Welcome to today's webinar, hosted by Inland Marine Underwriters Association. I'm Lillian Coulson, and I'm pleased to introduce the webinar. Remember, there are two ways to hear today's webinar. If you have computer speakers, you may listen to the webinar through your computer Internet connection to the webinar in listen-only mode. If you lose your Internet connection, you can still listen to the audio portion of today's webinar and follow along with the PDF of slides that was emailed to you by dialing in the number that was sent to you with the login instructions. While your phone will be muted during the presentation, our presenter will address questions at the end of the webinar. Directions will be provided at that time. Actually, during the webinar, you'll be able to ask questions. It'll be in the queue to your right-hand side, and you'll just type in your question, and then you'll click Submit. To view the presentation full screen, click the Full Screen icon in the top right-hand corner of the screen. To exit out of full screen mode, simply click the Full Screen icon one more time. It's important to note that you'll need to toggle out of full screen mode in order to type in your questions. Okay, we're ready to begin the webinar. There will be a short pause while I engage the recording. Hello and welcome to today's webinar titled, Reinsurance and Inland Marines Beyond the Basics. Please be aware of the IMUA statement. I'm happy to introduce today's presenter, Dennis Smith. Dennis is an Associate Broker in the New York Office of Guy Carpenter's Marine and Energy Practice. As an Associate Broker, Dennis is assigned to a variety of client teams and works on a wide array of treaty placements, ranging from traditional marine, excessive loss, to pro-rata off-share energy, to structured aggregate protection, as well as facultative placements. Dennis, the floor is all yours. Thanks, Lillian. Good afternoon, everyone. I'll start off by saying that this presentation will be conceptual but with some grounded examples. Although it's a webinar, please feel free to ask questions throughout. The beginning of the presentation forms the basis of the rest, so I'd like to make sure I don't overlook any aspects that aren't clear enough in the beginning. Besides that, it's more interesting to have a conversation than hear myself talk, so it'll be fine to break it up with questions. One thing I will say is that I did see there were several FAC underwriters on this call. You'll likely find that some of this is familiar, although the presentation as a whole is focused more on the treaty market reinsurance characteristics and mechanics. So with that, we're going to start with Reinsurance 101, the introduction of the basic concepts of reinsurance. Then we're going to delve into the functions of reinsurance and the types. Then that's where we'll start progressing more into the examples that you might find within Marine loss events, as well as the analytics of how reinsurance underwriters assess the risk and underwrite a portfolio. Then the final concepts, we'll go through just a few of the more minor characteristics of treaty placements and how they can vary, and we'll also go to just some more topical material. So reinsurance at its base is insurance for insurance companies. The contract, rather than being between a primary policyholder as an individual commercial entity and an insurance company, is instead between the insurance company and the reinsurer. So whereas the reinsurance transaction for a policyholder would be to cover their risk of loss, the insurance company, while it's covering the risk of loss, they're also transferring risk to protect their balance sheet, their earnings volatility, and use their capital more efficiently. And we'll go into this over the next few slides, going through the different functions that reinsurance can serve. Key similarities and differences between insurance and reinsurance. Right off the bat, there's less regulation in reinsurance, because as a whole, it's believed that the buyers are more knowledgeable about what they're buying. You'll find this more often than not in insurance companies, that you'll be required to vet the security that you're placing the risk with. And a lot of the rating agencies provide some more advice on exactly which markets should be used and which aren't. That's why everybody, you know, you're going to want an A-rated paper, and that's kind of a way that the insurance industry regulates who they do business with. Reinsurance doesn't provide any defense obligation, as the insurance company is providing the defense for the claims. The reinsurers are only providing indemnification based on the treaty wordings in the contract, as it's said. They reimburse that paid loss. Because reinsurance is covering large losses and catastrophe losses, there'll be international scope to diversify, you know, between Japanese earthquake and California quake or Florida windstorm. They're going to want to spread their risk as much as possible globally, and because of that, the major reinsurers are very much spread throughout the world and spread their risk throughout the world. And then, as I said before, going through the treaty reinsurance market, these markets are underwriting portfolios of risk. So they're looking at characteristics of the underlying policies, but also looking at how those come together and perform as a whole over time. At its core, though, they are very similar. It's concerned with uncertainty in the future. They involve underwriting, although the underwriting may be very different, and they provide protection for a payment of premium. Who buys reinsurance? Reinsurance, you'll have traditional insurance groups, but then you'll also have mutuals and risk retentions or captives. Some captive that – very often, captives will take the risk from within the company, but they may buy reinsurance on the risk that they've gathered from within the company. Reinsurers can also buy reinsurance. That's what we call a retrocession. And sovereign entities, such as government, may buy reinsurance. For example, Amtrak bought a catastrophe bond in order to cover their losses in a certain area. And very often, government entities will do that to – just to provide a backstop to their risk, because it's very difficult for them to budget disaster recovery. The sellers of reinsurance will be other reinsurance companies. Very often, those reinsurance companies have primary insurance counterparts. They'll also be capital markets, increasingly, through catastrophe bonds and other mechanisms. And sovereign entities, again, being a government, may provide that. The risk is transferred throughout the industry from retail clients through their agents and brokers and then through the primary insurance companies, who can go either direct to reinsurers or through intermediaries. And then those reinsurance companies or alternative capital markets very often will buy retrocession. We'll get into retrocession in a little bit, but