Introduction to Reinsurance Reserving

Peter A. Royek

Toa Reinsurance Company of America

Casualty Loss Reserve Seminar

Scottsdale, Arizona

September 13, 1999

Agenda

• Reinsurance Contract Types• Data Grouping Dimensions• Differences Between Reinsurance and Primary

that affect Loss Reserving• Applications, Complications, and Considerations

Reinsurance Contract Types

• What Policies Are Insured?• Mechanics of the Cover

Reinsurance Contract Types

• What Policies Are Insured?– Facultative Reinsurance

• Generally covers one insured/policy

• The one insured/policy is known to the reinsurer at inception

– Treaty Reinsurance• Covers multiple insured/policies which fit treaty specifications

• These multiple insured/policies are unknown at inception but become known to the reinsurer during the treaty term

Reinsurance Contract Types

• Mechanics of the Cover– Proportional Reinsurance

• “Follows the Fortunes” of the reinsured company– First-dollar sharing of premium and loss between the parties

• Reinsurer’s relative participation is pre-determined

• Examples:Quota Share, Surplus Share

– Excess Reinsurance• Responds when a loss, group of losses, or a loss ratio exceeds a set

figure

• Reinsurer’s relative participation is NOT pre-determined, but depends on the size of the loss or loss ratio

• Examples:Per Risk, Per Occurrence, Aggregate

– Others

Data Grouping Dimensions

• Accident Year vs Underwriting Year (or “Losses Occurring” vs “Risks Attaching” or “Policies Incepting”)

• Casualty vs Property• Treaty vs Facultative• Excess vs Proportional

• Broker vs Direct

Data Grouping Dimensions

• Accident Year vs Underwriting Year (or “Losses Occurring” vs “Risks Attaching” or “Policies Incepting”)– Accident Year allows for easiest application of standard

techniques

• Premium fixed as of December 31

• Population of claims fixed at December 31 as well, though many may be unknown

• May not always be an option for reinsurance

Data Grouping Dimensions

• Accident Year vs Underwriting Year (or “Losses Occurring” vs “Risks Attaching” or “Policies Incepting”)– Underwriting Year is often used in reinsurance,

especially for proportional contracts

– This is problematic as an UY can cover two policy years and three calendar years for losses

• The current UY as of 12 months is “incomplete”

The Incomplete Underwriting YearSample Time Line

Accumulation of IssuesReporting Lag/Development LagPrimary losses and premium develop more quickly than reinsurance losses andpremium if only due to the time it takes to report amounts to the reinsurer. The |-----------------------------------------------------|-----------------------------------------------------|

January 1, 1998 December 31, 1998 December 31, 1999broker turnaround time if one is involved this further increases the lag. These affect Accounting Datedevelopment viz primary.Premium estimates are needed in reinsurance moresothan in primary. You must reserve the premium you've earned or to which you've <----------Accident Year 1998----------->been exposed. Because of reporting lag, there can be a lot of late reported earnedpremium as of the accounting date that must be estimated. In Excess Covers,reporting lag compounds with development lag. This is because the reinsurer is not <----------------------------------------Underwriting Year 1998------------------------------>notified immediately of a loss and the actual loss does not hit the reinsurer's data Can cover policies incepting during this perioduntil the loss is greater than the dollar threshold in the XS contract.Think of a$150,000 loss for a primary company that has a per risk reinsurance cover with a$100,000 retention.If the loss is originally reserved at $50,000, the reinsurer is notaware of this loss. As the loss develops the reinsurer may be notified of thepossibility the loss may develop but not until the loss exceeds $100,000 will anydollars hit the reinsurer's experience and hence, their loss triangles. This could be

Example: - Underwriting Year 1998 covers any treaties written by the Reinsurer during 1998.- If the treaties cover "Risks Attaching" or "Policies Incepting" during a 12-month period,

What policies are reinsured? Underwriting Year 1998 can theoretically span two policy years (and three accident years).company, reporting lag can/will make the reinsurer's development different from the i.e. a Treaty incepting 12/31/98 will cover policies incepting 12/31/98 - 12/30/99.

- As of December 31, 1998, Underwriting Year 1998 is "incomplete". Using the standard- generally one insured/policy loss development techniques with factors derived from past underwriting years willTreaty overstate the ultimate experience for the "incomplete" year. Historical development after- multiple insureds/policies 12 months includes losses on exposures earned after 12 months of an underwriting year.

For example, losses that the primary company realizes in December that are Provision for these losses should not be in the December 1998 reserves for UnderwritingMechanics of the cover Year 1998.

