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					2008 Seminar on Reinsurance

    Reinsuring Commercial Umbrella




      Brian E. Johnson, ACAS, MAAA
          Agenda

          •   Basic Review of Commercial Umbrella
               –Umbrella vs Following Form Excess
               –How is an Umbrella policy written and priced?
          • Discuss   the more common ways an Umbrella portfolio
              can be reinsured
               –Quota Share (Cessions)
               –Excess of Loss
               –Things to consider
           Market   Trends


Slide 2
          Basic Umbrella Review

           Sometimes  a primary insurance company will write an
           excess liability policy.

           Excess   liability policies take two main forms
            –Umbrella
            –Following Form Excess

           Bothtypes of excess policies are written “on top” of
           underlying policy usually with a requirement that the
           insured maintain the underlying coverages.

           Otherthan where noted, these two coverages can be
           priced using similar methodologies.
Slide 3
          Basic Umbrella Review

             A Following Form Excess does just what it says. It
              follows an underlying policy and provides for
              additional limit. All the same coverages and
              exclusions on the underlying policy are applicable to
              the Following Form Excess policy.

             An umbrella policy is a little different. In addition to
              adding limits to an underlying policy (ies), it may
              “drop-down” to cover losses not covered by the
              underlying policy unless it is specifically endorsed to
              follow the underlying in coverage.

             An umbrella policy may also cover certain loss
              adjustment expenses not covered by the underlying
              policy (drop down coverage).
Slide 4
          Basic Umbrella Review

          Example of drop-down:

            Tatooine Cantina buys a $1M GL policy that excludes
            liquor liability. They also buy a $2M umbrella policy
            on top of it (attaching at $1M). The umbrella does
            not have the liquor exclusion. The bartender on duty
            continues to serve alcohol to a patron after he was
            visibly drunk. That patron gets into a bar fight and
            cuts off the arm of another customer, Bob. Bob sues
            Tatooine and wins $500K. Even though this loss is
            below the $1M retention, the umbrella “drops down”
            to pick up the loss.



Slide 5
          Basic Umbrella Review

             In commercial lines, excess or umbrella policies are
              priced by applying factors to the premium of the
              underlying policy. Manual or “net” premium could be
              used.

             These factors are derived from severity curves (ILFs)
              but include a load for the insurers’ profit and
              expenses.

             Typically the first $1M of Umbrella is priced as a
              percentage of the premium for the underlying lines
              (these are called umbrella factors).

             Additional layers are priced as a percent of the first
              $1M of umbrella or a percent of each preceding
Slide 6
              layer.
          Basic Umbrella Review

             In addition to the excess factors, there are usually
              minimum premiums per $1M in limit and/or policy
              applicable.

             Quite often, the underwriter also has some flexibility
              to apply discretionary credits/debits to the umbrella
              factors or final umbrella premium.

             An insurance company can write an umbrella policy
              over their own underlying policies or over another
              insurance company’s policies. (supported vs
              unsupported).



Slide 7
          Reinsuring an Umbrella Portfolio:
          Quota Share

             Typically reinsurance on umbrella policies is provided
              on a proportional basis.

             The quota share cession percentage can be the same
              for all limits or vary by layer.

             If there is enough credible information, a reinsurer
              pricing this business would be able to do an ELR
              analysis by trending umbrella premium and trending
              and developing umbrella losses.

             There will not be many losses in the layer. A loss
              ratio analysis based on experience rating would not
              be credible.
Slide 8
          Reinsuring an Umbrella Portfolio:
          Quota Share

             There are a few important things that must be
              considered in order to successfully experience rate
              an umbrella portfolio.
              – Historical individual umbrella losses with
                attachment point for every loss (also excess vs
                drop-down) and historical umbrella premium.
              – Underlying rate changes
              – Umbrella rate changes
                 Changes in umbrella factors
                 Changes in amount of discretionary pricing.
              – Excess loss development factors
Slide 9       – Drift in limits distribution
           Reinsuring an Umbrella Portfolio:
           Quota Share

              Another way to estimate the profitability of an
               umbrella quota share (ELR) is to split the analysis
               into two pieces:
               – Using ground-up data, estimate the adequacy of
                 the underlying premium
               – Estimate the adequacy of the umbrella factors in
                 comparison to some industry or reinsurance
                 company yardstick
               – The theory is that the ELR of the umbrella policy
                 would be affected by both the adequacy of the
                 underlying premiums and excess factors.