the one thing – we'll get into retrocession in just a short bit. The seeding companies can choose between two reins – they can either go broker or direct. Direct will probably be for narrower, simpler portfolios that are smaller. And then as they increase in complexity and size, very often, insurers will work with broker markets in order to structure the right type of cover for that – that risk. I also promise not to read all the slides. We're just getting through the very basics here to continue. The functions of reinsurance – now, this is going to be the really core part that forms the understanding of how reinsurance behaves and works and why it's purchased in one situation or another. And then also, these functions also decide exactly how the client buys it and what structure it is and where the pricing is and why it makes sense. At its core, reinsurance is a very key part of an insurance company's strategy. It allows them to use their capital better, and it allows them to build their strategy around their reinsurance purchase. I think I've made the analogy before that an individual is required to buy auto insurance when they have an auto because it's not likely that they're going to have enough money to pay a claim otherwise. In the case of insurance companies, the reinsurance – the regulators say that they need to have a certain amount of money for the risk that they're taking on. And if they don't have the money in their bank to pay for all the risk that they're taking, then they're not allowed to write more policies. So by buying insurance, similar to buying a personal auto policy, what you're doing is you're offsetting all that risk, and you're paying a reinsurance company to take that risk. And what that means is rather than have to hold all of that money to cover that risk, you can go and invest it better, write more policies, and make more efficient use of your capital. So while reinsurance can be very expensive for insurance companies, it makes sense because at the end of the day, they're able to use their capital in a better way and also maintain their rating and their integrity of their capital base. So why do companies want capacity? This is essentially what I just got to where regulators will say that they can only take so much risk for their policyholder surplus, but likewise, there may be certain lines of business, builders risk being one of them, where the limits are very high and the company does not want to take the full limit of risk in a given situation. And that's why you could either buy facultative reinsurance for a single risk, or you could buy treaty reinsurance for a portfolio risk in order to manage exactly how much liability is going to the company's balance sheet every time they write a policy. Are there any questions so far? I know I'm kind of going through these a little bit fast, and I don't want to rush through them. Okay. Stability. Companies want stability because they don't want volatile loss. It can affect stock price. It can affect your results. And like I said before, it can affect your strategy. If you're going to write a portfolio and you're going to have a large loss in one year and have 120% combined ratio, that's very difficult to just bounce back from the next year, even if it was an outsized loss for a given year. So purchasing reinsurance is going to stabilize that. Jim Pike has raised his hand. I'm trying to check if there's a question. Eileen, you may have to help me out here. Yeah. No. Actually, I do not see any questions, but Jim or anybody else on the webinar, if you do have a question, there's a Q&A pod, which is to the right of the PowerPoint slide. And all you would do is type the question in and hit send, or you could type the question in and click the little balloon icon, and Dennis will get the question. So that definitely is working, and we look forward to any questions. So again, now Steve raised his hand, but again, if you have a question, just type it in and hit the send button, and we will get your question. So in the meantime, what we mean by stability, we mean you want to take the volatile experience out of a book of business. Some books, like auto, may not really have much volatile loss experience. It's pretty consistent year over year, but a book of Florida wind-exposed property might be really volatile, because if it gets hit by a hurricane there's going to be a large loss and if it's not then it'll be very consistent and in order to take out those peaks of low frequency and high severity losses very often companies will buy reinsurance in order to mitigate that effect on their overall business strategy over time and I will say that so we talked about before about reinsurance and retrocession and in many cases reinsurers will sell the reinsurance to insurance companies but for peak exposures the reinsurers want the same type of coverage that insurance companies have so if reinsurers have a book of business that includes a lot of Florida properties that are exposed to wind they may buy retrocession on top of that and that's to mitigate their risk and cover their peak exposures however it's very important nowadays that company has gotten much better at tracking their aggregate exposure because in the 80s lawyers nearly went under because of the fact that people were doing retrocession and not keeping track of who had what so when multiple losses happened including Piper Alpha in the North Sea and the asbestos claims among others those losses started going through reinsurance contracts and retrocessional contracts and then further retrocessional contracts and people found that because nobody had kept track of exactly where had been going they were reinsuring their own books of business and so the loss as it's known as the Lloyd spiral spiraled out of control and Lloyd's nearly went under from it but thankfully was able to offset their liabilities by paying Berkshire Hathaway to take off those liabilities from the balance sheet in Equicat but just so everyone can see here this this is showing you that your gross results your highs are going to be high your losses are going to be higher when it's bad but your results will be better when it's good so you're paying a little bit of premium for the fact that you're buying reinsurance cover but it's stabilizing your results over time which allows you to create a business strategy that you can continue with it would be very hard to justify business strategy if your loss ratio is a hundred thirty percent in a given year and then try to get back to down here and so that's why you buy reinsurance in order to offset that. Catastrophe protection we talked about this this has to do with volatility of course you paying a premium in order to offset the chance that there might be a low frequency high severity event but it also ensures that the policy holder surplus is protected in addition to ensuring the continuation of business so more often than not you'll you'll hear that companies have large property cat covers and this covers very often