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Enterprise Risk Management for P&C Insurance Companies. Shaun S. Wang Robert T. Faber. Agenda. ERM Research Project Summary of Research Findings Underwriting Psychology Our Proposed Actions. ERM Research Project. Co-sponsored by Casualty Actuarial Society - PowerPoint PPT Presentation
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Enterprise Risk Management for P&C Insurance Companies
Shaun S. WangRobert T. Faber
2006-9-29 2
Agenda ERM Research Project
Summary of Research Findings
Underwriting Psychology
Our Proposed Actions
2006-9-29 3
ERM Research Project
Co-sponsored by Casualty Actuarial Society Risk Management Section (SOA & CAS) ERM Institute International, Ltd
Researcher Team Shaun Wang (actuary, scholar) Bob Faber (executive, senior underwriter) Assisted by Project Oversight Team chaired
by John Kollar (ISO)
2006-9-29 4
Objectives & Time line
Objectives: Propose a fresh
ERM Theory that is applicable to all sectors
Make ERM operational for P&C insurers
Time Line Feb 16, started June 15, exposure
draft August 1, completed
2006-9-29 5
The Concept of Risk Dynamics The big Universe consists of
many projects (risks and opportunities), external players (customers, competitors), external forces (financial, regulatory)
An enterprise sits within the big universe selected projects, internal players & internal
forces “risk dynamics” refers to the interactions of
forces and players within and without the enterprise.
2006-9-29 6
We define ERM as
studies of the system of risk dynamics of the enterprise, including interactions among internal and external risk dynamics, and how players’ actions (including the risk management practices) can influence the behaviors of the risk dynamics, with the ultimate goal of improving the performance and resiliency of the system.
2006-9-29 7
Element of ERM Framework
1) Analyze the business model2) Define the scope of business operations, 3) Identify operating constraints by regulators
and rating agencies, 4) Measure sensitivity to external and internal
forces, 5) Develop business or risk strategies to
interact with the various forces6) Monitor the dynamics
2006-9-29 8
P&C Insurer Risk Dynamics -- Players
Stock Analyst
Pricing
Claims &Reserving
I.T., H.R.Accounting
Investment
Marketing &Underwriting
Board ofDirectors
CEO; CFO;CIO; CRO
CompetitorRatingAgency
Regulator
2006-9-29 9
Net Effect of Diversification Benefit/Penalty It depends on the nature of business model,
& how you conduct the business Personal Lines: diversification essential for
managing catastrophe exposure Commercial Lines: we observed dramatic
differences in financial performance among companies with different underwriting/pricing practices
2006-9-29 10
Empirical Studies
A sample of 29 insurance companies:1) Small Companies (14 companies)2) Jumbo Regional (7 companies)3) Large National (8 companies)
Focused on WC and GL use gross loss ratios use gross loss triangles
2006-9-29 11