              Let’s illustrate this with an example.
Slide 10
                        Reinsuring an Umbrella Portfolio:
                        Quota Share
     Cortana Re has been given a chance to reinsure a book of commercial
     umbrella business written by Covenant Insurance. Covenant writes
     either $1M limit or $2M limit umbrellas over their own $1M GL
     policies. You have the following information about the account. You
     also use a pareto distribution to develop the following limited severity
     curve. Estimate the ELR on the Umbrella portfolio.
           ERL on Covenant's GL policies:        75%
              Umbrella factor for 1st Mill:      20% of underlying $1M policy
              Umbrella factor for 2nd Mill:      75% of 1st Mill of umbrella
               % umbrella policies at 1M:        40%
               % umbrella policies at 2M:        60%


                                      Limit   Avg Sev
                                 1,000,000     16,000
                                 2,000,000     19,084
Slide 11                         3,000,000     21,555
           Reinsuring an Umbrella Portfolio:
           Quota Share

                       the Umbrella factors are the ratio of
            Essentially
            umbrella premium to underlying premium:
                               premumb
                                premund

            Using your severity curve, you promulgate an excess
            loss factor for each layer:

                              lossumb
                              lossund

Slide 12
           Reinsuring an Umbrella Portfolio:
           Quota Share

              A ratio of the two factors (umbrella adequacy factor)
               multiplied by the underlying ELR equates to the
               umbrella loss divided by the umbrella premium.

                   lossumb
                   lossund              lossund             lossumb
                                X       premund     =       premumb
                   premumb
                   premund



              Using a simple Excel spreadsheet you can estimate
               the weighted average adequacy factor and ELR for
               an umbrella portfolio.
Slide 13
                   Reinsuring an Umbrella Portfolio:
                   Quota Share
                                                  1,000,000 1,000,000
                                                     xs         xs
                                                  Underlying 1,000,000
                                 Umbrella layer:         1st      2nd
           (1)          GL ISO % of underlying:      19.3%      12.9%
           (2)                 ISO Total Limits:     19.3%      32.2%
           (3)          Cortana % of underlying:     20.0%     15.00%
           (4)             Cortana Total Limits:     20.0%     35.00%
           (5)              Umbrella Limits Dist:    40.0%      60.0%
           (6)       Umbrella Adequacy Factor:       93.3%
           (7)    ERL on Covenant's GL policies:     75.0%
           (8)                   Umbrella ELR:       69.9%


           (1)   Based on ISOTruncated Pareto with client specific exposure distribtions
           (2)   Cumulative of (1)
           (3)   Given
           (4)   Cumulative of (3)
           (5)   Given
           (6)   = wtg average of (2) / wtg average of (4)
           (7)   Given
Slide 14
           (8)   = (6) x (7)
           Reinsuring an Umbrella Portfolio:
           Quota Share

              In practice, umbrella policies are typically written
               over multiple underlying coverages (i.e. GL, AL, and
               EL).

              The analysis for these situations is the same with
               multiple underlying ELRs and umbrella factors.




Slide 15
                     Reinsuring an Umbrella Portfolio:
                     Quota Share

                             1,000,000    1,000,000   1,000,000    1,000,000    1,000,000
                                xs           xs          xs           xs           xs
                             Underlying   1,000,000   2,000,000    3,000,000    4,000,000
           Umbrella layer:          1st         2nd          3rd          4th          5th
  GL ISO % of underlying:      13.17%         3.93%       2.29%        1.55%        1.14%
 CAL ISO % of underlying:      11.08%         3.91%       2.22%        1.48%        1.07%
 Avg ISO % of underlying:      12.60%         3.93%       2.27%        1.53%        1.12%
      XYZ % of underlying:     16.01%         8.01%       4.00%        2.00%        1.00%
            Premium Dist:      58.37%       22.14%        7.54%        3.38%        8.57%
Umbrella Adequacy Factor:        73.2%
        GL L&ALAE Ratio:         72.2%
       AL L&LALAE Ratio:         91.1%
Avg. AL/GL L&ALAE Ratio:         77.4%
     UMB ELR on 1st $5M:         56.6%




 Slide 16
           Reinsuring an Umbrella Portfolio:
           Quota Share

              Some things to consider if using this method:
               –You must consider the proper method to load for
                excess ALAE versus ground-up ALAE
               –You must factor in the effect of discretionary
                pricing
            You   must also factor in the effects of the minimum
               premiums.
               –The “actual” excess factor obtained because of
                your minimum premiums may be far greater than
                the filed excess factors.
               –This is sometimes very hard to do because it
                requires the cedant to keep premiums by layer in
Slide 17        the system.
           Reinsuring an Umbrella Portfolio:
           Quota Share

              The reinsurer must also be very aware of shifting
               limits (or attachment) points.
               – Some layers may be more or less adequate than
                 others.
               – A shift to higher or lower limit umbrella policies
                 may affect the adequacy factor.

              Once an ELR is determined the reinsurer can
               determine what commission can be paid the cedant.

              There must also be some consideration what load to
               add for “drop-down” coverage.


Slide 18
           Reinsuring an Umbrella Portfolio:
           Excess of Loss

              Another way to reinsure an umbrella portfolio is
               reinsure it on an excess of loss basis.

              This type of treaty can come in two varieties:
               – A cedent decides to include their umbrella
                 portfolio into their mainframe XOL treaty.
                 Typically the limit and attachment points are with
                 respect to first dollar i.e. $5M xs $1M
               – A cedent who writes unsupported umbrellas may
                 choose to keep a fixed retention on every umbrella
                 regardless of the attachment.

