1999 CAS Seminar on Ratemaking
Multiple Uses of Stop Loss Reinsurance
Brian Brown - Milliman & Robertson, Inc.
Larry Frank - Pegasus Advisors, Inc.
Lisa Walsh
- London Life & Casualty
Reinsurance Corporation
1
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Presentation Overview
Introduction
Characteristics
Pros and Cons
Case Studies
 Stabilize Results/Reduce Reinsurance Cost
 Finance Growth
 Adverse Development Protection
Questions and Answers
2
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Introduction
What is it?
Who Buys it?
Motivation to Purchase?
3
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Characteristics
 Retention/Attachment
 Limits (Sublimits)
 Experience Account (Profit Commission)
 Margin
 Premium Schedule
 Term (annual or multiyear)
 Funds Transfer/Funds Withheld
4
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons
Pro
Stop loss reinsurance is significantly less expensive
than working or low layer traditional reinsurance.
Con
No immediate cash recovery under stop loss as
compared to traditional. Somewhat offsetting
this is the ability for buyers to withhold premiums
under stop loss (i.e., no large cash outflows).
5
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons
Pro
Stop loss reinsurance provides broader
reinsurance protection/smoother underwriting
results and lower loss ratios than working or low
layer traditional reinsurance.
Con
Some traditional reinsurance coverages provide
unlimited coverage whereas stop loss is finite.
6
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons
Pro
Stop loss reinsurance profit sharing terms normally
provide a contractual device to build off-balance
sheet banks including interest on premium funds.
Con
Traditional reinsurance has less appearance of
being financial so it is subject to less regulatory
scrutiny for risk transfer.
7
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Pros and Cons
Pro
A technical review of the reinsurance
income/surplus protection vs. cost will reveal that
stop loss is generally a more effective and efficient
way to buy reinsurance.
Con
Stop loss reinsurance is very technical and requires
more time to arrange (i.e., CFO or Chief Actuary).
8
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Case Study #1
Prospective Accident Year Stop Loss
Stabilization of results and reduction of
reinsurance costs.
9
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Company Information
Type:
Insurance Company
Policyholders Surplus:
$500 million
Book of Business:
Multiline (P&C)
Expected Premium:
$500 million
Expected Loss Ratio:
70.0%
Net Property Cat PML:
$50 million
Budgeted Cat Losses
$0 million
Market Conditions:
Soft pricing, Cat protection
expensive at lower retentions
10
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Objectives
 Provide cat protection at a low cost
 Stabilize results
 Reduce total reinsurance costs
 Protect earnings and surplus
 Maintain expense ratio
 Maintain or improve AM Best rating
 Incorporate sufficient risk transfer (timing
& u/w risk) for accounting approval
11
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Stop Loss Terms
Type:
Aggregate Excess of Loss
Term:
Single Accident Year
Subject Business:
Whole Account
SNEP:
$500 million
Attachment:
65.2% (U/W neutral)
Limit:
$90 million (18% of SNEP)
Cat Sublimit:
$50 million
12
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Stop Loss Terms
Minimum & Deposit: 4.8% of SNEP (est. $24 million)
Additional Premium: 52.5% of UNL xs of 75.2% L/R
Maximum Premium:
9.0% of SNEP (est. $45 million)
Ceding Commission: 27.5% of M&D (M&D above is net)
Reinsurer’s Margin:
7.5% of ceded Premium
13
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Stop Loss Terms
All other reinsurance purchased
inures to the benefit of this cover.
 Funds Withheld - F/W.
 F/W balance is credited a
contractual rate of 7.0%
effective annually.
 Profit Commission of 100%.

