91 68%2002 $32.75 $24.88 76% $41.14 60%2003 $39.79 $25.57 64% $42.40 60%2004 $44.02 $27.07 61% $43.70 62%2005 $45.04 $29.86 66% $45.04 66%Total $534.25 $429.38 80%

Annual Growth1987-2005 (Exp. Fit) 3.4% 5.0%

1987-2005 3.1% 4.5% Amounts in USD Billions

Source: AM Bests Averages and Averages and primary company Annual Statements

US P&C Primary IndustryGeneral Liability Occurrence Loss Ratios

Note

1. GL includes Products Liability.

2. Losses grew at about 5% per year since 1987 and 7% per year since 1996.

3. Smoothing the premium virtually eliminates the cycle with only a small residual cyclical effect.


Slide 6

US P&C Primary IndustryGeneral Liability Occurrence Loss Ratios


0%

20%

40%

60%

80%

100%

120%

140%

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Accident Years

Lo

ss R

atio

s

Actual L/R

Restated L/R

Slide 7

Ultimate LossesAccident Primary Ultimate losses

Year Industry GDP As a % of GDP1995 $50.82 $7,398 0.69%1996 $53.05 $7,817 0.68%1997 $58.02 $8,304 0.70%1998 $65.87 $8,747 0.75%1999 $73.67 $9,268 0.79%2000 $77.41 $9,817 0.79%2001 $78.19 $10,128 0.77%2002 $72.42 $10,470 0.69%2003 $72.64 $10,971 0.66%2004 $75.37 $11,734 0.64%2005 $83.26 $12,487 0.67%

Average1995 - 2005

Annual Growth 5.1% 5.4% 0.71%Exponential Fit 4.5% 5.2% 0.71%

Amounts in USD Billions*Excludes Professional Liability

US P&C Primary Industry Commercial Casualty Losses* vs US Gross Domestic Product

1. Over the long term, losses and GDP have grown at approximately the same rate.

2. Losses as a % of GDP grew in the soft market and declined since 2002.


Slide 8

Umbrella:

Average Prices Per Million


0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: Marsh

Slide 9

Three Generic Primary Rate Monitors

Individual Policy Comparisons at Renewal

Need to adjust for (lim, att pt, exposure)

Unable to adjust for mix of business

New vs Renewal

Rate per Exposure Metric for Homogeneous Segments

Homogeneous segments rare for Commercial Lines

Comparisons to Benchmark

Need detailed benchmark

Questionable accuracy by mix

Consistency over time


Slide 10

Renewal Business Bias

Assumptions

Renewal Price Change -5%

New Business Price Change -25%

Renewal Retention 65%

Results

Calculated Actual

Annual price deterioration -5% -12%

Three Year Compound effect-14% -32%Price Monitoring:A Governance IssueCAS Ratemaking Seminar3/8/07

Slide 11

Renewal Business Bias

Price Monitoring:A Governance IssueCAS Ratemaking Seminar3/8/07 -35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

Calculated Actual

Annual Price Deterioration

Three Year Compound effect

Slide 12

Technical Issues

Minimum Premiums

Limits/Attachment Points

What about capital charge differences

Exposure

Units: Auto vs GL

Primary PremiumPrimary Expected LossD&O Market Value or Sales vs Market volatility

Schedule credits and debits

Experience mod/PH DIV/Retrospective rated

Rate increase vs “real achieved”

Risk Classification/Tier


Slide 13

Systemic Issues

Objectivity vs Subjectivity

New Business & Lost Business

Terms and Conditions

Underwriting risk selection and guidelines

Movement in a soft market from E&S to Standard market

Generally these items leverage and exaggerate calculated price movements


Slide 14


Correlates and leverages price declines in soft market

D&O – Entity Coverage

Umbrella – Aggregate Drop Downs

EPLI on GL/Umbrella policies for free

Extended reporting periods on prior acts for free

Multi year policies with cancellation option for free


Slide 15

Reinsurer Issues

Reinsurer needs to understand thoroughly primary rate monitor

Commission changes vs Premium changes – Reinsurer and Primary have different objectives

Measure against internal planning objective – alternate purpose


Slide 16

Premium at Present Rates Approach

Works well for:

Personal Lines

Standard and Small/Medium Commercial Lines

Rates current in force book at last year’s and this year’s rate levels


Slide 17

Sophisticated Benchmark

Used for:

Reinsurance treaties

Large commercial Accounts

Individually analyzed and priced deals

Consistently parameterized individual account pricing model


Slide 18

Sophisticated Benchmark

Need to measure actual parameters vs default parameters

Need to measure use of credibility against a standard

Experience vs Exposure rating

Experience years

Etc.

Interest Rate Movement

Subjective Issues

Underwriting/Risk selection improvement/deterioration



Slide 19

Reasons for having strong price monitoring

Input into reserving process

Input into corporate and strategic planning

Creates transparency on the pricing decisions and drives appropriate discipline

Price monitoring is important to reinsurers in the pricing process

Poor metrics will often be thrown out or tempered and replaced with more punitive defaults.


Slide 20

GovernanceThe Age of Information

On an individual account basis:

Record each pricing action/judgement

actual vs default parameters

credibility usage

Measure actual loss emergence vs expected

Measure actual loss payout vs expected

Measure actual premium pay-in vs expected

Measure actual profitability against expected

etc.Price Monitoring:A Governance IssueCAS Ratemaking Seminar3/8/07

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