California quake Florida wind business but then it can also cover worldwide exposures as well wherever that the company feels that it should be covered and you know this can cover all property that they feel is exposed and nowadays we model most of this in order to assess what the chances are of a major event impacting the company's bottom line. Now financing it's it's very important for a lot of reinsurance companies and especially with the startup business that the financing is addressed and that because there you write the premium and it earns out over time you're earning your premium out over time but your expenses are recognized immediately now for large companies are very established portfolios of business this isn't as much of an issue but for companies that are growing and they're recognizing all the expenses up front this may be a lot more difficult for them and very often we'll find those clients want quota share protection or similar where they're granted a seating Commission that eases their expense ratio and they're financing especially it prevents the surplus drain because as more people as more people write policies and liabilities hit the balance sheet that reduces how much they're able to write because it gets charged against the policy or their surplus one of the key let's hold on just a second that's helpful so yeah so it seems with that poll that everybody's very familiar with facultative reinsurance the one thing I'd like to point out for a good example of a startup reinsurance contract is after 9-11 banks builders wanted to rebuild but the banks didn't want to grant grant loans unless terrorism insurance was covered and none of the insurance companies at the time wanted to cover terrorism insurance because obviously there's they felt there's a large there's a chance of another large loss event and they didn't have the premium to pay it because of this the government was convinced to implement the terrorism risk insurance act and what that essentially did was it said that reinsurance companies would be asked to offer terrorism insurance at a premium but they could do this because the government would provide a backstop a huge 1 billion dollar reinsurance program that would prevent any loss beyond that point this was really important for the beginnings of terrorism risk reinsurance terrorism insurance coverage because it allowed the insurance companies to start offering it while being assured that for a large loss event they wouldn't be as exposed as they would have otherwise so that's a really key way of how reinsurance can allow a book to start scaling up and getting better and you know now if many years 15 years behind them they have much more reinsurance premiums it can begin to take take on more risk all right do we have any questions so far through all that so that's just very conceptually how reinsurance works from the treaty side of things you you'll all be generally familiar with facultative reinsurance and we'll discuss that a little bit facultative reinsurance of course you want it for capacity you want it for risk that don't quite fit with the portfolio and there's different ways to structure facultative what a lot of what we're talking about with the functions of reinsurance is on the treaty capacity so that'll be you know it's a all of your companies will most likely buy a cover that covers all of the portfolio builders risk or inland marine more generally and they'll also buy property catastrophe protections to protect major events in the in Florida California quake and the like and so facultative is a key part of that because it manages what the portfolio is going to do and it affects exactly how the treaty program is going to be priced so here's the matrix of reinsurance contracts you have treaty or facultative and facultative as we know it's a one-off basis can be either pro-rata or excess of loss and very often it can also be a reporter basis where it's each and every but there are pre-agreed rates rated on each exposure and each exposure has to be reported then there's treaty which is going to be much like there's pros and cons to each but treaty covers pro-rata or excess of loss and we're going to go into those in just a short bit but you may be familiar with some of these depending on how often you assess the reinsurance or if you're aware of your reinsurance attachment for a property per risk then you might have an understanding a bit of how these excess of loss or surplus share quota share works so the different types of treaty and facultative I made sure to put a lot in here for your reference going forward and anyone can feel free to email but and I don't I don't want to read up a slide but treaty essentially covers our portfolio of business now that's really helpful because facultative is probably facultative is the best form of reinsurance because you know exactly what the risk is and it's being underwritten in a very specific way however facultative reinsurance it's it's not feasible to be doing every single one of your policies under facultative insurance so to create those efficiencies treaty placements cover an entire portfolio there's certain information that's provided to reinsure so that they can underwrite it effectively and then there are certain treaty terms that might not apply to each and every policy but apply to the portfolio in a very general way now very often people will buy facultative because it doesn't quite fit within the treaty or maybe the limit is higher than they normally would write and so you want to net it down and that'll be taken into account there's no reason that you would only have one form of reinsurance very often these these programs work together in tandem and we'll get into that with the example in a little bit the one thing I will mention about treaty reinsurance part of the contract wording very often is occurrence limitations because they'll be on a occurrence basis and reinsurers want to limit their risk they may say it's a 96 hour limitation and the problem we run into with that a little bit more and it's developing in the market is that very often these hours hours clauses are implemented but in recent years we've had hailstorms that might start and go across the Midwest and take many weeks or at least many days and that starts trying to question whether it's a single occurrence because it's a single storm or whether it really is multiple occurrences because it happened in many different places oh sure you have a note here I'll tell you that Dennis I was just saying I don't know if you see that one question oh do I have to click yeah you put the top you put the two little icons on the top there's people there so the question I'm not sure if you saw it from Jim Pike yeah no I'm sorry it's in the Q&A pod I'm not sure if you saw that question from Jim Jim Pike yeah okay good so the iris ratio iris rule is essentially saying that we had the ratio of three to one earlier it's you know it's different for which line of business you have and because of the