14
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Stop Loss Terms
F/W balance = All Premium; less
Ceding Commission paid; less
Reinsurer’s Margin; less
UNL Paid by Reinsurer; plus
Interest Credit
 All FET and LOC costs are paid by the company.
Premium & Loss reporting - Quarterly bordereaux.
 UNL Settlements - From F/W account first until
depleted, then from reinsurer’s funds.
15
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Accounting Results
1) Expected - No property cat losses excess of budget
SNEP = $500M
Subject Losses = $350M (70% L/R)
(incl. expected cats)
Calculations:
Attachment = 65.2% x $500M=
Limit = 18% x 500M=
Ceded Losses = 350M - 326M=
Net Ceded Premium = 4.8%x500M=
Underwriting Income = 24M - 24M=
Potential PV Cost = 7.5% x 24M=
326.0M
90.0M
24.0M
24.0M
0.0M
1.8M
16
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Accounting Results
2) Partial Use - $50M cat loss excess of budget
SNEP = $500M
Subject Losses = $400M (80% L/R)
(incl. $50M unplanned cats)
Calculations:
Attachment = 65.2% x $500M=
326.0M
Limit = 18% x 500M=
90.0M
Ceded Losses = 400M - 326M=
74.0M
Net Ceded Premium = 4.8% x 500M= 24.0M
Add’l Premium=52.5%x(400M-376M)= 12.6M
Total Premium = 24.0M + 12.6M=
36.6M
Underwriting Income=74M - 36.6M= 37.4M
Potential PV Cost = 7.5% x 36.6M=
2.7M
17
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Accounting Results
3) Full Use - $40M cat loss & $26M other xs of budget
SNEP = $500M
Subject Losses = $416M (83.2% L/R)
(incl. $66M unplanned)
Calculations:
Attachment = 65.2% x $500M=
326.0M
Limit = 18% x 500M=
90.0M
Ceded Losses = 416M - 326M=
90.0M
Net Ceded Premium = 4.8% x 500M= 24.0M
Add’l Premium=52.5%x(416M-376M)= 21.0M
Total Premium = 24.0M + 21.0M=
45.0M
Underwriting Income=90M - 45M=
45.0M
Potential PV Cost = 7.5% x 45M=
3.4M
18
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Accounting Results
4) Favorable - $10M improvement over budget
SNEP = $500M
Subject Losses = $340M (68% L/R)
Calculations:
Attachment = 65.2% x $500M=
Limit = 18% x 500M=
Ceded Losses = 340M - 326M=
Ceded Premium = 4.8% x 500M=
Return Premium Accrual* =
U/W Income=14M - 24M + 9.8M=
Potential PV Cost = 7.5% x 24.0M=
326.0M
90.0M
14.0M
24.0M
9.8M
-0.2M
1.8M
* Accrual = 24M - 1.8M margin + interest credit of 1.6M - 14M losses = 9.8M
19
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Reinsurer’s Analysis
 Client Assessment - Published Rating
 Senior Management to communicate objectives
 Client Data Requirements

Losses - historical and projected

Payout pattern projections and support

Mix of business - historical and projected

Catastrophe exposure information/modeling
20
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Reinsurer’s Analysis
 Supplementary Data

