The Impact of Reinsurance on Primary
Company Financials
A Case Study
Andrew Rippert
President, Bunker Hill Insurance
Chief Underwriting Officer, Plymouth Rock Corp.
Casualty Actuarial Society
Loss Reserve Seminar
Washington, D.C.
September 18 – 19, 2008
Objective
• Small, regional, monoline homeowners insurance
company needs to produce net underwriting income that
will provide at least a minimum acceptable return on
capital over a reinsurance price cycle.
• Operating constraints include:
– Maintain and ultimately improve company rating
– Protect insurance entity and holding company parent from
catastrophic loss
– Manage reinsurance costs to minimize negative impact on net
underwriting income and stabilize primary market prices
– Deliver maximum capital flexibility
– Use homeowners underwriting capacity to complement and
support affiliated group companies
2
Context
• Competitors are for the most part
– Multi-line writers with different underwriting income and returnon-capital objectives for their homeowners line of business
[pricing issue]
– Mutual property insurers with different return-on-capital
requirements [pricing issue]
• If primary market rates are to remain reasonably competitive, capital
levels required to maintain ratings drive return-on-capital to
unacceptably low levels [capital management issue]
• Reinsurance price volatility and capacity constraints based on CAT
activity and changes to CAT models [pricing and “soft capital”
management issues]
3
Context - continued
• Post Katrina-Rita-Wilma (KRW) catastrophe models changed the
catalog of storms and increased the frequency and severity of
storms in Northeast U.S. [risk management, rating agency, RBC,
primary and reinsurance pricing issues]
• Post-KRW rating agencies increased capital requirements via risk
based capital (RBC) models and required the use of CAT model’s
higher, near term view estimates [rating and RBC issues]
• Holding Company Board of Directors
– Risk appetite that is incongruent with rating agency RBC [capital
planning and management issues]
– Belief that models over-estimate, and reinsurers overcharge, for
loss at low CAT excess attachments points [capital planning and
management issues]
4
Reinsurance Price Changes
•
CAT X/S reinsurance
price volatility drives
volatility of earnings and
ROC
Passing price volatility
through to policyholder is
impractical and will
undermine growth,
retention and marketing
objectives. Additional
regulatory and consumer
advocacy group issues
around primary market
price increases
Sample Property CAT X/S Reinsurance Price Index
2.200
2.000
Reinsurance Price Trend Factor
•
1.800
1.600
1.400
1.200
1.000
0.800
0.600
2000
2001
2002
2003
2004
2005
2006
2007
2008
Renewal Year
The average year-on-year percentage change in
the reinsurance price index pre-KRW is
approximately 4%.
The year-on-year percentage change in the
reinsurance price index for the two years postKRW is 28% and 39%, respectively.
5
BCAR Changes
•
BCAR Scores at every rating
increased significantly post
KRW
Higher BCAR scores were
driven primarily by a revised
capital methodology that
imposes two 1:100 storms on
an insurer’s portfolio and by
CAT model changes (i.e.,
introduction of the Warm
SST/Near Term models)
Observed Median BCAR Scores by Rating Category
350
Observed Median BCAR Score
•
300
A++
250
A+
A
200
AB++
150
B+
B
100
B50
0
2002
2003
2004
2005
2006
2007
2008
Effective Year
•
Meeting return targets on
higher capital requirements
through price increases is
problematic – disruption to
retention levels, growth &
marketing objectives and
distribution channel
The average year-on-year percentage change in
median BCAR scores pre-KRW is less than 1%.
The average year-on-year percentage change in
median BCAR scores for the two years post-KRW
is 8.5%.
6
Initial Reinsurance Program
• Program cost – 19% DWP
• Coverage
– ratio of net retained-to-gross loss 37% at 0.4% exceedance
probability
– Entry >90% probability of exceedance
– Exit 1.2% probability of exceedance
• Description – standard property cat x/s program and quota share
that provided cat coverage alongside property cat x/s
Pros
Easily evaluated within the context of
RBC and rating agency models
Easy execution
Cons
High cost and volatile cost
Subject to availability of reinsurance
capacity
Another constraint on execution of
market strategy
7
Revised Reinsurance Program
•
Program cost – 14.5% DWP
•
Coverage
– ratio of net retained-to-gross loss of 31% at 0.4% exceedance probability
– Entry >90% probability of exceedance through capital maintenance facility
– Entry >81% probability of exceedance through cat x/s
– Exit 0.6% probability of exceedance
•
Description – capital maintenance facility supported with irrevocable letter of credit,
standard property cat x/s program and quota share that provided cat coverage
alongside property cat x/s
Pros
Better alignment between risk appetite and
retained loss – more protection against
extreme events and higher retention of
small events
Increased capital flexibility & more optimal
capital structure
Cons
Does not fit easily within rating agency &
RBS models
Legal, regulatory, accounting & tax issues
Negotiate non-standard documentation and
LOC
Lower dependence on reinsurance markets
Easier to execute market strategy
Retains profit on most “over” priced layers
8
Benefits of Change in Reinsurance Program
• Provided savings of 4.5 points of DWP
that can be used for a variety of strategic
and tactical initiatives
• Better able to execute market strategy
• Increased level of catastrophic loss
protection
• Increased flexibility of capital structure
• Higher return-on-capital
9
Other Important Considerations
• Communication and transparency with
rating agency
• Triggers and conditions for contingent
capital
• Portfolio monitoring and guidelines
• Holding company has a track record of
supporting insurance entity and
contributing capital if necessary
10