regulation on insurance companies and the ratings you wouldn't encounter as much in inland marine because of the fact that not all of the business is rated and you don't have to file the rating as you would with maybe a homeowner's policy or auto but what it's essentially doing is depending on the type of business that a company writes you can only write so many policies against your premium base so in this case we said the ratio being a jet by general rule is three to one meaning that if you have a hundred million dollars if you have a hundred and twenty million dollars of written premium you have to have at least a policyholder surplus of 40 million now if we take that example and we can say that well the company can limit its risk by buying some reinsurance so they pay a little bit for reinsurance now their risk comes down to a hundred million then they're able to you then they're able to write more policies and I hope that makes sense it's really just about the fact that the regulators are going to be looking at the risk that companies have on their balance sheets and the premiums that they're writing compared to their policyholder surplus being what they can pay because what the regulators want to do is ensure that insurance companies are able to pay their claims should something go wrong and by purchasing reinsurance these companies are limiting their liability and catastrophe losses and as a result the regulators will will assess that and allow them to write more policies than they would be able to otherwise so if a company is exposed for hurricane but they think the chances are unlikely it's better for them to pay for reinsurance rather than to save money in case it happens so when they pay for reinsurance they're reducing their exposure and they're able to use their capital more efficiently and also that that also allow their pricing to be more competitive right because they don't need to charge as much because they have a budgeted price of what they're charging for reinsurance rather than trying to create a huge fund for when a catastrophe disaster does happen so a lot of our clients will not only are we are not only our insurers looking to reinsurance to you know as a purchase but also they want to make sure that they're in line with the regulators and they are the best rated paper and not going to run afoul of that So, there's two reinsurance forms. There's pro rata, which is very often referred to as quota share, and that'll be the sharing concept where there's a determined percentage of sharing, in this case, 40% quota share, so 60% the company retains, and for every dollar of premium that comes in, they split it that way, and for every dollar of loss that comes in, it is split that way. We'll get into, because of that, obviously, the reinsurers are doing a lot less work and receiving a lot of the premium and the losses, and that'll be recognized in the form of a seeding commission, which recognizes that the insurance company is paying acquisition expenses, and they also have their own internal expenses of administering all these policies, so the reinsurer will agree to pay a seeding commission out of their profit, but as a result, their balance sheet takes the losses while they also receive premiums for that risk. Meanwhile, excess of loss reinsurance, you'll find this much more common with the large carriers and their trees. Quota share might be for a smaller or a unique type of business. We see it a lot in offshore energy, but the excess of loss would be a company that says there's a certain amount of attritional loss that they're comfortable with keeping, so in this case, we say under $20 million, they're pretty comfortable that those losses they understand are relatively consistent, and they don't want to pay for the reinsurance at that level. However, they purchased excess of $20 million, $50, excess of $20 million, and then on top of that, $80 million, excess of $70 million, and they're going to pay for that. They may recover some years. They may not other years, and the losses are only going to the reinsurer if the loss exceeds $20 million, so anything under $20 million is being retained by the company in that retention. Just to break down the quota share or pro-rata concept, seeding company and reinsurer share equally all losses, and as we said, the reinsurer agrees to a seeding commission. So in this case, the policy limit is $500,000, which means $200,000 is seeded, and the premium for a $12,500 is going to be seeded at the same proportions. When the loss comes in, that same loss is also divided up that way. And so that will go throughout the portfolio. So besides the seeding commission, the reinsurer's loss experience will be the exact same as the primary insurer that they're reinsuring. But in effect, for this case, if we said that there's a 30% seeding commission, the reinsurer would only receive 70% of its $5,000 of premium for $3,500. So that means that that $1,500 of seeding commission would come to the seeding company as risk-free income to cover acquisition and internal expenses. And so in many cases, if the losses are performing quite well, that seeding commission will cover acquisition expenses of agencies and the like, but it might also create a risk-free profit to the insurance company, provided that their loss results are good enough that reinsurers are willing to support a higher seeding commission. Now here's where we're going to get into, and that you'll be much more familiar with from builder's risk and the like, is there's per-risk excess of loss. Many of your programs will be covered under these. And this is a way to take out the volatility coming from a single policy. Facultative may be purchased higher, but per-risk will be purchased for a large majority of the portfolio. And so the seeding company, which is the insurance company, has a retention that applies separately to each risk. And so if three risks, all are major losses, then it can only recover based on the loss from one risk. And we're going to get into an example, just this next slide. So in this slide, we had an $80,000 claim, a $500,000 claim, and a $600,000 claim. And in this instance, we said it all happened in the same fire. We apply it each time to the reinsurance contract, which is $500,000 in excess of $100,000, and we apply it separately each individual time. So in the first example, there's no recovery. In the second, there's $400,000, and in the third, there's $500,000. So in total, there's $900,000 recovered from reinsurers in this instance out of the total loss of $1.18, and $280,000 is going to be retained by the seeding company. Now obviously, they made a good retention there, but they would have to be paying for that cover. So the loss experience and the portfolio characteristics drive the pricing of reinsurance, and we'll get into that a little bit later. Per occurrence. Now this will be for the larger events. It also will factor in the per risk cover in many cases. But per occurrence is going to cover, as we said before, like