Industry Losses

Industry Payout Patterns

Other client information

Press releases
21
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Reinsurer’s Results
Ceded
Losses
Reinsurer’s
PV Cash
Flows
Return on
PV Surplus
Relief
Return on
Premium
PV
(ending
F/W)
0.0%
24,000
1,800
n/a
7.5%
13,555
75.0%
5.0%
49,000
1,800
1.5%
7.5%
1,515
79.0%
9.0%
69,000
2,545
1.4%
7.5%
0
84.1%
14.1%
90,000
0
0.0%
0.0%
(3,375)
88.1%
18.1%
90,000
(4,495)
-1.9%
-10.0%
(7,870)
Subject
Losses
Deviation
from
Expected
70.0%
At expected payout
22
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Reinsurer’s Results
Subject
Losses
Deviation
from
Expected
Ceded
Losses
Reinsurer’s
PV Cash
Flows
Return on
PV Surplus
Relief
Return on
Premium
PV (ending
F/W)
70.0%
0.0%
24,000
1,800
n/a
7.5%
12,950
75.0%
5.0%
49,000
1,800
1.4%
7.5%
0
80.0%
10.0%
74,000
0
0.0%
0.0%
(2,750)
85.0%
15.0%
90,000
(4,505)
-1.7%
-10.0%
(7,880)
90.0%
20.0%
90,000
(9,890)
-4.2%
-22.0%
(13,265)
Payout pattern shifted one year forward.
23
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Company’s Results with Stop Loss
Company's Cost/Underwriting Benefi
with expected payout
50
Millions
40
30
U/W Benefit
Cost
20
10
0
-10
68%
72%
76%
80%
84%
88%
Loss Ratio
24
1999 CAS Seminar on Ratemaking
Case Study #1
Prospective Accident Year Stop Loss
Stop Loss versus a Traditional Cover
Scenario 2 with $50M catastrophe
Low Layer
Traditional Property
Cat Cover*
Accident Year
Stop Loss
M&D Premium
$10.0M
$24.0M
Additional Premium/
Reinstatement Premium
10.0M
12.6M
Loss Cession
50.0M
74.0M
Underwriting Benefit
30.0M
37.4M
1 to 3.0
1 to 20.8**
No Loss Cost/Benefit Ratio
* Traditional cover with $50M in limits for a 20% rate of line. Reinstatement premium
of 1 at 100% as to time, prorata as to amount.
** Reinsurer’s PV cost = $1.8 million @ expected level..
25
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Case Study #2
Financing Growth
26
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Company Information
Type:
Privately owned insurance company
Policyholder Surplus:
$100 million
Book of Business:
Excess & Primary Workers Compensation
Net Premium:
$50 million
(Expects 50% growth in premium)
Expected Loss Ratio:
80.0%
Market Conditions:
Company writes economically profitable
business, but due to statutory regulations,
expansion causes strain on their surplus.
27
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Company Objectives
To expand premium writings.
To increase Statutory Surplus
Reduce gross and net leverage tests
(Premiums and Liabilities)
Maintain or improve AM Best ratings
Improve RBC test results
28
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Stop Loss Terms
Type:
Aggregate Excess of Loss
Term:
Single Accident Year
Subject Business:
Whole Account
Projected SNEP:
$75 million
Attachment:
70.0% (15% below plan)
Limit:
$22.5 million (30% of SNEP)
29
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Stop Loss Terms
Minimum & Deposit:
5.25% of SNEP (est. $3.9M)
Additional Premium:
20.0% of ceded UNL
AP Threshold:
85.0% L/R (est. $63.8M)
Maximum Premium:
8.25% of SNEP (est. $6.2M)
Ceding Commission: 30.0% of M&D (M&D above is net)
Reinsurer’s Margin:
12.0% of net ceded Premium
30
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Stop Loss Terms
All other reinsurance purchased
inures to the benefit of this cover.
 Funds Withheld (F/W).
 F/W balance is credited a
contractual rate of 7.0% effective
annually.
 Profit Commission of 100%.

31
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Stop Loss Terms
F/W balance =
All Premium; less
Ceding Commission paid; less
Reinsurer’s Margin; less
UNL Paid by Reinsurer; plus
Interest Credit
All FET and LOC costs are paid by the company.
Premium & Loss reporting - Quarterly bordereaux.
UNL Settlements - From F/W account first until
depleted, then from reinsurer’s funds.
32
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Accounting Results
1) Expected
SNEP = $75M
Subject Losses = $63.8M (85% L/R)
Calculations:
Attachment = 70.0% x $75M=
52.5M
Limit = 30% x 75M=
22.5M
Ceded Losses = 63.8M - 52.5M=
11.3M
Net Ceded Premium = 5.25%x75M=
3.9M
Underwriting Income = 11.3M - 3.9M= 7.4M
Potential PV Cost = 12.0% x 3.9M=
0.5M
33
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Accounting Results
2) Full Use
SNEP = $75M
Subject Losses = $75M (100% L/R)
Calculations:
Attachment = 70.0% x $75M=
Limit = 30% x 75M=
Ceded Losses = 75M -52.5M=
Net Ceded Premium = 5.25% x 75M=
Add’l Premium=20%x(75M-63.8M)=
Total Premium = 3.9M + 2.3M=
Underwriting Income=22.5M - 6.2M=
Potential PV Cost = 12.0% x 6.2M=
52.5M
22.5M
22.5M
3.9M
2.3M
6.2M
16.3M
0.7M
34
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Accounting Results
3) Only 25% Growth in Premium - Expected Losses
SNEP = $62.5M
Subject Losses = $53.1M (85% L/R)
Calculations:
Attachment = 70.0% x $62.5M=
Limit = 30% x 62.5M=
Ceded Losses = 53.1M -43.8M=
Net Ceded Premium = M&D =
Underwriting Income=9.3M - 3.9M=
Potential PV Cost = 12.0% x 3.9M=
43.8M
18.8M
9.3M
3.9M
5.4M
0.5M
35
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Reinsurer’s Analysis
 Client Assessment - Financial Statements
 Client Data Requirements

