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Specialty Lines PricingSpecialty Lines Pricing
Gerson SmithCARe Seminar
Washington, D.C.July 11, 2001
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Surety Excess-of-LossReinsurance Pricing
Surety Excess-of-LossReinsurance Pricing
Experience Rating
Exposure Rating
Economic Conditions
Market Conditions
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Surety Bonding: Estimation of Loss Amounts
Surety Bonding: Estimation of Loss Amounts
Contract Balances (Revenues)
Cost to Complete (Liabilities)
Other Costs
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Contract Balance = Original Contract Price +/- Change Orders
- Cash Payments Made by Obligee to Principal or
Surety
Surety Bonding: Estimation of Loss Amounts
Surety Bonding: Estimation of Loss Amounts
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Cost to Complete: comprised of
- Variable Costs: Labor, Materials, Equipment
- Fixed Costs: Subcontractors & Suppliers
Surety Bonding: Estimation of Loss Amounts
Surety Bonding: Estimation of Loss Amounts
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Other Costs: - Liquidated Costs - Unpaid Suppliers - Subcontractors’ Current Payments Due - Contingencies
Surety Bonding: Estimation of Loss Amounts
Surety Bonding: Estimation of Loss Amounts
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Experience Rating: Loss Data – What to Include?
Experience Rating: Loss Data – What to Include?
Contract Balances
Collateral – cash or secured by LOC
Salvage (e.g. indemnities) – only when realized
Anticipated Salvage – no
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Surety Bonding Treatment of ALAESurety Bonding Treatment of ALAE
Proportional Treaties – ProRata in addition
Excess-of-Loss – included in definition of loss
SAA - ALAE appr. 5% of aggregate losses (decreasing trend over time)
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Experience Rating:Parameter SelectionExperience Rating:
Parameter Selection
Loss Development
Trend – Severity / Frequency
Rate Level
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Experience Rating: Loss Development – Ground
Up
Experience Rating: Loss Development – Ground
Up Age ATA ATU
12 2.500 3.26924 1.250 1.30736 1.050 1.04648 1.025 0.99660 0.993 0.97272 0.999 0.97984 0.999 0.98096 0.996 0.981108 0.992 0.985120 0.995 0.993
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Experience Rating: Loss Development – Excess
of Loss
Experience Rating: Loss Development – Excess
of Loss Age ATA ATU
12 1.950 1.62324 0.990 0.83336 0.973 0.84148 0.982 0.86460 0.995 0.88072 1.001 0.88584 0.960 0.88496 0.985 0.920108 0.978 0.934120 0.980 0.956
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Exposure Rating: Limits Profiles
Exposure Rating: Limits Profiles
Per Bond vs. Per Principal
Max Work Program vs. Bonded Work-on-Hand
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Exposure Rating: Limits Profile Adjustments
Exposure Rating: Limits Profile Adjustments
Co-Surety %’s
Bonded/Unbonded Split
Utilization
PML
Benefit of Inuring Reinsurance
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Def. - Ratio of bonded work-on-hand to total limits (may be ratio to either bonded or unbonded)
Dependent upon: - Amount of Construction Work (esp. public works) - Seasonality - Type of Project - Project Duration
Exposure Rating: Utilization
Exposure Rating: Utilization
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Def. - Probable Maximum Loss as a % of Exposure (may be relative to unbonded, bonded, or utilized work-on-hand)
Varies by: - Region - Contractor Size - Contractor Type
Exposure Rating: PML’s
Exposure Rating: PML’s
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1) Using cessions %’s on a per-bond basis, determine total retained % for portfolio
2) Judgmentally select per-contractor retained %’s by band, making sure to balance back to total retained %
3) Per-contractor retained %’s should decrease with contractor size
Exposure Rating: Steps to Estimate Benefit of
Inuring
Exposure Rating: Steps to Estimate Benefit of
Inuring
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Alternate Method (where available)1) For each contractor (or limits band), obtain number
of bonds, work program limit & max bond limit2) Assume largest bond ceded according to schedule3) Calculate average limit excluding largest bond,
apply cessions schedule.4) Add retained amounts from 2) & 3)5) Other possibilities, e.g. 2x or 3x average
Exposure Rating: Steps to Estimate Benefit of
Inuring
Exposure Rating: Steps to Estimate Benefit of
Inuring
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Exposure Rating Size of Loss Curves
Exposure Rating Size of Loss Curves
Loss-to-Value (PML)
Derived from coordinated loss & exposure data (preferable: remaining exposure @time of loss)
Alternate Method – Frequency/Severity approach, where severities are derived from loss data and frequencies are based on default rate for implicit contractor ratings
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Surety Bonding Commercial (Non-Contract)
Surety
Surety Bonding Commercial (Non-Contract)
Surety Historically low limits and small portion of XS
Gradually including larger and riskier classes
Historical loss ratios ~ 20%
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Surety Bonding: Historical Perspective
Surety Bonding: Historical Perspective
SAA - 30 year (net) loss ratio result = 40%
Worst Years - 1975/76 (recession) and 1986/87 (expansion) Loss ratios ~ 70%-75%
Best Years - 1989-1999 (recession & expansion)Loss ratios in the 30%’s throughout the period
Conclusion: Surety results not correlated w/economy
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Surety Bonding: Profitability
Surety Bonding: Profitability
Contractor Profits / ROE’s follow the economy w/ peaks in mid-’80’s and mid to late ’90’s, trough in the early ’90’s
Surety Results stable since late ’80’s
Initial Conclusion: Surety results independent of construction industry profitability
Alternate Conclusion (pending updated results for 2000/2001): Surety results decline in the face of extended periods of profitability and economic prosperity
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Surety Bonding: Can We Anticipate the
Cycle?
Surety Bonding: Can We Anticipate the
Cycle?Difficult for High Excess-of-Loss – Random Events
Consecutive Years generally correlated
Underpricing of underlying business not as apparent as in other P/C lines
Enhancements: 1) Improved rate monitoring techniques, 2) Econometric forecasting