Mean and Deviation of Loss Ratio in relation to Size of Written Premium - WC
Workers's Compensation: Small Companies, Jumbo Regional, Large National
0%
20%
40%
60%
80%
100%
SC: l
ogP=
10.4
SC: l
ogP=
11.4
SC: l
ogP=
11.5
SC: l
ogP=
11.6
SC: l
ogP=
11.8
SC: l
ogP=
11.9
SC: l
ogP=
12.1
SC: l
ogP=
12.7
SC: l
ogP=
12.8
SC: l
ogP=
12.9
SC: l
ogP=
13.3
SC: l
ogP=
13.9
JR: l
ogP=
12.1
JR: l
ogP=
12.3
JR: l
ogP=
14.3
JR: l
ogP=
14.5
JR: l
ogP=
14.6
JR: l
ogP=
14.9
JR: l
ogP=
15.0
LN: l
ogP=
15.0
LN: l
ogP=
16.0
LN: l
ogP=
16.2
LN: l
ogP=
16.4
LN: l
ogP=
16.5
LN: l
ogP=
16.8
LN: l
ogP=
17.1
LN: l
ogP=
17.6
Type of Company & Logarithm of Written Premium during 1985 - 2003
Deviation of Loss Ratio
Mean Loss Ratio
Linear (Deviation of Loss Ratio)
Linear (Mean Loss Ratio)
2006-9-29 12
Mean and Deviation of Loss Ratio in relation to Size of Written Premium - GL
General Liability: Average and Stdev of Loss Ratio By CompanySmall Companies, Jumbo Regional, and Large National
0%
20%
40%
60%
80%
100%
120%
SC: l
ogP=
9.93
SC: l
ogP=
10.0
SC: l
ogP=
10.2
SC: l
ogP=
11.0
SC: l
ogP=
11.4
SC: l
ogP=
11.5
SC: l
ogP=
11.6
SC: l
ogP=
11.6
SC: l
ogP=
11.7
SC: l
ogP=
11.8
SC: l
ogP=
12.1
SC: l
ogP=
12.3
JR: l
ogP=
12.8
JR: l
ogP=
13.0
JR: l
ogP=
13.1
JR: l
ogP=
13.4
JR: l
ogP=
14.1
JR: l
ogP=
14.7
JR: l
ogP=
14.8
LN: l
ogP=
15.0
LN: l
ogP=
15.0
LN: l
ogP=
15.1
LN: l
ogP=
15.3
LN: l
ogP=
15.6
LN: l
ogP=
15.6
LN: l
ogP=
16.2
LN: l
ogP=
16.4
Type of Company & Logarithm of Written Premium (1985-2003)
Deviation of Loss Ratio
Mean Loss Ratio
Linear (Mean Loss Ratio)
Linear (Deviation of Loss Ratio)
2006-9-29 13
Summary Result by Company Type
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Small Companies Jumbo Regional Large National
Workers Compensation: Loss Ratios By Company Type
Average (MeanLoss Ratio)
Average(Deviationof Loss Ratio)
2006-9-29 14
Loss Reserve Practices
For a selected company and 1997 accident year, we observe booked loss ratios at 12/31/1997, 12/31/1998, up to 12/31/2004.
Loss Development for Accident Year 1997 = {Estimated Incurred Loss as of 12/31/2004 } – {Initial Incurred Loss Ratio of12/31/1997 }
2006-9-29 15
Workers Compensation Loss Development
Worker's Compensation Reserve Development: Difference in Updated Loss Ratio and Initial Loss Ratio
-0.30
-0.25
-0.20
-0.15
-0.10
-0.05
0.00
0.05
0.10
0.15
0.20
0.25
1992 1993 1994 1995 1996 1997 1998 1999 2000
Large Companies
Small Companies
Jumbo Regionals
2006-9-29 16
General Liability Loss Development
Other Liability (Occurrence) Reserve Development:Difference in Updated Loss Ratio and Initial Loss Ratio
-0.30
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Large Companies
Small Companies
Jumbo Regionals
2006-9-29 17
Back Testing of the Chain-Ladder Development Method For each company and a given line of
business (WC or GL), we use the loss triangle data up to the end of year 2000 as input.
Applied the Chain-Ladder method to project future development to end of 2004.
Compared the projected losses with the actual observed losses by the end of 2004.
