impact of financial crisis on d&o 15 september 2009
TRANSCRIPT
Impact of Financial Crisis on D&O
15 September 2009
Lessons Learned
We need to improve risk management practices for D&O insurance exposure
We need better models and better understanding of models, particularly understanding of limitations of models
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Is D&O the same type of risk as Property Cat?
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Is D&O the same type of risk as Property Cat?
Property Cat D&O
Frequency Low Low
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Is D&O the same type of risk as Property Cat?
Property Cat D&O
Frequency Low Low
Severity High High
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Is D&O the same type of risk as Property Cat?
Property Cat D&O
Frequency Low Low
Severity High High
Accumulation Risk High High
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Is D&O the same type of risk as Property Cat?
Property Cat D&O
Frequency Low Low
Severity High High
Accumulation Risk High High
Consistency of Risk Low Low over time
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Is D&O the same type of risk as Property Cat?
Property Cat D&O
Frequency Low Low
Severity High High
Accumulation Risk High High
Consistency of Risk Low Low over time
Available Historical Data About 100 yrs Limited
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Low Frequency/High Severity Business What is an Actuary to Do?
Lack of a complete historical catalogue of events We have difficulty estimating the expected loss. It is even more difficult to estimate the
tail There are many black swans.
Risk is enormously complex to model Hurricane – wind speed, central pressure, sea surface temperature, landscape, etc. D&O – legal climate, complexity of corporate structure, etc.
Exposure changes over time Property cat – climate change, improvements in building codes, improvements in
engineering, improvement in loss mitigation D&O – M&A, judicial rulings, Sarbanes-Oxley
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UncertaintyWhat does this mean?
Model risk and parameter risk are hugeᅳWe don’t fully understand the riskᅳ No model can reflect every aspect of the risk, even if we understood it perfectlyᅳ Model and parameter risk far outweigh the process risk
Pricing estimates have enormous uncertainty; i.e. you can not calculate the price precisely
What do you do? Create models but don’t over-rely on themᅳ Unbiased, consistent benchmark for risk selection – which risks are better than
others?ᅳ Sensitivity test to try to understand uncertaintyᅳ Create decision rules to go with the model – but be flexibleᅳ Don’t forget to use judgment
Understand correlations within the portfolio and with other portfoliosᅳ Measure accumulationsᅳ Management must set risk tolerances for accumulations
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Putting it to Work
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Portfolio Management Monitoring Accumulations
Hypothetical D&O PortfolioUnderwriting Review
Industry Type Industry Group Policy Count Limit
Policy Count Limit
Policy Count Limit
Policy Count Limit
Policy Count Limit
Policy Count Limit
(1) (2) (4) (5) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
Financial Asset Mangers 16 290.0 0 0.0 10 175.0 0 0.0 5 100.0 1 15.0
Financial Banks 12 201.5 4 86.5 3 60.0 2 20.0 1 10.0 2 25.0
Financial Finance Companies 0 - 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0
Financial Insurance 1 10.0 1 10.0 0 0.0 0 0.0 0 0.0 0 0.0
Financial Professionals 0 - 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0
29 501.5 5 96.5 13 235.0 2 20.0 6 110.0 3 40.0
E & O E P LCombined All Coverages Side A - D & O Full - D & O Fiduciary Liability
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Portfolio Management Tool
An exposure model simulating industry losses based on financial data Company loss based on in-force portfolio Model captures:
ᅳ Endurance loss and alae for each category, and in totalᅳ Industry claim frequency above various attachments for each categoryᅳ Average severity of industry losses in various layers for each categoryᅳ Industry increased limits curves
Uses for Model Enterprise Risk Management Verification of pricing model parameters Reserving Strategy
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Warren Says It Best
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Warren Buffet’s 2001 Letter to Shareholders
“What counts in this business is underwriting discipline. The winners are those that unfailingly stick to three key principles:
They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors, including remote scenarios, carry the expectancy of profit. These insurers ignore market-share considerations and are sanguine about losing business to competitors that are offering foolish pricing or policy conditions.
They limit the business they accept in a manner that guarantees they will suffer no aggregation in losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlations among seemingly unrelated risks.
They avoid business involving moral risk: No matter what the rate, trying to write good contracts with bad people doesn’t work. While most policyholders and clients are honorable and ethical, doing business with the few exceptions is usually expensive, sometimes extraordinarily so.”