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Reinsurance Extracting Value from Reinsurance Analytics
Steve Mathews FIA CERA
Batuhan Avci
November 2013
© 2013 Towers Watson. All rights reserved.
Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Agenda
Motivation
Reinsurance considerations
Case study
Next steps
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The business planning cycle
Year End
Back testing
Experience
Update
Planning Loss
Ratio
Assumption
Next Year
Business
Planning
Reinsurance
Strategy
Reinsurance
Optimisation
Reinsurance
Placement
January
February
March
April
May
June
July
August
September
October
December
Achieving
Business
Objectives
November
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Why buy reinsurance?
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Supplements capital
Provides capacity
Reduces risk exposure
Smooths results
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Forms and types of reinsurance
Traditional Reinsurance Structures
Facultative Treaty
Proportional
Non-proportional
There are a number of traditional reinsurance structures to choose from
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Risk Excess of Loss
Risk Stop Loss
Stop Loss
Catastrophe Excess of Loss
Risk Excess of Loss
Event Excess of Loss
Facultative obligatory
Surplus
Quota share Coinsurance
Fronting arrangements
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And even more hybrid structures now available!
Hybrid types of Reinsurance
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Adverse Development Cover
Contingent Products
Holistic Risk Programme
Franchise Layers
Loss Portfolio Transfer
Peak Risk Protection Cat Bonds
Umbrella Excess Top and Drop
Risk Swaps
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Reinsurance in Turkey
There has been a constant small use of excess of loss covers over the last few years
The high use of quota share and surplus treaty reinsurance seen throughout the Turkish
insurance market is an unusual feature by international standards
The prevalence of earthquake risk in Turkey can lead to a competitive disadvantage
amongst insurers with proportional arrangements compared to those with only non-
proportional
Regulations around reinsurance in Turkey are not particularly stringent
Insurers potentially have significant flexibility in exploring various reinsurance structures to meet
their various business objectives
And in the news…
A.M. Best recently downgraded the financial strength rating of Milli Reasurans Turk Anonim Sirketi.
Subsequently, a reduction in the annual premium income by the reinsurer has been observed.
The successful issuance of the catastrophe bond Bosphorus Re Ltd has demonstrated a significant
appetite in the capital markets for a diversifying opportunity
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
How much do insurers in Turkey spend on their reinsurance?
Each year, Turkish insurance companies routinely spend significant amounts
on their outwards reinsurance purchase
Aside from claim payments, reinsurance purchase is often an insurer’s single
largest business expense
But there is a large variation in reinsurance ceded by insurer
Source: TSB 2012 Tables
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0%
10%
20%
30%
40%
50%
60%
70%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Benchmark comparison of Ceded Ratio for major insurers in Turkey
Ceded Ratio
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The company's risk appetite is fundamental to the
reinsurance decision-making process
How risk-averse are we as a company?
Any change to the current reinsurance programme
will require a framework in which to measure the
potential impact
An example of a quantitative risk appetite
statement includes a measure of downside risk,
over a specified time horizon and with a specified
probability
Risk appetite
Value of
reinsurance
Reinsurance
objectives
External
factors
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Considerations in determining the most appropriate
reinsurance structure
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Considerations in determining the most appropriate
reinsurance structure
Risk appetite
Value of
reinsurance
Reinsurance
objectives
External
factors
For some insurers, especially smaller and newer
market players, a comprehensive reinsurance
programme is an absolute necessity
On the other hand, for well capitalised insurers,
reinsurance can be a useful tool, to be used as and
when required
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
Risk appetite
Value of
reinsurance
Reinsurance
objectives
External
factors
Establish the purpose of the current reinsurance
programme
Capital adequacy, support of premium volumes and
profit stability may all be valid yet conflicting
objectives
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Considerations in determining the most appropriate
reinsurance structure
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Risk appetite
Value of
reinsurance
Reinsurance
objectives
External
factors
The availability and cost of raising additional capital
Regulatory and rating agency requirements
What is the reinsurance market offering in terms of
structure, capacity, price and security
Broker and supplier relationships
Balancing of local versus global objectives and
targets
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Considerations in determining the most appropriate
reinsurance structure
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So what now?
