the actuary’s perspective · actuary’s analysis and the financial forecasts for the captive...

Captive Academy of the 14th Annual Executive Educational Conference

The Actuary’s Perspective

Legaré Gresham, FCAS, MAAA

Bartlett Actuarial Group, Ltd.

145 King Street, Suite 203 Charleston, SC 29401

(843) 377-0993

legareg@bartlettactuarialgroup.com

Captive Academy of the 14th Annual Executive Educational Conference

First, What Is an Actuary? Definition (websters.com) – “a person who computes premium rates, dividends, risks, etc., according to probabilities based on statistical records.” Experts in measuring and managing risk In order to become credentialed, there is a rigorous series of professional examinations. Accountants Look Back, We Look to the Future

1

Captive Academy of the 14th Annual Executive Educational Conference

How Can an Actuary Help?

• Feasibility Studies

• Reserve Reviews

• Support for Ongoing Operations

• Support for Business Plan Changes

2

Captive Academy of the 14th Annual Executive Educational Conference

What is a Feasibility Study?

Purpose - to assess the viability of forming a captive insurance company or risk retention group.

• Project loss costs

• Estimate other costs and premiums

• NPV comparison of alternatives

• Develop program structure

• Estimate required capitalization

• Pro forma financials

3

Captive Academy of the 14th Annual Executive Educational Conference

Pre-Feasibility

• Conceptual review

• Funding appetite

• Commitment to an alternative market solution

• Specifics of program (lines of coverage, limits, etc.)

• Determine ownership structure

5

4

Captive Academy of the 14th Annual Executive Educational Conference

5

• Retention Levels

• Reinsurance Alternatives

• Loss & Expense Forecasts

• Premium Estimates

• Capital Requirements

Core Financial Considerations

Captive Academy of the 14th Annual Executive Educational Conference

6

Retention

Reinsurance

Net L&LAE Forecast Net Premium

Capital Requirement

Captive Academy of the 14th Annual Executive Educational Conference

7

Retention Considerations

• Cost of Reinsurance

• Current Commercial Policies

• Lines of Business

• Actual Exposure

• Risk Appetite

Captive Academy of the 14th Annual Executive Educational Conference

Retention

Reinsurance

Net L&LAE Forecast Net Premium

Capital Requirement

8

Captive Academy of the 14th Annual Executive Educational Conference

• What exposures are being written in the captive?

─ Are they frequency or severity driven

• Risk appetite of the captive’s owners

• How much capital is available

• Size of program

Reinsurance Considerations

9

Captive Academy of the 14th Annual Executive Educational Conference

• Pro rata (%)

• Excess of loss ($)

• Treaty

• Facultative

Reinsurance Alternatives

10

Captive Academy of the 14th Annual Executive Educational Conference

Retention

Reinsurance

Net L&LAE Forecast Net Premium

Capital Requirement

11

Captive Academy of the 14th Annual Executive Educational Conference

Loss and Expense Forecasts

• Gross (Direct and Assumed) versus Net losses and loss

adjustment expenses (L&LAE)

• Effect of Retention/Reinsurance

• Correlation between lines of business?

12

Captive Academy of the 14th Annual Executive Educational Conference

Developing Expected Losses

• Company Experience

─ Most applicable but not always credible

─ Is history predictive of future?

• Industry Information

─ Credible but perhaps not an exact match

13

Captive Academy of the 14th Annual Executive Educational Conference

Exposures

• Basic Rating Unit ─ Reasonable

─ Closely Correlated to Loss Potential

─ Easily Verifiable

─ Not Subject to Manipulation

15

14

Captive Academy of the 14th Annual Executive Educational Conference

15

Company Data

• Paid and Reported Losses for last 5-10 Years • Claim Count for last 5-10 Years • Historical Exposure (# autos, revenue, etc) • Historical Premium • Historical Retentions • Large Loss Listing • Triangles (Historical Development)