Losses - historical and projected

Payout pattern projections

Paid and incurred data triangles

Pricing history (Rate filings, deviations)

Marketing strategy and support
36
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Reinsurer’s Analysis
 Supplementary Data

Industry Losses

Industry Payout Patterns

Other client information

Press releases
37
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Reinsurer’s Results
Subject
Losses
Deviation
from
Expected
Ceded
Losses
Reinsurer’s
PV Cash
Flows
Return on
PV Surplus
Relief
Return on
Premium
PV
(ending
F/W)
85.0%
0.0%
11,250
473
0.9%
12.0%
281
87.0%
2.0%
12,750
509
0.8%
12.0%
0
91.2%
6.2%
15,900
0
0.0%
0.0%
(584)
95.1%
10.1%
18,791
(545)
-0.5%
-10.0%
(1,198)
100.0%
15.0%
22,500
(1,284)
-0.9%
-20.7%
(2,026)
105.0%
20.0%
22,500
(2,040)
-1.5%
-33.0%
(2,782)
With $75M SNEP and expected payout
38
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Reinsurer’s Results
Ceded
Losses
Reinsurer’s
PV Cash
Flows
Return on
PV Surplus
Relief
Return on
Premium
PV
(ending
F/W)
0.0%
11,250
473
0.9%
12.0%
58
85.4%
0.4%
11,544
480
0.9%
12.0%
0
88.8%
3.8%
14,135
0
0.0%
0.0%
(542)
92.2%
7.2%
16,667
(503)
-0.5%
-10.0%
(1,106)
100.0%
15.0%
22,500
(1,807)
-1.2%
-29.2%
(2,549)
105.0%
20.0%
22,500
(2,616)
-1.9%
-42.3%
(3,358)
Subject
Losses
Deviation
from
Expected
85.0%
With $75M SNEP and payout pattern shifted one year
39
1999 CAS Seminar on Ratemaking
Case Study #2
Financing Growth
Millions
Company’s Results with Stop Loss
18
16
14
12
10
8
6
4
2
0
-2
Company's Cost/Underwriting Benefit
U/W Benefit
Cost
83%
87%
91%
95%
99%
103%
107%
Loss Ratio
40
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Case Study #3
Facilitating a Sale
Adverse Development Cover
41
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Company A (to be Acquired) Information
Type:
Policyholders Surplus:
Insurance Company owned by
non insurance parent
$300 million
Book of Business:
Regional Commercial Business
Net Premium:
$500 million
Carried Loss Reserves:
$500 million
Market Conditions:
Owner wants maximum sales
price and no seller contingencies
post sale.
42
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Company B (Buyer) Information
Type:
Large Insurance Company
Book of Business: Regional Commercial Lines
Concerns:
Overall adequacy of Company A loss and
alae reserves.
-General Case and IBNR development
-EIL and Asbestos loss reserves
-Y2K on old occurrence years
Objective:
Insulate future earnings from adverse
development on 1998 and prior accident
years loss reserves
43
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Adverse Development Coverage (ADC)
 Company B requires Company A to arrange
at least $150M of limit above the year end
carried loss and alae (L&ALAE) reserves.
 Cover must be placed contemporaneously
with the sale of the company (EITF D 54Accounting).
 Retention to be set to equal carried L&ALAE
reserves less premium expense of coverage
(u/w income neutral).
44
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Accounting Implications
Company A at Closing:
 Purchase of ADC is u/w neutral.
 Federal Income Tax benefits (discount of reserves).
 Surplus is maintained.
Combined Companies:
 Future earnings reduced by lost investment income
on expensed premium by A for the ADC.
 Future earnings protected by the offset of any direct
L&ALAE development with up to $150M of
reinsurance recovery.
45
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
ADC Key Terms
Type:
Adverse Development Cover
Subject Business:
Whole account
Subject Losses:
$500M of carried reserves
Premium:
$50M
Attachment:
$450M (=$500M – $50M)
Limit:
$200M (=$500M+$150M-$450M)
Reporting:
Quarterly 60 days in arrears
Settlements:
Quarterly 75 days in arrears
46
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Combined Company’s Annual Results
Subject
Losses
Deviation Positive/
Annual
from
(Negative) Interest
Expected Develop Expense
U/W
benefit
of ADC
Pretax Without
Income
ADC
Benefit/
(Detriment)
of ADC
$400M
-20.0%
100
(3)
0
97
100
(3)
$450M
-10.0%
50
(3)
0
47
50
(3)
$500M
0.0%
0
(3)
0
(3)
0
(3)
$550M
10.0%
(50)
(3)
50
(3)
(50)
47
$600M
20.0%
(100)
(3)
100
(3)
(100)
97
$650M
30.0%
(150)
(3)
150
(3)
(150)
147
47
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Reinsurer’s Analysis
 Client Assessment - Published Rating
 Client Data Requirements