              One of the biggest concerns is how a shift in limits or
               attachment points could change the expected loss in
Slide 19
               your reinsured layer.
                         Reinsuring an Umbrella Portfolio:
                         Excess of Loss

Let’s start with a scenario where every umbrella has the same
attachment point, limits vary and the excess of loss cover is $4.0M xs
$1.0M from the ground:                                Limited
                               Prem                  Limit   Severity
           Limit Attachment   Distr. XS Factor    500,000      18,147
  4,500,000       1,000,000   25.0%     95.3%    1,000,000    21,623
   1,500,000      1,000,000   10.0%    100.0%    1,500,000    23,604
  3,000,000       1,000,000   35.0%    100.0%    2,000,000    24,946
  5,000,000       1,000,000   30.0%     91.5%    2,500,000    25,940
                              Wavg:     96.3%
                                                 3,000,000    26,719
                                                 3,500,000    27,353
  Given an umbrella ELR of 65%                   4,000,000    27,884
  the rate we would charge would                 4,500,000    28,338
  be 63% plus load.                              5,000,000    28,733
                                                 5,500,000    29,081
Slide 20
                                                 6,000,000    29,391
           Reinsuring an Umbrella Portfolio:
           Excess of Loss




Slide 21
                      Reinsuring an Umbrella Portfolio:
                      Excess of Loss

Let’s look at a scenario where the umbrella attachment points and limits
vary and the excess of loss cover is $4.0M xs $1.0M with respect to the
ground:

                               Prem
           Limit Attachment   Distr. xs factor
 4,500,000         500,000    25.0%     67.2% =(28733-21622)/(28733-18147)
 1,000,000        1,500,000   10.0%    100.0%
 3,000,000        1,500,000   35.0%    100.0%
 1,500,000       3,000,000    30.0%    100.0%
                              Wavg:     91.8%




Slide 22
           Reinsuring an Umbrella Portfolio:
           Excess of Loss




Slide 23
                   Reinsuring an Umbrella Portfolio:
                   Excess of Loss

 Let’s look at a scenario where the umbrella attachment points and limits
 vary and the excess of loss cover is $4.0M xs $1.0M with respect to the
 umbrella:
                           Prem
       Limit Attachment   Distr. xs factor
4,500,000      500,000    25.0%      48.4% =(28733-23604)/(28733-18147)
1,000,000     1,500,000   10.0%       0.0%
3,000,000     1,500,000   35.0%      50.7% =(28338-25939)/(28338-23604)
1,500,000    3,000,000    30.0%      28.0% =(28338-27884)/(28338-26718)
                          Wavg:      38.3%




 Slide 24
           Reinsuring an Umbrella Portfolio:
           Excess of Loss




Slide 25
           Reinsuring an Umbrella Portfolio:
           Excess of Loss

              order to properly rate the XOL on umbrella business
            In
            the reinsurer will need data that may not be readily
            available from the cedant.
             –A matrix distribution of limits by attachments
             –Historical information on how limits and
              attachments have shifted over time
           A shift in the limits or attachment points could make
            the average expected loss cost increase or decrease
            significantly.
              some cases it may make more sense to charge a
            In
            schedule of rates which vary by attachment and limit
            as opposed to a single rate.
Slide 26
           Reinsuring an Umbrella Portfolio:
           Excess of Loss

            The reinsurer may also want to rethink the
            appropriate load (for parameter risk) needed to write
            this type of cover.
            Usingan XOL load typically used when reinsuring
            primary policies may not be appropriate.
            Theremust also be some consideration what load to
            add for “drop-down” coverage.




Slide 27
           Reinsuring an Umbrella Portfolio:
           Market Trends

              Like the rest of the market the rates have been
               decreasing.
               – Decreasing manual rates
               – Decreasing discretionary mods
               – Decreasing umbrella factors
               – Increased use of umbrella credits
               – Umbrella on E&S business hit the hardest

              More companies trying to purchase auto carve-outs
               for their umbrella portfolio.

              Companies are looking at the option of moving from
Slide 28       an umbrella quota share to an XOL.
           Reinsuring an Umbrella Portfolio:
           Market Trends

              Continued deterioration of terms and conditions
               – Little to no referral guidelines
               – Decreasing minimums per million

              Increase in the umbrella limits primary companies
               are willing to write.

              More primary companies are willing to attach higher
               (write the excess umbrellas as opposed to lead
               umbrella) where it is perceived rates per million are
               more adequate.

              Increase in the number of companies willing to offer
               SAM in the umbrella for certain classes (i.e. social
Slide 29
               services)
           Reinsuring an Umbrella Portfolio:
           Market Trends

              More risks, typically written in the E&S markets, are
               being written in the standard umbrella market at
               standard umbrella rates.

              Actuaries and UWs need to make sure they
               understand the underlying umbrella form.
               – While there is a standard ISO form most
                 companies use a hybrid form
               – Recently the umbrella forms have been
                 broadening

              Actuaries should also make sure umbrellas are
               properly endorsed to reduce the chance of drop-
               down coverages (i.e. a driver is excluded on the
Slide 30
               underlying but not on the umbrella)