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Actuary as a deal maker

VIEWS: 1 PAGES: 52

									           Baltimore Actuaries Club

   Session 1: Overview of the Health
          Reinsurance Market

                   Michael L. Frank
                   Aquarius Capital


                      April 7, 2009

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               Copyright and Disclaimer
The material contained in this presentation has been prepared solely for
informational purposes by Aquarius Capital Solutions Group LLC (Aquarius). The
material is based on sources believed to be reliable and/or from proprietary data
developed by Aquarius, but we do not represent as to its accuracy or its
completeness. The content of this presentation is intended to provide a general
guide to the subject matter. Specialist advice should be sought about your specific
circumstances. This document and its contents are proprietary to Aquarius. Neither
this document nor its contents may be copied or reproduced in any manner without
the express consent of Aquarius. Any requests or questions about this material
should be forwarded to bac-questions@aquariuscapital.com.




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                        Biography of Speaker
•   20+ Years Experience - Life, Accident & Health
•   Specialties – Insurance, Reinsurance & Employee Benefits
•   Services – Actuarial, Brokering/Consulting, Reinsurance, U/Wing, Risk Mgmt
•   Actuarial Credentials: ASA, FCA, MAAA
•   Actuarial Society of Greater NY, Chairperson for Continuing Education
•   Society of Actuaries - Section Councils:
        Current: Reinsurance Section, Entrepreneurial Actuarial Section
        Retired: Actuary of the Future Section
        Various NAIC/AAA Committees & Task Forces
•   Other Credentials
        Licensed life, accident and health broker (25+ states)
        Licensed reinsurance intermediary & managing general underwriter
        Licensed life settlement broker
        Listed Arbitrator for Reinsurance Association of America (RAA)
        Associate, American College of Healthcare Executives (ACHE)
•   Other: Speak at Industry Meetings, Publish Articles, Industry Committees
•   Website: www.aquariuscapital.com

     AQUARIUS CAPITAL                         3
                   Overview
•   Who Purchases Reinsurance?
•   Why Companies Purchased Reinsurance?
•   Types of Reinsurance Structures
•   History of the Market/Capacity
•   Sample Transactions (Cases #1-3)
•   Trends in the Stop Loss Insurance Market
•   Finite Risk/Structured Risk Finance


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             Reinsurance Purchasers
                (Accident & Health)
• Insurance Carriers
        Program Managers on Behalf of Carrier Clients
         • Managing General Underwriters (MGUs)
         • Third Party Administrators (TPAs)
         • Marketing Entities/General Agencies
• Reinsurers/Retrocessionaires
•   Captive Insurance Companies
•   Health Maintenance Organizations (HMOs)
•   Medical Provider Groups (“Risk Taking”)
•   Employer Groups (“Self-Funded”)
•   Disease Management Companies
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Underlying Product Lines Reinsured
         (Accident & Health)
 •   Shorter Tail Coverage
        Medical – Traditional, Consumer Driven, Limited Medical
        Dental
        Vision
        Disability Income
        Group Life and AD&D – Combined with health coverage
 • Longer Tail Coverage
        Long Term Care
        Long Term Disability
        Medicare Supplement
 • Other (Hybrids)
        HMO/Provider Excess Reinsurance
        Accident Medical Coverage
        Self-Funded Stop Loss Reinsurance
        Disease Management Carve-Outs

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  Reasons for Reinsurance Purchase
• “Intellectual Capital”
    Entry into new markets
• Risk-Based Capital (“Surplus”) Relief
• Regulatory Requirements
• Remove volatility in results (risk transfer of catastrophic events)
   Mitigate experience on new product offers (quota share)
   Reduce exposure to catastrophic claims (excess of loss)
• Leveraged Return on Capital – See Sample Cases
• Not a vehicle to “dump loses on ignorant capacity”


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            Reinsurance Structures
•   Quota Share
•   Variable Quota Share
•   Yearly Renewable Term (YRT)
•   Aggregate (Excess of Loss)
•   Retrospective Premium Adjustments (“Swing Rate”)
•   Contracts with maximum limit caps
•   Insolvency Coverage
•   Letter of Credit
•   Surety Bond
•   Parental Guarantees (“Keepwell” Agreement)


     Note: A&H market borrowed many concepts from P&C market!