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Situation
Cost of reinsurance can be significant
Varying levels of risk appetite
Complication
How much to cede and how much to retain?
Availability of different contracts in the market
Mean profit is not always the best benchmark
Resolution
Comparison of different reinsurance contracts must consider both risk
and return
To understand the impact of various reinsurance structures, there
is a need to use a more analytical approach
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Background
Consider some different reinsurance options
Unlimited excess of loss (XOL) above 2.0m
One limited XOL layer of 8.0m xs 2.0m
Surplus treaty
A stop loss reinsuring 80% of losses when loss ratio is 100% – 135%
A simple business plan for a company writing one class of business
Expected losses typically split down into Attritional/Large (below/above a threshold):
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Mean Very Bad Bad Medium Good Very Good
Gross Premium 60.0 60.0 60.0 60.0 60.0 60.0
Total Losses 50.7 107.3 60.9 48.5 38.1 22.1
Total Loss Ratio 84.5% 178.9% 101.5% 80.8% 63.4% 36.8%
Profit 9.3 (47.2) (0.9) 11.5 21.9 37.9
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Gross Profile
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The company may be required to hold capital at the 1 in 200 (0.5th percentile) level to
remain solvent i.e. 47.2m
But is likely to be more focussed on the bad and good scenarios
Mean Very Bad Bad Medium Good Very Good
Expected
Profit 9.3 (47.2) (0.9) 11.5 21.9 37.9
Expected
Return on Capital 19.7% (100.0%) (1.9%) 24.5% 46.5% 80.4%
Profit Distribution_Gross
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
-40,000,000 -30,000,000 -20,000,000 -10,000,000 0 10,000,000 20,000,000 30,000,000 40,000,000
Value
Pe
rce
nti
le
Profit Distribution
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1. Net of Unlimited XoL
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Net distribution is tighter around mean
But with lower expected profit
Mean Very Bad Bad Medium Good Very Good
Expected
Profit 8.2 (34.5) (0.5) 9.0 17.9 32.7
Expected
Return on Capital 23.6% (100.0%) (1.6%) 26.2% 52.0% 94.9%
Profit Distribution_Unlimited
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
-40,000,000 -30,000,000 -20,000,000 -10,000,000 0 10,000,000 20,000,000 30,000,000 40,000,000
Value
Pe
rce
nti
le
Profit Distribution
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2. Net of Limited XoL
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Limited XoL better than Unlimited XoL in most scenarios
But in most extreme downside scenario coverage exhausts so worse
Mean Very Bad Bad Medium Good Very Good
Expected
Profit 8.5 (38.1) (0.3) 9.7 18.7 33.6
Expected
Return on Capital 22.3% (100.0%) (0.7%) 25.4% 49.2% 88.4%
Profit Distribution_Gross_Limited
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
-40,000,000 -30,000,000 -20,000,000 -10,000,000 0 10,000,000 20,000,000 30,000,000 40,000,000
Value
Pe
rce
nti
le
Profit Distribution
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3. Net of Surplus Treaty
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Surplus treaty saves capital
But sacrifices lots of profit in good scenarios
Mean Very Bad Bad Medium Good Very Good
Expected
Profit 6.4 (34.8) (0.6) 8.0 15.3 29.0
Expected
Return on Capital 18.4% (100.0%) (1.8%) 22.9% 44.1% 83.2%
Profit Distribution_Surplus Lines
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
-40,000,000 -30,000,000 -20,000,000 -10,000,000 0 10,000,000 20,000,000 30,000,000 40,000,000
Value
Pe
rce
nti
le
Profit Distribution
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4. Net of Stop Loss
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Stop Loss limits downside loss and reduces capital requirement
But increase in likelihood of a loss
Mean Very Bad Bad Medium Good Very Good
Expected
Profit 7.4 (34.7) (3.0) 7.4 17.7 33.7
Expected
Return on Capital 21.3% (100.0%) (8.6%) 21.2% 51.0% 97.1%
Profit Distribution_Gross_Stop Loss