California quake or Gulf wind storm. It's going to cover major events that are going to affect the company's balance sheet, and especially for inland marine and property books, the company needs that protection in order to assure its balance sheet is going to continue. So in this case, we're going to say a tornado hit three houses all at once. It was determined to be one occurrence by the contract terms, and so these losses are going to be combined into a single loss because it's a single loss stemming from the same occurrence. So we took the same ones, 80,000, 500,000, and 600,000, and the occurrence was 1 million retention for 2 million excess of 1 million recovery. So in this case, they only recovered 180,000. While they would have recovered less from this program, they also probably would pay less for it because their loss experience might be that way. Sorry. What do we have here? Okay. Are there any questions between how those two work? Okay. We're going to get into an example coming up that uses both the per risk and per occurrence and shows you how they might work in a major loss. I know I said it before, but I do want to reiterate a lot of this, it's a lot going on sometimes, but it's so crucial because buying the reinsurance, because it's so expensive and it may cost 5% to 10%. If a company makes $200 million of premium a year, 5% to 10% of that may be going to their reinsurance purchasing. So it costs quite a bit of money, and as a result, it's a major foundation of a company's business strategy and how they're going to underwrite their business, how they want to diversify throughout the U.S., through which lines they want to write, and exactly kind of the characteristics that drive their portfolio and at what level they want to reinsure. So we're going to get into that in this example coming up right now. I've left this in here as well, aggregate loss or stop loss, that's just a different form of reinsurance and can also work with these. We see it very often in crop insurance, but there's many different uses for it, and it can protect a company's retention and very often is used in conjunction with other reinsurance covers. All right. So the last example we're going to go through is – do we have that poll question here, Eileen? We'll bring it out now. Yep. I know there's a lot of different lines of an inland marine, so I was just trying to get an understanding of exactly where everyone's coming from, although I'm sure it's predominantly builder's risk. Okay. So we have a pretty good split. You'll see that all of these are part of inland marine portfolios, and so very often they'll be subject to the same treaties, although we do find certain covers and certain lines of business from inland marine, such as fine arts and the like, may be included in ocean marine covers because of just the way that the treaties work and the way that a certain insurance company may decide to run its business and make recoveries. Yeah. I'll take it away. Okay. Perfect. So here's the loss example. So we're going to take Sandy as a sample loss. We have various assurance with different lines of business that are all subject to the same programs. More often than not, inland marine, because of builder's risk especially, will fall under property per risk covers and property cap covers. So in this case, the total inland marine loss was $50.6 million, and we're going to go through the example of exactly how that would be applied before figuring out the insurance company's retention after the loss. So the first thing we would want to apply this to is the property per risk because the way that the treaties would work is that the property cap would say that it has the benefit of the per risk. So you first apply the loss to the per risk to see if there's any recoveries there. And in the case of Insured A, it was a $30.6 million loss, but the company retention per risk is only $10 million. The reinsurance recovery is going to be $20.6 million from that policy. And as a result, that's going to net down the overall loss. So we're going to take the overall loss that we had before, but taking out the property per risk recovery is going to give us $30 million is subject to the property cap cover. So the property cap cover has a $20 million retention. The original loss is $50.6 million, less property per risk, less the recovery of $10 million here, leaves the company with an overall retained loss of $20 million. So obviously that made a really big difference because the company in a catastrophe event only paid $20 million of a $50.6 million loss. And that's reinsurance performing as it should, and it would likely be priced accordingly as a result. Now the way that this plays out over time is that some years there's recoveries and some years there aren't recoveries. So we have this slide here, which is going to show you gross premiums, losses, expenses, and it's going to show you also the reinsurance payable. In this case, we did $25 million over three years. And the reinsurance recoverable, which was $20 million one year, $70 million in another year, and $0 million in another year. What the key takeaway to this slide is that over time, your gross combined ratio without reinsurance would have gone 90 to 115, down to 70. But with reinsurance, it moderates that result so that you have 92.5, 92.5, 85. Now it does seem very helpful to have a 70% loss ratio, combined ratio, without paying for any reinsurance, but you wouldn't be able to get rid of years like these, which would really throw out your results for a long time to come. So although the reinsurance is extremely expensive, it's a key part of how the business operates, because it moderates the results in a way that they can build a strategy around. Did everyone understand that example more or less? Okay. So we're going to get into structure considerations now. Quota share, as we've said before, it may be helping a book starting up, it may be helping with expenses. It may just be helping with the characteristics of the book. Perhaps there are... Builder's risk is interesting because, of course, there's large limits, but they very much only get to that level at the very end of the policy. We also deal with... I also deal with offshore energy, where there's very large limits, and because of that, access to loss doesn't make as much sense, so many people buy quota share reinsurance for that. The advantages is that reinsurance recovery is first dollar on quota share business, but at the same time, many larger companies who are comfortable with their loss results don't want to cede away the premium that is associated with quota share business, because they're giving a lot of your results away to reinsurers, even if you have a very good ceding commission. And so many larger companies will decide that they would prefer to retain the lower level attritional losses and purchase excess of loss insurance instead. Excess of loss is very much for books that are more mature, that are able to handle the high frequency... The low