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  The Reinsurer’s Perspective – The
      Reinsurance Food Chain
• Employer contracts with carrier
 Fully insured arrangement
 Self-funded: specific and/or aggregate
  stop loss
• Carrier’s administration options:
 Provided directly to employer
 Outsourced admin and/or marketing
  through TPA
 Outsourced underwriting through MGU
• Reinsurer assumes risk from carrier
• Multiple reinsurers/retrocessionaires
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Don’t forget about brokers and reinsurance
 intermediaries?




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            History of Reinsurance
Profitable Period (Late 1980’s- early 1990’s)
• Less Capacity
• Purchaser less focused on cost of reinsurance
    Smaller “slice of the expense pie”
• Impact:
    High medical trend
    Market accepted high premium trend
    High margin allowed room for mistakes
    Reinsured less focused on cost of reinsurance



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Who are the traditional medical reinsurers?
 P&C and Life Reinsurers!




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              History of Reinsurance
Unprofitable Period (mid 1990’s – 2000)
   • Many reinsurers experienced poor loss ratios
        Stop Loss: specific > 125%; aggregate > 200%
        Too much capacity including reinsurance MGUs
   • Major exodus in 1998 & 1999
        Retrocessionaires lose $ in pools
           • e.g., Workers Comp, many other pools
        True-up of historical reserves – Unanticipated Losses


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              History of Reinsurance
Unprofitable Period (mid 1990’s- 2000)
• Losses were due to a combination of all of the following
    Capacity in mid 90’s significantly greater than the early 90’s (Market
     Pressure drives rates downward)
    Non-risk-bearing entities (e.g., MGUs) were writing for fee income
    Uncontrolled expenses
    Ineffective underwriting and pricing for managed care
    Sold rates were materially below manual rates
    Reserve strengthening from prior underwriting years



   AQUARIUS CAPITAL                  14
           History of Reinsurance –
      Companies Exit Medical Reinsurance Arena
    Many Companies in Market in 90’s Out by 2002/03:

• Swiss Re                          •   General American
•    Sun Life                       •   Guardian
•    Transamerica Re                •   Life Re
•    CNA                            •   AUL
•    Lincoln                        •   ManuLife
•    D&H                            •   Phoenix Mutual
                                    •   Many others
     Note: More than 30 companies exited market!
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      History of Reinsurance – Today
         Mixed Results Period (mid            2004 to today)

• Mergers & Acquisitions – Many consolidations
• Growth in limited medical plans
• Still significant stop loss direct writers (>25)
• Limited medical reinsurance capacity for A&H (<5)
    Limited HMO reinsurance/provider excess writers
    Limited fully insured quota share capacity
    Reinsurance MGUs becoming extinct (not direct MGUs)
    Change in the “finite risk” or financial reinsurance market
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History of Reinsurance – Impact of “Disputed”
or Litigious Claims on Reinsurance Financials
 •   Disputed claims have become a common practice in
     reinsurance in late 90’s and today due to historical
     losses
        Workers Comp, LMX, reinsurance pools
 •   Reinsurers have been assessing the likelihood of
     legal settlements
 •   Claim Valuation/Reserving: Art vs. Science?
        Time will tell based on empirical data (actual settlements)
 •   Will influence business today & going forward

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         Evaluating Opportunities
• Internal risk margin, RBC, and ROE requirements
• Quality of potential business partner(s)
• Medical claim costs & leveraged trend
• Environmental factors
• Reviewing the reinsurance contract



