Actuarial Audits of Umbrella Programs - “Observations From The Road” Gerard Palisi, FCAS, MAAA Seminar on Reinsurance Boston, MA June 7-8, 2004

Actuarial Audits of Umbrella Programs -

“Observations From The Road”Gerard Palisi, FCAS, MAAA

Seminar on ReinsuranceBoston, MAJune 7-8, 2004

Page 2

Presentation Overview

Why Audit?

Difficulties in Pricing Umbrella Treaties

Categorizing Umbrella Programs

Basics of Umbrella Pricing

Pricing Issues

Interview with an Actuary

Making Sense of the Audited Files

Other Issues

Miscellaneous Observations & ConclusionsSeminar on ReinsuranceBoston, MAJune 7-8, 2004

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Why Audit?

To confirm that client is operating consistent with expectations and treaty terms

Gain insight into client-specific nuances not available in a typical submission

Determine the extent of actuarial involvement in the pricing and management processes

Offer suggestions, make recommendations, provide benchmark versus peers


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Difficulties in Pricing Umbrella Treaties

Wide variation / heterogeneity as to type of business written, limit/attachment philosophy, pricing, etc.

Limited or no industry statistics or benchmarks

Even within a program, continual shift in book of business - moving target (“as if” issue)

Traditional pricing approaches strained due to extreme price level changes, large/uncertain trend and development factors

Better understanding of the client’s business and pricing should translate into better treaty pricing assumptions


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Categorizing Umbrella Programs

Layer: lead umbrella, excess, high excess/capacity

Insured: small business, middle market, national account, global

Insurer Size: regional/specialty, global/national

Primary Insurer: supported, unsupported

Regulatory: admitted, non-admitted/E&S

Rating approaches can vary based on these distinctions!Seminar on Reinsurance

Boston, MAJune 7-8, 2004

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Basics of Umbrella Pricing - (Insurer’s Perspective)

Start with “appropriate” underlying GL and Auto premiums

Apply 1st million umbrella factor (or unit rate for auto) to derive 1st million umbrella layer

Apply excess layer factors to specified reference layer(s) to derive excess layers

For each layer, premium is the greater of the calculated layer premium, or the minimum premium for the layer

If applicable, add charge for ancillary coverages (e.g. Liquor, Aircraft, Watercraft, Foreign)


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Umbrella Pricing Example - $25mm lead umbrella, E&S market


indicated selected average PPM rel toUnderlying exposure rate base premium premium PPM prev layerGL 200,000 0.9 sales (000) 180,000 200,000Auto PPT 10 800 units 8,000 8,000Auto Med 50 1250 units 62,500 62,500

1st mil UmbrellaGL 0.13 U/L premium 26,000Auto 0.15 U/L premium 10,575

36,575 36,575 36,575

4 xs 1 xs U/L 1.25 1 xs U/L prem 45,719 45,719 11,430 31.3%

5 xs 5 xs U/L 0.30 5 xs U/L prem 24,688 24,688 4,938 43.2%

5 xs 10 xs U/L 0.45 5x5xU/L prem 11,110 11,110 2,222 45.0%

5 xs 15 xs U/L 0.60 5x10xU/L prem 6,666 7,500 1,500 67.5%

5 xs 20 xs U/L 0.65 5x15xU/L prem 4,333 7,500 1,500 100.0%

Total (25 xs U/L) 133,092

Minimum Premium: 1,500 per mil

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Pricing Issues: Underlying Primary GL

Common bases for deriving the first mil layer:

– Manual premium (exposure x loss cost x ILF x LCM): the most common base.

concern: may not be appropriate for a specific insured; may be too high/low due to inefficiencies in the ratemaking process

– Manual with judgment credit/debit: adjustment of manual to reflect individual risk characteristics.

concern: adjustment may be more market driven than risk driven; adjustment may not be appropriate for umbrella/excess layers


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Pricing Issues: Underlying Primary GL (cont’d)

Common bases (cont’d):

– Actual (sold) premium: usually available; may be used directly, or as a check on selected premium base

concern: market price may be inadequate, or (if over other carrier) its derivation unknown

– Adjusted Actual: e.g., 150% of actual.

concern: market driven and arbitrary

– Experience rated / Loss rated premium:

concern: these adjustments may not be appropriate or credible for pricing severity layers


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Pricing Issues: Underlying Primary Auto

Use actual or re-rated primary auto premium

Unit Rating: price per unit times number of units

Alternatively, take the higher of actual/manual premium or unit rated premium

A variation on unit rating is to develop 1st mil umbrella unit rates rather than primary unit rates, and therefore avoid reference to primary Auto altogether.


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Pricing Issues - First Million Umbrella Layer

1st mil umbrella factors typically vary by ISO Table (or similar proxy for hazard) for GL, and vehicle type for Auto

Factors can vary widely based on categorizations discussed above. For example, E&S programs tend to have much heavier factors than standard admitted programs.

More common to have specific factors for this layer rather than ranges, so 1st mil price itself is usually the most straightforward and layer least susceptible to underwriting judgment

Where do factors come from? Generally ISO ILF-based, but tend to be infrequently reviewed or updated


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Pricing Issues - Higher Layers

For layers above the first million umbrella, two common approaches are:

– single million layers - price is a % of previous million layer

– “blocks” - 4 xs 1, 5 xs 5, 5 xs 10, etc. Price is a % of some previous layer (first $5mm, preceding $5mm)

Percent ranges are generally very broad; enables rating plan to have maximum flexibility

Actuarial rigor breaks down here (if it was ever present!) Factors may be dictated by management, or completely based on underwriter discretion.


