Pricing Excess and Surplus Lines (COM-4) Ronald J. Herrig, FCAS Markel Corporation Deerfield,...

Pricing Excess and Surplus Lines(COM-4)

Ronald J. Herrig, FCAS

Markel Corporation

Deerfield, Illinois

What Is the Surplus Lines Industry?

The Surplus Lines industry provides a market for hard-to-place risks; risks the standard market chooses not to write.

Why are these risks not written by the standard market?

• Distressed Risks/Markets

• Unique Risks

• High-Capacity Risks

Distressed Risks – Something about the risk itself

that makes it undesirable to the standard market.

• Start-Up Manufacturer – No track record

• New Physician

• Physician with a History of Drug-Abuse

Distressed Markets – Something about the

entire category of risks that makes it undesirable to the standard market.

• OB/GYNs - SOL

• Junk Yards

• Nutritional Supplements – What’s the new Ephedra?

Unique Risks – Characteristics of the risk make it too unusual to fall within standard U/W classes.

• Fireworks Accounts

• Shamu Transportation

• Architectural Projects

High-Capacity Risks – Risks needing high limits of protection and in-depth underwriting

• High Rise Buildings

• Directors & Officers

• Aviation Property/Liability

How Can Surplus Lines Companies write this Junk

(Profitably)?

By being Fast, Fluid and Flexible!

Regulation

• No need to file rates/forms

• Licensing required only in state of domicile

• Not an unregulated industry, though

Regulations That Do Apply

• Annual Statements

• Triennial Reviews

• Market Conduct Exams

• Risk-Based Capital Requirements

• SEC Requirements

Adaptable Policies

• Claims-Made Coverage

• ALAE included within Limits

• Sublimits

• Customized Endorsements

And most importantly…

Expert Underwriting

Underwriters need:• to understand their

company’s appetite for risk – and abide by it

• knowledge of book’s underlying statistics

• to understand each insured and its associated risks

Claims Handling

• Knowledgeable Claim Handlers

• Standardized Approach to Claims Reserving

• Consistent Approach to Claims Reserving

Effects of the Market Cycle

Hard Market and E&S

• Admitted Companies become more selective.

• Surplus Lines applications increase dramatically.

• Rates Firm, Coverages Contract.

• Small Decrease in Admitted Market can increase Non-Admitted Market Substantially.

Change in Applications(2000 Baseline = 100 units)

0

50

100

150

200

250

300

350

Products Med Mal

20002001200220032004

Soft Market and E&S

• Admitted Companies become less selective in their Underwriting.

• Fewer Risks are Declined.

• E&S companies develop new products to maintain volume.

Examples of New Products

• Employment Practices Liability

• Tenant Discrimination

• Environmental Impairment Liability

EPLI(1994 Baseline = 100 units)

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1994 1996 1998 2000 2002 2004

E.P. (000)

New Product Development

1. Opportunity identification

2. Product design

3. Testing

4. Product introduction

5. Life-cycle management

Opportunity Identification

• Broker Recommendations

• Marketing

• New Product Teams

• Media

Product Design

• Target Market

• Coverages

• Policy Wording

• Rating

Testing

• Beta-Test on Select Market

• Honest Feedback

• Rate, rate, rate

Ratemaking Methods

Ratemaking Methods for New Products

• Pure Premium Methods

• Piggy-back Method

• Festus Method

Pure Premium Methods

1. Ultimate Losses / Ultimate Exposures

2. Frequency x Severity

Pure Premium Methods

1. Trend individual ‘ground-up’ losses; remove base deductible

2. Develop losses; cap at basic limit

3. Aggregate all adjusted losses.

Pure Premium MethodTreatment of Exposures

1. Multiply individual units of exposure by applicable relativity factors (state, class code, claims-made step-rate, etc.)

2. Aggregate all adjusted exposures

Pure Premium MethodCalculation of Rate

Pure Premium =

Aggregate Adjusted Losses

Aggregate Adjusted Exposures

Base Rate = Pure Premium

Permissible L/R

Pure Premium Method

• Works well for an existing product

• Works best for a product with a well-defined exposure base (doctors, employees)

• Requires detailed loss and exposure info (claim-by-claim, policy-by-policy)

• Actuarially sound

Piggy-back Method

1. Start with Comparable Product

2. Adjust Rates for Coverage differences

3. Adjust for Limits/Deductible differences

4. Adjust for Expense differences

5. Others?

Piggy-back Method

• Works well for Enhancement of Existing Product

• Requires knowledge of Comparable Product• Judgmental• Danger of being too

Conservative/Aggressive?• Difficult to Support to Others

The Festus Method

The Festus Method

Ratemaking Tools

• Imagination!

• Innovation!

• Intuition!

• Internet!

Useful Sites

• www.google.com – Big Brother is Watching!

• www.firstgov.gov - U.S. Government’s Official Web Portal

• www.bls.gov - Bureau of Labor Statistics

• www.federalreserve.gov - Interest Rates

Other Useful Websites

• www.cas.org

• www.cnn.com

• Where ever else the web may take you!