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      Evaluating Opportunities –
     Quality of Business Partner(s)
•   Who performs various functions?
       Actuarial, underwriting, claims, marketing, etc.
       Carrier (Ceding Company) vs. Reinsurer vs. third party
•   Considerations:
       Reputation and track record
       Level and breadth of expertise
       Compensation and incentives
       Critical Mass vs. Start up
       Business goals: growth, profit, core business, etc.
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                     Reinsurance
               Critical Success Factors
•   Requires strong financial underwriting by a reinsurer
•   Different state jurisdictions (local Department of
    Insurance)
        Will have different regulatory requirements
        Varying RBC standards
        Varying reinsurance rules/interpretations
•   How well does reinsurer understand underlying business
    being reinsured?
•   Reinsurers may have different or additional reporting
    requirements than the plan is accustomed to, including
    specified turnaround times for reporting.
    AQUARIUS CAPITAL                20
              Critical Success Factors
                    (Continued)
•   May not be accepted by reinsurer or ceding company’s executive
    management
      Not comfortable with the concept - - especially finite risk deals

      Assuming insolvency risk or credit risk

•   Each ceding company will require a unique solution.
•   This will change your organization’s financial statements
•   Do all parties understand amount of risk transferred?



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              Reinsurance Terminology
•   Premium
•   Claims
•   Loss Ratio – Gross vs Net?
•   Intermediary (brokerage) fees – if applicable
•   Various parameters may be incorporated to handle reinsurance
    transaction
        Experience Refund
        Ceding Commission (Used for Case #1)
        Future Premium
        Deductibles (Attachment Points for Aggregate)
        Reserves
        Other

    AQUARIUS CAPITAL                    22
      Other Reinsurance Terminology
•   Treaty vs Slip
•   Inclusions:
      Underwriting Guidelines -- may include MGU provisions

      Claims Notification – may include TPA provisions

      Bordereaux Reporting

•   Other Provisions:
      Funds Held Provision

      “Poison Pills” - Ratings Downgrading, Change of Control

      Extra-contractual obligations

      Arbitration Clause


    AQUARIUS CAPITAL             23
                        Sample Case #1
    (Surplus Relief & Leverage Return on Income)
•   Multi-line insurance company
      Writes $100 million of annual premiums
      RBC formula requires more than $40 million in capital
•   Reinsurer
      Provides (assumes) 50% of the quota-share
      On paper - $50 million in premium and the same % of the total
       risk, 50%.
      Transaction - Quota share w/ sliding scale ceding (administrative
       expense) allowance
      The profit and income levels of the plan may be achieved based
       on a sliding scale ceding commission or experience refund
       component.
     AQUARIUS CAPITAL               24
                 Sample Case #1 (Cont.)
•   Insurance company receives reserve credit since claims
    reinsured.
•   Transaction is written on a funds held basis, thereby ceding
    company has a large working fund to pay underlying claims
    and administrative expenses.
•   Company may free up significant capital to manage the
    business or reinvest into the company (surplus/RBC
    relief).
•   Cost may be more efficient than borrowing capital from:
       Venture capital market - Would want ownership plus high costs.
       Parent company – May be challenged to allocate capital if
        competing with other ventures and product lines.

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                                     Sample Case #1
(Sample Financials – 50% Quota Share Reinsurance)
 Results in Millions                                      Before           Transaction           After

 1. Premium                                           $   100.0    -   $      50.0       =   $    50.0

 2. Claims                                            $    70.0    -   $      35.0       =   $    35.0

 3. Admin. Expenses                                   $    25.0    -   $      12.5       =   $    12.5

 4. Reins. Risk Charge                                $        -   -   $       0.5       =   $     0.5

 5. Experience Refund                                 $        -   -   $      (2.5)      =   $     2.5


 6. Pre-Tax Profit: (1)-(2)-(3)-(4)+(5)               $     5.0        $      (0.5)          $     4.5


 7. Capital Requirement - Illustrative                $    42.5                              $    22.3


 8. Pre-Tax Return on Capital: (6)/(7)                    11.8%                                  20.2%


 Note: Investment income and taxes not illustrated.