frequency... They're able to handle the high frequency, low severity losses, which we would usually term attritional losses, and then determining exactly how the excess of loss will work will determine exactly where the company feels comfortable with having the cover attached and also exactly what price it's at, because the price is going to drive exactly what they're willing to buy. So companies are going to look at their retention based on their previous loss history and the characteristics of their portfolio and the pricing that they're able to get from the reinsurance market, and then they'll also look at their limit. Very often we model these types of losses. You can model builder's risk and contractor's equipment to an extent you can model, but other things that are movable, such as cargo, you wouldn't be able to really pinpoint exactly where it would be. And those will fall into the risk tolerance of the company, what they're willing to take on, and other corporate reinsurance covers that might come into play and might be worth considering. All right, so we just got through a lot of the concepts of reinsurance. I hope that was helpful to most of you. I think that if you don't understand your treaty right now, not that you particularly have to, but it's a very interesting thing. You can ask anybody you work with to understand exactly where your treaty attaches and exactly the characteristics and how it drives both your pricing that you're able to offer and exactly where you want to write business. Some companies may decide that they want to write business in a different area because it's not going to drive up their reinsurance price and it diversifies their premium base. And then in other cases, knowing that their reinsurance is giving them a good price may make them more, may make a company more inclined to offer more capacity in certain areas. So it very much supports and informs the business strategy and as a result, insurance companies are very keen to make sure that their reinsurance purchasing is as best as it can be. So now we're going to get into a little bit of the underwriting side of reinsurance. While we're not reinsurance underwriters, it's good to understand exactly how a portfolio is looked at when it's being assessed for reinsurance and what type of things drive that price for the reinsurance market. Increase rating, burn costs, you can do this with any insurance policy, although with reinsurance very often you're looking at a whole portfolio so there may be some trending of how the losses develop out over time. For a liability book, that's not going to develop out for a while. The reinsurance will take that into account that the losses might not be paid until five years after the fact or similar. There's also trending for the inflation rate so that a claim that happened ten years ago is adjusted for today's dollars. And then we also have conversations with reinsurers which is saying that the company may have had a loss ten years ago but they don't write that line of business or that category of business anymore and reinsurers will often take that into account as well because they're trying to get a present day view of how the portfolio that they're writing can be expected to perform in the coming year and over time. And because it takes a lot of work to get an understanding of these portfolios of business, you'll find that many reinsurance programs will be supported by the same markets over time because it's not a very good opportunistic play but it is a good play for them to, you know, just like insurance to be with the account for, you know, more than a year for many times over. This is just showing experience rating. Just looking at past losses, looking at how they might affect layers as it currently is priced and what that burn cost would look like. It doesn't mean that every layer will be affected. In this case, the 10X to 50 layer is actually doesn't have any historical losses but obviously that doesn't mean no loss can happen if they're writing policies that large and there'll be certain charges for the capital that's being provided in order to back that up. Meanwhile, exposure rating is going to take into account historic loss ratios based on so a company that wrote $20 million of premium last year and now writes $40 million is obviously going to have an increased loss experience. And so as a result, the reinsurer is going to look at their exposure based on past experience and try to look at the present day exposure and exactly how the losses might come into play. So it's informed by both experience, especially for stabilized book experience will be very helpful because the book is consistent over time but for growing books of business or even slightly growing books of business, you want to make sure that you understand the exposure, the limits that are being written, where it's being written, the premium that's being charged, things of that nature. If anybody really does want to get very technical, I'm freely available. You can definitely follow up if you have any questions about these slides after the call but definitely encourage looking at it a bit if you are very interested in it. This is just more into exposure rating. Again, you can feel free to follow up but it's just taking the idea that just because you have a policy with a certain limit, a million-dollar policy is less likely to have a $500,000 loss than a $10 million policy but at the same time, it's rare to have a full limit loss for a lot of these and so as a result, this analysis takes that into account in the fact that there will be many partial losses to limits. So the higher the limits, the greater the losses but at the same time, for certain policies, especially builder's risk, there may not be a loss because the limit exposed might not be quite to that level during the course of the policy and so reinsurers will take that into account. They'll take their historical perspective and look at loss ratio curves over time to determine exactly how they want to assess the exposure of the portfolio. It's more of the same. The one thing that I will note is that while you're doing a burn cost, you may be looking at this program is running at a certain loss rate over time but in addition to that, reinsurers are going to be trying to look at what's the volatility. So there may be a certain average loss but one book may have a pretty consistent loss over time whereas the other one may have wild swings and major years where the entire reinsurance cover has to pay out a lot of money and that will be taken into account because it means that the reinsurer's chance of having a major event is really going to wipe out a lot of their premium base. Catastrophe modeling. So catastrophe modeling is very interesting because it's amazing to me, at least, how the industry was able to work for so long without catastrophe modeling, and I don't think – I think back in time, in the early 80s, there wasn't quite the understanding of aggregated risk the way that there is now. In