2006-9-29 18
Large National Companies
Li berty Mutual WC Loss Devel opment Actual vs. Proj ected Losses as of 12/ 2004
0
1, 000, 000
2, 000, 000
3, 000, 000
4, 000, 000
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Acci dent Year
Actual Loss Proj ected Loss
Conti nental WC Loss Devel opment Actual vs. Proj ected Losses as of 12/ 2004
0
400, 000
800, 000
1, 200, 000
1, 600, 000
2, 000, 000
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Acci dent Year
Actual Loss Proj ected Loss
2006-9-29 19
Small & RegionalCentral WC Loss Devel opment Actual vs. Proj ected as of
12/ 31/ 2004
0
5, 000
10, 000
15, 000
20, 000
25, 000
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Acci dent Year
Actual Loss
Proj ected Loss
West Bend WC Loss Devel opment Actual vs. Proj ected as of 12/ 31/ 2004
010, 00020, 00030, 00040, 00050, 00060, 00070, 00080, 000
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Acci dent Year
Actual Loss Proj ected Loss
2006-9-29 20
Number of Insurer Upgrades vs. Downgrades, 1993 to 2003 (Source: Standard & Poor’s)
0
2
4
6
8
10
12
14
16
18
20
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Upgrades
Downgrades
2006-9-29 21
Leading Indicators vs Lagging Indicators Reserves can only be a lagging indicator.
-at 12 months, are almost never in an adverse position to precipitate big change
-24-36 months at best for true indications Rate change indications on renewal are adequate only if:
-constant policy form (SIRs, deductibles, limits, etc) dominates the book of business and-policies are rated on a true exposure basis, and-new business constitutes a small percentage of premium.
By 1997, most companies were rate monitoring and were still surprised by the depth of unmeasured rate decreases for 1998-1999.
2006-9-29 22
Underwriting Psychology Underwriting psychology is more important to understand than
underwriting philosophy. Most underwriters think frequency more than severity. It is more
tangible. Most underwriters have not been in the position long enough to
live with their tail. The adverse development always belongs to others.
Especially in larger companies, underwriting is not a career path, management is.
It is much easier to cut the rate on new business than on renewals. (You didn’t screw up the rating last year)
Underwriters learn the unwritten rule early: No matter what management says, those with the bigger books of business get rewarded. Premium is measured by underwriter, loss ratio and development is not.
2006-9-29 23
Price Monitoring True price monitoring can only take place
when anchored firmly on a rate for the exposure base, attaching at first dollar.
The goal of price monitoring is to project the loss ratio range. This can only occur if the proper rate level per exposure unit is known.
Failing that goal, projecting the direction and magnitude of the change still has value.
What has a higher priority with company management: expense ratio or price monitors
2006-9-29 24
Terms and Conditions
Experience rating by its very nature, using valued claims, can have a market or insured driven bias.
Deductible and Self Insured Retention valuations have to take place exactly in accordance with price monitoring techniques.
Changes in coverage have to be quantified, if only by estimate.
2006-9-29 25
Quantification of Risk Risk level increases significantly as the attachment
point rises. Deductibles and SIRs remove the more predictable part of the risk.
Risk knowledge decreases as risk size increases. It is harder to establish exposure bases and there are more variables to balance.
Balance of knowledge shifts to the buyer as size increases, increasing risk.
Risk level increases with the inexperience of the underwriter on the book. (Note we did not say inexperience of the underwriter)
2006-9-29 26
Monitoring Process
Establish base rates per exposure units to be measured against. This does not fully recognize risk quality, but creates a hard base line.
Measure renewals creating a history. Force identical quantification of all terms variation
(composite rates, deductibles, SIRs, etc) against these base rates.
Measure new business against the same standards Even when using experience rating as a methodology,
measure the resulting rate against the same basis. Take tracking of rate level change to desk level.
2006-9-29 27
Correcting the Decision-Making Process Effective price monitoring has to occur at the
same location as effective underwriting; the underwriter’s desk.
Price monitoring needs to become a real part of the evaluation process for rating agencies and analysts. (Remember the grading chart)
Senior management and analyst emphasis on top line premium growth and expense control is often at odds with effective price monitoring.
2006-9-29 28
ERM Implementation First line of defense
starts at the desk-underwriter
Track exposure data Track pricing data Integrate pricing /
underwriting/ claims / reserving
Pricing
UnderwritingClaims
Reserving
ERMFor P&C
Companies
29
Contact
1. Shaun Wang, [email protected], 678-524-9222
2. Bob Faber, [email protected], 847-428-2533