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Pricing Issues - Minimum Premiums

Can have account minimums and layer minimums

Layer minimums may vary by class or hazard (low, medium, high) and/or layer

Layer minimums presumably cover operating and capital costs

In reality, they are of undetermined origin and are market driven

Underwriter’s layer factor selections determine how fast the price is driven to the minimum premium


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Pricing Issues - Other Features

Accounts with large underlying deductibles or SIR’s

– often priced incorrectly: primary premium reflecting deductible/SIR credit is used as base for umbrella

– presence of deductible on underlying GL should have no impact on umbrella price

– presence of SIR does shift umbrella attachment higher, but credit associated with this can be estimated (e.g. via ILF’s), and effect decreases as layer increases

Primary attachments other than $1mm

– can price properly using ILF’s


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Interview with an Actuary

Additional insight and perspective can be gained by setting aside some time during the audit to discuss the program with the actuary (or management)

Key areas for discussion:

– extent of actuarial involvement, in general

– support for account pricing

– role in model development and maintenance

– price monitoring

– market conditions and trends

Underwrite the actuary!


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Interview with an Actuary - Discussion Points


What is the extent of actuarial involvement in the pricing process?

Do actuaries get involved in pricing for specific accounts? If so, what criteria prompts their involvement?

Do actuaries determine/monitor/update the various pricing factors used by underwriters? If not, who does? How often?

How are minimum premiums determined? What prompts a change in the minimums?

If an umbrella/excess pricing model is used, what is the extent of actuarial involvement in the development/monitoring/updating of the model?

If external inputs to the model are required (e.g. ISO loss costs and ILF’s), how often are they updated, and by whom?

How sophisticated is the pricing model? Is it based on ISO methodology (current or prior?) or some other approach?

How much flexibility does the model provide to underwriters to input values or deviate from default factors?

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Interview with an Actuary - Discussion Points (cont’d)

If an account involves large primary deductibles or SIR’s are they handled properly in the pricing formulas?

Does the pricing model explicitly price for drop-down or first dollar coverages?

For cessions treaties, is the determination of ceded premium automated, manual or some combination? Is there a cessions model linked to the pricing model?

Are underlying primary and umbrella/excess carriers (if any) identified in the file? Are the underlying premiums captured?

Are multiple pricing models, or different versions of the same model, being used concurrently by different underwriters/offices?

Is there a consistent pricing approach among underwriters? Among the branch offices?


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Making Sense of the Audited Files

First order of business: is the client’s pricing methodology clear from the files?

Is the pricing consistent:

– with the rating plan

– with client management’s perception

– among accounts?

Are shortfalls in one layer offset by overages in another? (see example - next slide)


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Price Comparison: Two Competitors


Prem/Ops Premium: 80,000Products Premium: 20,000

100,000

1st mil P/O 11% 8,800 14% 11,2001st mil P/CO 14% 2,800 16% 3,200

tot (1 xs P) 11.6% 11,600 14.4% 14,400

1 xs 1 60% 6,960 50% 7,2001 xs 2 65% 4,524 60% 4,3201 xs 3 75% 3,393 70% 3,0241 xs 4 90% 3,054 80% 2,419

tot (4 xs 1) 155% 17,931 118% 16,963

5 xs 5 47% 13,745 25% 7,841

tot (10 xs P) 43,276 39,204

Company A Company B

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Making Sense of the Audited Files (cont’d)

Particularly for High Excess, does the file document the actual premium charged by underlying carriers? How does the actual compare to the client’s theoretical price for the underlying layer?

Valuable to collect data across multiple accounts:

– judgment credits/debits

– 4 xs 1 factors (explicit or implicit)

– 5 xs 5 factors

– average and dispersion of these statistics can shed light on pricing consistency, and (over multiple years) on umbrella market pricing cycles


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Other Issues

Price change analysis & monitoring

– does calculation properly adjust for changes in exposure, limit, and attachment?

– does calculation include all business (e.g. minimum premium accounts, high excess)?

Validation of ceded premium for cessions treaties

– review reinsurance layoff sheets for accuracy

– is process automated, manual, or some combination?

– does cession follow pricing exactly, or is it estimated (e.g. via curves)?


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Miscellaneous Observations & Conclusions

Underwriters have a great deal of discretion in pricing umbrella/excess - deal with it

For a given insured, Umbrella is often the last line of business to be priced; limitations on insurance budget may influence price

Clients want to hear reinsurer’s perspectives on the market, and on how their pricing and practices measure up against peers

Actuaries can help advance the “state of the art” by continuing to research excess trend, loss development, and loss distributions


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Miscellaneous Observations & Conclusions (cont’d)

Favorite Quotes (common to all clients):


“All our underwriters have at least 20 years experience underwriting umbrella”

“Competitors X, Y, … are pricing irresponsibly and undermining the market”

“No one is getting better price increases than we are”

“Thanks. We value your observations and input”

Documents

Actuarial Audits of Umbrella Programs - “Observations From The Road” Gerard Palisi, FCAS, MAAA Seminar on Reinsurance Boston, MA June 7-8, 2004