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
-40,000,000 -30,000,000 -20,000,000 -10,000,000 0 10,000,000 20,000,000 30,000,000 40,000,000
Value
Pe
rce
nti
le
Profit Distribution
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Summary of different reinsurance options
Key metrics for each reinsurance option:
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Premium Expected Losses Expected Loss
Ratio Expected Profit
Capital: 0.5th %-
tile Profit
Expected
Return on
Capital
Gross 60.0 50.7 84.5% 9.3 (47.2) 19.7%
Unlimited XoL 54.8 46.7 85.1% 8.2 (34.5) 23.6%
Limited XoL 55.7 47.2 84.7% 8.5 (38.1) 22.3%
Surplus Treaty 42.0 35.6 84.5% 6.4 (34.8) 18.4%
Stop Loss 55.8 48.4 86.7% 7.4 (34.7) 21.3%
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Summary of different reinsurance options
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Premium Expected Losses Expected Loss
Ratio Expected Profit
Capital: 0.5th %-
tile Profit
Expected Return
on Capital
Gross 60.0 50.7 84.5% 9.3 (47.2) 19.7%
Unlimited XoL 54.8 46.7 85.1% 8.2 (34.5) 23.6%
Limited XoL 55.7 47.2 84.7% 8.5 (38.1) 22.3%
Surplus Treaty 42.0 35.6 84.5% 6.4 (34.8) 18.4%
Stop Loss 55.8 48.4 86.7% 7.4 (34.7) 21.3%
Key metrics for each reinsurance option:
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Summary of different reinsurance options
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Premium Expected Losses Expected Loss
Ratio Expected Profit
Capital: 0.5th %-
tile Profit
Expected Return
on Capital
Gross 60.0 50.7 84.5% 9.3 (47.2) 19.7%
Unlimited XoL 54.8 46.7 85.1% 8.2 (34.5) 23.6%
Limited XoL 55.7 47.2 84.7% 8.5 (38.1) 22.3%
Surplus Treaty 42.0 35.6 84.5% 6.4 (34.8) 18.4%
Stop Loss 55.8 48.4 86.7% 7.4 (34.7) 21.3%
Key metrics for each reinsurance option:
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Summary of different reinsurance options
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Premium Expected Losses Expected Loss
Ratio Expected Profit
Capital: 0.5th %-
tile Profit
Expected Return
on Capital
Gross 60.0 50.7 84.5% 9.3 (47.2) 19.7%
Unlimited XoL 54.8 46.7 85.1% 8.2 (34.5) 23.6%
Limited XoL 55.7 47.2 84.7% 8.5 (38.1) 22.3%
Surplus Treaty 42.0 35.6 84.5% 6.4 (34.8) 18.4%
Stop Loss 55.8 48.4 86.7% 7.4 (34.7) 21.3%
Key metrics for each reinsurance option:
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Summary of different reinsurance options
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Premium Expected Losses Expected Loss
Ratio Expected Profit
Capital: 0.5th %-
tile Profit
Expected Return
on Capital
Gross 60.0 50.7 84.5% 9.3 (47.2) 19.7%
Unlimited XoL 54.8 46.7 85.1% 8.2 (34.5) 23.6%
Limited XoL 55.7 47.2 84.7% 8.5 (38.1) 22.3%
Surplus Treaty 42.0 35.6 84.5% 6.4 (34.8) 18.4%
Stop Loss 55.8 48.4 86.7% 7.4 (34.7) 21.3%
Key metrics for each reinsurance option:
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Complexity of reinsurance purchase decisions
Choosing the right reinsurance programme is not easy
Buy Less Reinsurance?
Surplus of capital
Retain more premium
Reduce transaction costs
Why share profits?
Buy More Reinsurance?
Regulatory pressure
Share losses with
reinsurers
Safe from any
catastrophic events
“The safer the better”
Which Form/Type of Reinsurance?
Size and structure of portfolio
Frequency and size of losses
Management and underwriting
capability
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Proprietary and Confidential. For Towers Watson and Towers Watson client use only.
The reinsurance purchase decision is critical to the success of an
insurance venture
Too much or inappropriate reinsurance spend suppresses profitability
Too little or ineffective reinsurance can expose the venture to excessive risk
Today there are more diverse and complex reinsurance options than
ever before
To evaluate the best reinsurance structure we need:
An analytical review of the business under each reinsurance scenario
Combined with an understanding of the company’s risk appetite
and success measures
Conclusions
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