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    Drivers of RBC Formula for A&H

•   Premium
•   Incurred Claims
•   Reserves (Incurred & Unpaid Claims)
      Morbidity Assumptions
      Discount Rates




    AQUARIUS CAPITAL           27
           Evaluating Opportunities –
             Types of Large Claims
•   Organ Transplants
•   High Tech Cardiovascular
•   Neurological Conditions
•   Cancer
•   High Risk Maternity & Neonates
•   Severe Trauma Including Burns
•   Other Catastrophic Illnesses
      HIV/AIDS
•   High Cost Prescription Drugs
      Factor VIII


    AQUARIUS CAPITAL            28
            What is “Leveraged” Trend?




                              Leverage
                              Trend


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                    Leveraged Trend
•   2004
           Ground-up claim = $100,000
           Specific deductible = $50,000
           Claim in excess of deductible = $50,000
           1st dollar trend = 13.5%
•   2005
           Ground-up claim = $113,500 ($100,000 * 1.135)
           Specific deductible = $50,000
           Claim in excess of deductible = $63,500

    Trend on excess portion of claim = 27% ($63,500 / $50,000 – 1)

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          Disease Management Reinsurance
                     (Case #2)
•    Disease Management Company (DMC) assumes risk from HMO
•    DMC guarantees (e.g., 10%) reduction in post acute cost due to:
      better contracts
      reduced admits
      reduced length of stay (LOS)
•    HMO requires guaranteed savings
         Letter of credit from DMC to assume risk reserve transfer (3 months
          capitation)
         DMC obtains a reinsurance policy to protect against insolvency




    AQUARIUS CAPITAL                     31
    The Disease Management Co.
 Reinsurance “Food Chain” – Case #2
           REINSURER


           DISEASE MGMT CO.        INTERMEDIARY


           HMO                     CONSULTANT(S)

           DIRECT
           BROKER/GA

           EMPLOYER


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Is Reinsurance Cheaper than Borrowing from
  Capital Markets? Is Capital Available from
  Parent Company?




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Sample Case Study – Multi Year Portfolio
    Aggregate Stop Loss (Case #3)
 •   Insurance Company buys a three (3) year aggregate stop loss
     to smooth earnings.
 •   Goal to handle adverse experience for a non-performing
     (exiting) line of business
 •   Years 2 & 3 - Attachment points in at highest level
       Increase with trend (inflation) and prior experience
       Losses carried by reinsurer on its balance sheet for Years
         1 and 2.
       Year 2 & 3 - Functions as a “sleep” cover
       Deficit (carry forward) handled through risk charges.
 •   Premium to buy coverage potentially tax deductible to
     insurance company.
  AQUARIUS CAPITAL                34
             Aggregate Stop Loss - Case #3
               (BEFORE Reinsurance)


 Results in Millions                       Year 1       Year 2       Year 3



 1. Premium                           $    100.0    $   125.0    $   140.0



 2. Incurred Claims                   $     90.0    $   107.0    $   120.0



 3. Medical Loss Ratio:   (2) / (1)        90.0%        85.6%        85.7%




AQUARIUS CAPITAL                      35
            Aggregate Stop Loss - Case #3
                    (Continued)

•    Premium = $2 million per year
•    Coverage Period = 3 years
•    Claims Attachment Points
        •    Year 1 = Coverage for total claims > $84.5 million
        •    Year 2 = Above $120.0 million
        •    Year 3 = Above $135.0 million
•    Maximum Benefit = $25 million



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             Aggregate Stop Loss - Case #3
                (AFTER Reinsurance)

Results in Millions                                Year 1           Year 2           Year 3

1. Premium                                     $   100.0    $       125.0    $       140.0

1a. Reinsurance Premium                        $    (2.0)   $        (2.0)   $        (2.0)

1b. Reinsurance Premium: (1) – (1a)            $    98.0    $       123.0    $       138.0

2. Incurred Claims                             $    90.0    $       107.0    $       120.0

2a. Reinsured Claims                           $    (5.5)       $        -       $        -

2b. Net Incurred Claims: (2) – (2a)            $    84.5    $       107.0    $       120.0

