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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) 350 300 250 2000 200 2001 150 2002 2003 100 2004 50 0 Products Med Mal 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) 45000 40000 35000 30000 25000 20000 E.P. (000) 15000 10000 5000 0 1994 1996 1998 2000 2002 2004 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 Method Treatment 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 Method Calculation 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!
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