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
Page 3
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 4
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 5
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
Page 6
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)
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 7
Umbrella Pricing Example - $25mm lead umbrella, E&S market
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
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
Page 8
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 9
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 10
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.
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 11
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 12
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.
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 13
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 14
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 15
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!
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 16
Interview with an Actuary - Discussion Points
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
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?
Page 17
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?
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 18
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)
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 19
Price Comparison: Two Competitors
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
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
Page 20
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 21
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)?
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 22
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
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
Page 23
Miscellaneous Observations & Conclusions (cont’d)
Favorite Quotes (common to all clients):
Seminar on ReinsuranceBoston, MAJune 7-8, 2004
“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”