3. Loss Ratio:    (2b) / (1b)                      86.2%            87.0%            87.0%

4. Loss Ratio Improvement from Coverage             3.8%            -1.4%            -1.2%



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        Employer Stop Loss – Innovations?
•   Underwriting tools
    •   Aggregating specific deductibles (ASDs)
    •   Lasers
•   Marketing
    •   PEOs and employee-leasing firms
    •   Associations
    •   Potential FAS 106 or GASB 45 Solutions for OPEB
•   Underlying benefit plan design
    •   Consumer-driven and mini-med plans
    •   Carving out certain benefit categories, e.g., Rx or transplants
    •   Different cost sharing arrangements, e.g., monthly deductibles
    •   Can TPA/carrier administer plans as written or priced?
•   Pricing “innovations” require more sophisticated modeling

    AQUARIUS CAPITAL                      38
            Employer Stop Loss –
    Aggregating Specific Deductibles (ASDs)
•    Additional deductible or retention for ceding company
        Functions as cost shifting exercise to reduce premium
•    Unique to per person excess of loss coverage
•    Lowers plan costs
        After reaching individual deductibles, claims not paid until
         exceeding an additional aggregate deductible
        Used to offset rate (inflation) increases
•    Becoming more popular
•    Aggregating Deductible traditionally a multiple of
     deductible (e.g., 2, 3 or 4 times specific deductible)

     AQUARIUS CAPITAL                 39
          Employer Stop Loss – “Lasers”
•   Additional deductible or retention for ceding company, for specifically
    identified individual(s)
      Functions as cost shifting exercise to reduce premium
      Lowers plan costs by increasing individual deductibles
      Underwriting tool to combat anti-selection, separating “known”
        versus “unknown” risk
•   May be viewed negatively by some market participants
      “Singling out individuals is not insurance”
      The alternative might be reinsurers not quoting or rating up to
        cover this non-lasered cost
•   Lasers may be placed separately or in combination
      Combination lasers may resemble ASDs or be contingent upon
        factors such as loss ratio

    AQUARIUS CAPITAL                 40
                   Disclosure Statements
What information is requested on a disclosure statement?
• Individuals currently disabled or confined in a medical facility/hospital
• Individuals pre-certified within the last three months.
• Individuals that received medical services during the current plan year the cost of
  which exceeds the lesser of, 50% of the lowest Specific Retention Amount
  applied for or $50,000, and for which bills have been received and processed by
  the by the Claims Administrator (TPA) and entered into their Claims System.
• Individuals that have been identified as a candidate for Case Management and as
  having the potential to exceed during the policy period, the lesser of, 50% of the
  lowest Specific Retention Amount applied for, or $50,000.
• Individuals that have been diagnosed, during the current plan year, with a
  condition represented by any of the ICD-9 codes contained in the attached list
  and have also received medical services costing $5,000 during the same period.


   AQUARIUS CAPITAL                      41
    Employer Stop Loss - Modeling
• Are there any operational changes, i.e., changes in
  administration, claims, marketing, etc.?
• Changes in plan design?
• Do you expect any impact from behavioral changes,
  e.g., “ownership” of an HRA or HSA account?
• Changes in the frequency and/or severity of claims?
• Will the claim run-out pattern change?
• Is data sufficient and appropriate?
• Are the assumptions appropriate?
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                Websites to Know!

• Self-Insurance Institute of America
  (www.SIIA.org)
• Society of Professional Benefit Administrators
  (www.SPBATPA.org)
• MyHealthGuide LLC (www.myhealthguide.com)
• SOA Reinsurance Section Council (www.soa.org)


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What other medical reinsurance opportunities
 exist outside of commercial medical?