Data Grouping Dimensions

• Casualty vs Property– Casualty business generally has a longer development tail

– Line of business detail is often not available to the reinsurer, but if it is you might want to further subdivide by LOB as different LOBs may develop differently

Data Grouping Dimensions

• Treaty vs Facultative– These display different development patterns, all else

equal

Data Grouping Dimensions

• Excess vs Proportional– Should be separated from each other

• Different development patterns

• Possible reserve adequacy mix– Excess case reserves are generally reviewed by reinsurer’s claim

department, which may use ACRs to make case reserve adequacy more consistent among the claims

– Proportional case reserves are generally booked as reported by the reinsured company without review

– Subdivide Excess further, if possible by type of layer - low, high, catastrophe, etc, as these exhibit different development patterns as well

Data Grouping Dimensions

• Broker vs Direct– Reinsurers obtain business from ceding companies either

directly from that company or though a broker

– In the case of “broker” business, the data flows through the broker as well - reports are submitted to the reinsurer periodically (monthly, quarterly, or some other increment)

– Because of this, there should be less of a reporting lag for “direct” business than for “broker” business - all else equal

– Therefore, it should be expected that the development patterns differ

Differences Between Reinsurance and Primary that affect Loss Reserving

• Reporting Lag/Development Lag

• Data

• Increased Variability

• Tailor-Made or Atypical Contracts or Features

• “Accumulation of Issues”

Differences Between Reinsurance and Primary that affect Loss Reserving

• Reporting Lag/Development Lag– Primary losses develop faster than reinsurance losses if

only due to the time it takes for information to reach the reinsurer

– Proportional business (“broker”): Accounts are often not due to the reinsurer until 30-90 days after the close of the quarter

• It is then possible that losses that the ceding company books in calendar year “X” will be realized and booked by the reinsurer in calendar year “X+1”. The same loss will be in two different triangle “cells”

Differences Between Reinsurance and Primary that affect Loss Reserving

• Reporting Lag/Development Lag– Excess business: Reporting lag compounds with development

lag• The reinsurer is not notified immediately of the loss• The losses do not “hit” the reinsurer’s data until they exceed the threshold

established in the Excess reinsurance contract• Example:

– Primary company has $400,000 excess of $100,000 per risk reinsurance cover– Loss occurs in Year 1, reserved for $25,000– Year 3, reserve increased to $50,000, reinsurer is verbally notified that this

loss MAY eventually reach their contract– Year 5, reserve increased to $150,000, reinsurer incurs loss, loss “hits”

triangles 4 years after it did for the primary company

Exhibit C-1

Primary vs. ReinsurerHistorical Loss Development

Automobile Liability

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9 10

Report Period (Years)

Primary Companies Data Source: A. M. Best Company

Pe

rce

nta

ge

of U

ltim

ate

Reinsurers

Primary Companies

Exhibit C-4

Primary vs. ReinsurerHistorical Loss Development

Workers Compensation

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 2 3 4 5 6 7 8 9 10

Report Period (Years)

Primary Companies Data Source: A. M. Best Company

Pe

rce

nta

ge

of U

ltim

ate

Reinsurers

Primary Companies

Differences Between Reinsurance and Primary that affect Loss Reserving

• Reporting Lag/Development Lag– Premium Estimates

• Premium estimates are needed in reinsurance more than for primary insurance

• Reserves must be set against premium earned/exposed as of the accounting date

• Reporting lag can cause large earned premium amounts to be unreported to the reinsurer as of the accounting date

• This creates a need for premium to be estimated

Differences Between Reinsurance and Primary that affect Loss Reserving

• Data– Quantity

• The “infinite” detail of primary company data is often lost when reported to reinsurers as data gets “collapsed” along several dimensions

– Accident dates not reported

– Lines of business not reported

• Industry benchmarks by line of business or accident year can thus be difficult to use

Differences Between Reinsurance and Primary that affect Loss Reserving

• Data– Quality

• Quality of data affected by “varied quantity”:– Some ceding companies report more detail to reinsurers than

do others

– As reinsurance data for reserving is organized along the greatest common denominator in terms of reported data fields, this has an impact on the quality of the analysis

Differences Between Reinsurance and Primary that affect Loss Reserving

• Increased Variability– Primary insurers purchase reinsurance (among other

reasons) to make their results less variable (ie from catastrophes)

– Reinsurer data is subject to this reinsured variation

– Depending on the type of reinsurance cover, reinsurer data may BE this variation

Primary Experience Gross of Reinsurance

0

20

40

60

80

100

120

140

160

180

1990 1991 1992 1993 1994

$ Millions of Losses

Primary Experience Net of Reinsurance

0

20

40

60

80

100

120

140

160

180

1990 1991 1992 1993 1994

$ Millions of Losses

Reinsurance Experience

0

20

40

60

80

100

120

140

160

180

1990 1991 1992 1993 1994

$ Millions of Losses

Differences Between Reinsurance and Primary that affect Loss Reserving

• Tailor-Made or Atypical Contracts or Features– Many (possibly large) reinsurance contracts have

features that affect the way their experience will develop vis-à-vis other contracts with which they would otherwise be grouped

• Examples: Stop loss arrangements, loss corridors, sunset clauses, etc

Differences Between Reinsurance and Primary that affect Loss Reserving

• “Accumulation of Issues”– Each primary insurer faces issues such as changing reserve

adequacy, changing settlement patterns, etc

– These issues affect that company’s loss reserving data, and the primary company reserving analyst has tools to neutralize the effects of these on the reserving data

– Reinsurance loss reserving data is an accumulation of the data of primary companies each of which may have these issues

– This adds a further complication to the reinsurance loss reserving process