Independent Actuarial Review

Internal Projections

Confidence Intervals

Incurred Loss Triangles

Paid Loss Triangles
48
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Reinsurer’s Analysis
 Client Data Requirements (continued)

Historical pricing of business

Historical inuring reinsurances

Claims audits

Reserving policies

Changes to claims handling
49
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Reinsurer’s Analysis
 Supplementary Data

Industry Losses

Industry Payout Patterns

Peer company information

Press releases
50
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Reinsurer’s Results
Subject
Losses
Deviation
from
Expected
Positive/
(Adverse)
Develop
PV
Reinsurer’s
Results
Probability
of
Occurrence
Weighted
Probability
$400M
-20.0%
100
50
5%
2.5
$450M
-10.0%
50
50
15%
7.5
$500M
0.0%
0
30
50%
15.0
$550M
10.0%
(50)
0
15%
0.0
$600M
20.0%
(100)
(40)
10%
(4.0)
$650M
30.0%
(150)
(90)
5%
(4.5)
Total Probability Weighted:
16.5
51
1999 CAS Seminar on Ratemaking
Case Study #3
Facilitating a Sale
Reinsurer’s Analysis
 Expected Results based upon actuarial
projected probabilities is $16.5 million.
 Upside to downside is 1.0: 1.8
 Return on Equity (Capital allocation)
 LOC usage
 Underwriting constraints
 Relationship implications - historical/prospective
 Subject Loss Limitations (Asbestos/EIL, Y2K caps)
52
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Conclusions
Addresses multiple reinsurance needs
Customizable
Cost Effective
Efficient
Offers considerable advantages over
traditional approaches
53
1999 CAS Seminar on Ratemaking
Stop Loss Reinsurance
Speakers
Lisa Walsh is Vice President of London Life and Casualty Reinsurance
Corporation domiciled in Barbados, West Indies. Lisa is a Fellow of
the Casualty Actuarial Society, Member of the American Academy
of Actuaries and a Chartered Property and Casualty Underwriter.
Lisa was previously employed with The St. Paul Companies in St. Paul,
MN primarily in the medical malpractice area.
Larry Frank is Vice President of Pegasus Advisors, Inc.. Larry is a New
York Certified Public Accountant and a member of the American
Institute of Certified Public Accountants. Larry is a summa cum
laude graduate of Long Island University, C.W. Post College, where
he earned a B.S. degree in accounting. Larry was previously
employed with G.L. Hodson and Son, Inc., a member of the Willis
Corroon family, and Price Waterhouse.
54