***Projected Exposure***

Captive Academy of the 14th Annual Executive Educational Conference

• Insurance Industry

– Commercial Rates

– Development Patterns

– Loss Ratios

– Benefit Level Change Factors

• Other

– Inflation Trends

– Specialized Expertise; eg NOAA, Ponemon Institute

16

Industry Information

Captive Academy of the 14th Annual Executive Educational Conference

17

• Deterministic – Single Point Estimate —Loss Cost/Pure Premium —Frequency and Severity —Expected Loss Ratio

•Current Premium •Other Commercial Rates

• Stochastic Models - Estimate a Loss Distribution —Confidence Levels

Possible Methods

Captive Academy of the 14th Annual Executive Educational Conference

18

Retention

Reinsurance

Net L&LAE Forecast Net Premium

Capital Requirement

Captive Academy of the 14th Annual Executive Educational Conference

19

• Sufficient to cover all expenses, including the cost of reinsurance and/or fronting

• Reinsurance decreases the net expected L&LAE, which decreases the net premium

• Expected Payout Period/Time Value of Money

• Adjusted to Projection Period – Trend, Benefit Level, Exposure, etc.

• Safety/Risk Margin?

Premium Considerations

Captive Academy of the 14th Annual Executive Educational Conference

20

Rate = Loss Rate + Safety Margin + Expenses ………………………………………………………………………………

Premium

= Rate x Exposures

Or

= (Expected Losses + Fixed Exp) /

( 1 –Variable Exp- Safety Margin)

Premium Calculation

Captive Academy of the 14th Annual Executive Educational Conference

21

Premium

Loss & LAE

Other Operating Expenses

Risk Margin

Captive Academy of the 14th Annual Executive Educational Conference

22

Retention

Reinsurance

Net L&LAE Forecast Net Premium

Capital Requirement

Captive Academy of the 14th Annual Executive Educational Conference

23

Capital Considerations

• Premium

• Anticipated Reserves

• Per Occurrence/Aggregate Retentions

• Adverse Case

• Statutory Requirements

• Lines of business

Captive Academy of the 14th Annual Executive Educational Conference

24

Retention

Reinsurance

Net L&LAE Forecast Net Premium

Capital Requirement

Captive Academy of the 14th Annual Executive Educational Conference

25

Pro Forma Financials

• Assess the viability of the program

• Projected balance sheets, cash flow, and income statements

• Five to ten year time horizon

• Expected and Adverse Case Scenarios

–Adverse = “Worse” not “Worst”

Captive Academy of the 14th Annual Executive Educational Conference

27

An actuarial report is filed with the captive application and provides a written explanation of the actuary’s analysis and the financial forecasts for the captive (pro formas). • The report should provide a clear explanation of the

assumptions and projected results should be included in the actuarial feasibility study report.

• Ask questions. You know the unique nature of your operations better than anyone else.

• It’s your capital at risk. Be sure you’re comfortable with the answers.

Actuarial Report

Captive Academy of the 14th Annual Executive Educational Conference

Annual Work

28

• Fiscal Year End Reserve Review Actuarial Report Statement of Actuarial Opinion

• Additional Reserve Reviews

• Pricing Analysis

• Benchmarking

• Emergence Tests

Captive Academy of the 14th Annual Executive Educational Conference

Annual Reserve Review • Loss Reserving

– Process of determining the required amount of money to be set aside to cover liability the insurance company currently has for claims by and against its policyholders

• Statement of Actuarial Opinion

– Required to be filed annually and to be presented to Board of Directors

– Based on NAIC requirements – Reasonable, Excessive, Deficient, Qualified or No Opinion

29

Captive Academy of the 14th Annual Executive Educational Conference

Additional Work

• Retention Analysis

• New Coverage Pricing

• Review of Gaps in Coverage

• Pro Formas for Business Plan Changes

• Benchmarking

• Risk Transfer Analysis

• Regulation Changes – Solvency II, Legislative, Judicial Interpretation, etc.

• Enterprise Risk Management Review

30

Captive Academy of the 14th Annual Executive Educational Conference

• Captive Application Review – outsourced by DOI and/or

internal review by DOI staff actuaries

• Financial Condition Examination – DOI will review risk, reserves, underwriting, etc. to confirm solvency of company

• Because they are awesome!!!!

Why Else Might I Talk to an Actuary?

31