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   Growth in the Mini-Med Markets
• Another approach to consumerism
• Also referred to as Limited Benefit Medical Plans
• Develop affordable benefits for part time employees
   Premium: 25-60% of traditional health benefits
   Covers costs of 20-50% of traditional benefits
   Popular with food chains, blue collar industries,
     nursing, other
• Part-time populations have administrative challenges
  (volatile group)
   Significantly more administration is required
   May process premium weekly or monthly
  AQUARIUS CAPITAL           45
          Mini-Med Markets (cont.)
• Benefit offerings focused on either catastrophic benefits
  or preventative care (both not an option)
• Benefits may be associate-pay-all with no company
  subsidy.
• Coverage available on self-funded or fully insured basis
  only.
    Fully insured carriers may buy reinsurance (e.g., quota share,
     aggregate)
    Buyer of coverage (employer) typically prefers fully insured
    Structure proposals so that the costs of development are
     included in premium rates:
      • enrollment material (brochures)
      • call center enrollment,
      • mailing of material (e.g., ID cards, SPDs/plan documents)

  AQUARIUS CAPITAL                      46
 Growth in the Mini-Med Markets
  (Sample Medical Plan Offering)
Hospital Room & Board                $    500     (per day, up to 90 days a year)
Inpatient Surgery                    $   1,500    (maximum surgical schedule)
Inpatient Anesthesia                 $    150     (per procedure)
Outpatient Surgery                   $    500     (surgical schedule)
Outpatient Anesthesia                $     50     (per procedure)
Doctor's Office Visits               $     35     (up to 4 visits per year)
Radiology & Cardiovascular           $     70     (up to 4 visits per year)
Pathology                            $     35     (up to 4 visits per year)
Phys. Medicine & Chiropractor        $     35     (up to 4 visits per year)
Wellness                             $     50     (up to 2 visits per year)
Emergency Room                       $     50     (up to 3 visits per year)
Ambulance                            $    100     (maximum 1 per year)
Prescription Drugs (max per month)   $     35     ($10 generic copay; $20 brand copay)

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    Medicare Market – “Baby Boomers”
           (Humana: Winter 2009 Newsletter)
•   Start Collecting Social Security Benefits (SSB)– Feb 2008
•   2008 – 3.2 Million turn 62 (365 per hour)
       Half Expected to retire early and draw 75% of SSB
•   80 Million to qualify for SS & Medicare over next 22 Yrs
•   2011: First group turn 65 and become Medicare Eligible
•   2012: Boomers that do not retire early turn 66 and
    become eligible for full benefits
•   2020: People ages 55-65 projected to increase 75%
•   2030: People > 65 expected to double
•   2050: People > 85 expected to grown by 382%

    AQUARIUS CAPITAL
                                                            48
    Financial Reinsurance/Structured
    Risk Finance - Proposed Structures
•   Quota Share
        Use of experience refunds, sliding scale commissions
•   Aggregate
•   Letter of Credit
•   Surety Bond
•   Parental Guarantees
        “Keepwell” Agreement

    AQUARIUS CAPITAL            49
    Challenges for Reinsurers in Finite/Financial
            Reinsurance Product Line
•      Management expectations for “consistent” profits balanced
       w/ comfort level of type of product
•      Competing for capital with true-risk product lines
•      Developing new products to meet reinsurance needs with
       limited data availability/accessibility
•      New & Changing Regulatory Environment
•      Risk Transfer – Does this meet the “10/10” rule
•      Addressing any political concerns of entering into product
       lines that may not be favored by senior management
•      Potential FAS 106 or GASB 45 Solutions for OPEB


    AQUARIUS CAPITAL              50
             Open Discussion – Questions

•   Will financial position of reinsurance market improve?
      Impact of the subprime
      Other lines of business exposures (e.g., Hurricanes, etc.)
•   Is the “sins of the past” still haunting people today?
•   Is a shrinking market for these types of coverage a concern?
•   Impacts of regulatory market (risk manager conservatism)
•   Will health plan/HMO consolidation result in fewer or
    different opportunities?


     AQUARIUS CAPITAL           51
                      Thank you

            Michael L. Frank, ASA, FCA, MAAA
                    President & Actuary
                      Aquarius Capital
                  Phone: (914) 933-0063
        E-Mail: michael.frank@aquariuscapital.com
 Websites: www.aquariuscapital.com & www.aquariuslife.com

          (Visit “Aquarius in the News” on Websites)


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