Hurricane Andrew, which hit in 1992, there was some awareness of modeling, but most people hadn't made it a core part of how they underwrote the business, and as a result, Hurricane Andrew resulted in 11 insurance companies going out of business because they had to pay their claims associated with the storm. That means, of course, policyholders couldn't get paid, and people were just very caught off guard by the fact that they had so much risk in one area that could be hit by a hurricane. So while it was fortunate that Hurricane Andrew didn't hit Miami, it still did enormous amounts of damage in areas where people didn't realize they had the exposure they did. Since that time, catastrophe modeling has become a major part of, of course, insurance, but reinsurance as well, where companies are carefully tracking their aggregate exposure. They want to also track building codes, deductibles, and sublimits, and catastrophe modeling is interesting because while a hurricane hasn't gone straight into Georgia before, they model that chance that it could happen, of course. So they look at past events and do their best to assess exactly if a similar event happened in a certain area, what exactly would be the implication. And so there's three catastrophe modeling components. There's the hazard, the storm, storm track, and the strength of the storm. There's the vulnerability, which we'll take into account, construction types, whether things are secure, exactly what's being covered under the insurance policy, and then there'll be the financial module. An important part of the financial module will be the deductibles, right, because if you have 1,000 policyholders with a $10,000 loss, you're going to have $10 million, but if they each have a $500 deductible, you've just limited your entire loss by $500,000. So that's going to come into play, and it's very key when we capture that data that we're getting the sublimits for windstorm and all the appropriate deductibles that go with that because it can make a big impact on the portfolio of business for the results to the company and also the results to the reinsurers. Catastrophe modeling also gave rise to modeled catastrophe events, and that modeling allows for financial mechanisms that weren't available previously, namely cap bonds, which we'll get into at the very end of the presentation for any of you that are interested in that. As we said before, the cap modeling outlet is used to manage a portfolio, and it's also used to monitor exposure growth. Just as the insurance companies may use that to assess their portfolio management, reinsurance companies will use it to assess their portfolio management. So many reinsurers we talked to, they only have a certain amount of aggregate limit that they're allowed to give for certain peak events, such as Gulf of Mexico windstorm or Japanese quake. They only have a certain amount that they're allowed internally to deploy because they're not allowed to write every single piece of business in that area because that would just leave them too exposed to a peak event. They need to manage and make sure they're diversifying carefully. I think catastrophe modeling can also help a company realize that if they're going to write another policy in a certain cap exposed area, they're going to need to charge additional money because they need to make it worth it from their parent point of view. So a company that has no business in Florida would be much more willing to write a policy in Florida than a company that has a ton of exposure in Florida and really doesn't need anymore and needs to diversify elsewhere. And that will also be enforced by the rating agencies, which will see companies that have too much risk in one area in which companies are much better diversified. Treaty mechanics. Actually, I will just go back to this one thing. Catastrophe modeling, we do have real-time event analysis, which is very helpful for us and insurance companies to allow them to look at exactly what accounts might be at risk, contact their policyholders accordingly, encourage good and brisk management. And then we also have companies that may say that they can offer more reinsurance capacity during the event for a certain price based on what's going on. Does anybody have any questions? Any particular things you were keenly interested in hearing? Okay. It's kind of difficult here without an audience, so I hope everyone's enjoying it well enough. These are a few things, treaty mechanics. I don't need to go extremely in-depth, but I do want to just touch upon a few of them. The basis of reinsurance being losses occurring or risk attaching. You may find this with your own policies, but with reinsurance contracts, they can be losses occurring, which obviously are nice for reinsurers because they know that after a certain amount of time, that risk has occurred and they're off the risk. Or they can be risk attaching, which is better for insurance companies because they know that if they decide to stop running the business, all of their policies that they previously wrote are covered. I'll explain burn costs right now. I feel that there are many things with insurance and reinsurance, and sometimes I deal with facultative people and I realize that I don't know quite the same acronyms and terms, even though we're using the same terms. Burn costs is what we're talking about is really just the amount of loss that can be expected divided by the expected premium. We would be looking at if there's $5 million of loss spread out over five years, we'd say the burn cost was $1 million, but then there's volatility because it can be one year. It's a very simplistic view. Burn cost essentially is your loss ratio. Burn cost is just a different way that we've described it in many scenarios, but it's essentially what it's running at. Is it running at a 60%, a 30%? A lot of reinsurance programs probably won't be running at 95% because of the fact that there's so much volatility. So they may be running at 50%, but in their bad years, they're running at 300%. So it can very much be a dynamic of the volatility and the average loss over time. Lillian asked about geocoding on slide 43. Geocoding is going to... Yeah, that was emailed in. Dennis, someone emailed that question in to me while I was watching the webinar. Okay. So geocoding is going to refer to getting the coordinates for the risk or the zip code, the best thing would be an address. The better information that is able to be provided bears out in the results. It's the same thing with the deductibles and sublimits, if they're accurate, and the construction type. Geocoding for marine more often, we will make sure that geocoding is positioned along the coast because it's reflecting different docks and cargo and piers. But construction is the same thing. For anything that can be modeled, such as a property, we want to make sure that geocoding is correct and that the location is determined so that it can be assessed correctly by the modeling vendors, which would be RMS or AIR, among others. One of the things that we do find sometimes as well is that while mobile equipment is deemed to be moving and so sometimes it might not seem evident why you would want to put an address at it, in a major catastrophe event, mobile equipment, contractors' equipment, if you have a lot of contractors' equipment in one certain area, that can really aggregate and create a very major loss in a way that doesn't seem apparent because it's very hard to sometimes account for exactly how much mobile contractors' equipment is in the same place. So geocoding is extremely important in order to make sure that the model is capturing all the information correctly and informing insurance companies about their portfolio and giving them the best detail they can. So in Treaty Mechanics, we were just talking about the risk attaching. In this case, we're going to say that the policy was written in June 2015 and the reinsurance program renewed on January 1st. So we're going to say that the policy was written in June 2015 and the reinsurance program renewed on January 1st. So when it experienced a loss in March, the reinsurance contract, if it was loss-occurring, would be covering that loss as a 2016 loss, but if it was risk-attaching, it would say that it was written in 2015 and so the 2015 reinsurance contract covers it. Thank you. We also have effective rate and rate online. Again, similar to burn costs, these are just terms that we use, but they're really nothing that unique. The effective rate is going to be the payment of premium is going to be rated on the subject premium income. So if you write a $20 million book and you pay $400,000 in premium, your effective rate is 1.5%. And very often that effective rate will be there to ensure that if you write more business, you're going to be paying more in reinsurance. And if you write less business, you'll be paying less in reinsurance. That effective rate is really just allowing the premium to adjust based on the exposure, at least within a certain range. And then in the meantime, the rate online is going to be 20% because you're saying you're spending $400,000 to cover $2 million in limit. It's an easy way to refer to the programs, but really the rate online will be driven by all sorts of things. It will matter exactly where the layer is, what it's covering, et cetera. So it's not a very clear-cut pricing mechanism except where you have the context surrounding it. We didn't cover this in some of the loss examples, but just so that you're aware, there are reinstatement costs on most of these programs. And what that means is that as you recover from reinsurance for the loss, you'll also be paying the same price you originally paid to reinstate the cover. So in this case, if there's a certain amount of loss, then however much the loss is proportional to the layer is how much you're going to be reinstating it at based on the original pricing. It's a simple enough concept when you see it in practice, so if anyone has any questions, let me know. It is just something to be aware of that unless you have free reinstatements that you've negotiated and paid for at the beginning of your contract, your loss recovery will likely not be the full limit. It'll always be a little bit less because you're deducting the reinstatement out of it. And the reinsurers price the program that way, taking that into account that they know their loss will be done that way. There's also an annual aggregate deductible, which you might find in some programs, especially some property programs covering builder's risk and the like, because it's a way to reduce the cost of reinsurance program without increasing the retention too much. So in this case, there's a $500,000 AAD, so it means that the first loss, that AAD is going to continue to be with the company, but once that's gone, then the reinsurance program will attach at the same level of $1 million. So for this example, we said loss number one is $2 million, so $1.5 million, the $1 million retention, that $500,000 AAD is retained, and $500,000 is recoverable. In the second loss, a million dollars is retained, but then a million dollars is recoverable because the AAD is now gone from the first loss. And like I said, all of these types of things can all be best understood looking at your own reinsurance programs. That'll probably... This, as I said, is very conceptual, and there are some examples, but the most interesting part is really understanding how your own reinsurance program works and how it informs the decisions your business makes. This is just wrapping it up. I usually include this just as alternative capital. It's a new area, basically, that's been enabled by a lot of modeling. A catastrophe bond I spoke about before. One of the most clear examples of this was the Tohoku earthquake in Japan because of the structure of the catastrophe bond, which was paying interest rates on the bond for several years. When the earthquake happened, the size of it triggered the contract parameters. It was called a parametric bond for that reason. And so the earthquake was over nine on the Richter scale, and as a result, it paid out 300... In full, $300 million was paid out within 70 days to Japan in order to cover that. So there are many catastrophe bonds that have grown in popularity, and many investors invest in them. And it's an interesting dynamic because of the fact that the financial markets have much more capital and so are able to handle some large loss events and cover a little bit more of those catastrophe events at a certain level because of the model's loss that they're comfortable with. And this last slide is just going to cover a little bit of where the typical investor base is with cap bonds and just some other stuff if you're interested. Feel free to follow up. There are many different ways to do reinsurance, and it's always pretty interesting how it works with insurance companies. And this is just going to show you a little bit about how certain events affect the catastrophe bond market. Anyways, that's it. Thank you guys all for listening. I hope everyone relatively enjoyed it, and I really encourage you to follow up with any questions you might have. I know your specialty is in the marine. I do some in the marine, but my specialty is really reinsurance more than anything else. So I really look forward to anybody that has any questions to follow up, and I included a lot of material in these slides in case anybody's interested to learn more. Dennis, thank you for that presentation. Very informative. Thanks, Lauren. Thank you also to our attendees for your participation and your comments. All attendees will receive an email with a link to an electronic survey. Please take a moment to respond to the survey and provide your feedback to IMUA. This ends today's webinar. Thank you.

Inland Marine Underwriters Association

reinsurance mechanics

treaty structures

catastrophe modeling

effective rate

burn costs

reinstatement costs

alternative capital

geocoding

risk locations