Nuts and bolts of Reinsurance Pricing/Underwriting
I’ve been in insurance and reinsurance for close to 40 years working in a variety of roles that include CFO, CRO, Chief Actuary both in Life and Health Insurance and Reinsurance; both in developed and developing markets. Here are some of my price related insights gained during my journey. The focus is on reinsurance professionals but it can also apply to direct writing insurers.
The roles of the Pricing Actuary include pricing, underwriting and professional “goalkeeper”; saving your portfolio from terrible business is a HUGE part of the job.
Can we price the risk? Some risks cannot; this could be due to..
- The actual risk (political, systemic, lack of diversification, accumulation, financial elements etc)*
- The lack of claims experience
- The team is does not have pricing expertise in this line
- Treaty wording
- Insufficient time to conduct a rigorous analysis
- Other critical factors
The further the underwriter or pricing actuary is from the origin of the risk, the fuzzier the understanding of the risk. Meetings between your client maager and the client/cedant counterpart are not sufficient to develop this understanding. Face times between the your pricing actuary/underwriter with the client/cedant counterpart is crucial.
In an ideal world… pricing involve 3 teams to provide the following. (But any pricing must involve these elements)
- Best estimate of claims (either using exposure, burning cost, credibility theory etc)
- Adding margins, taxes, expenses, commission, profit-sharing loading, retro costs etc…
- allocating appropriate capital and its associated cost (usually the finance team)
Actively embrace the concept of the control cycle (basically price the risk, monitor the experience, and then use what you learn to manage and reprice the business). The link to the seminal paper on the control cycle is set out here.
Risk Attaching and multi-year risks should be escalated to highest level for review and sign off and must include sufficient margins to compensate for additional risk. Be very selective with such deals and this should not be the first transaction with the client.
It’s very important that every line of business should have their own profit and loss statment down to net profit. But it’s crucial that for very large blocks that can move the dial of your profit & loss, you must construct specific profit& loss financials to monitor results (including separate IBNR models)
Data is key to monitoring your portfolio. If your systems (or financials) cannot monitor key characteristics of a deal (eg financing) don’t go there. You cannot manage what you cannot measure.
Establish standard treaty clauses for each line of business/product and document any divergences from your standard. Try to be the party that drafts the contract; It’s a form of anchoring. If you are not in charge of the wording, take extra time to understand what you agree to.
Your pricing actuaries should be independent of your reserving actuaries. If your pricing considers ‘less than adequate reserves’ then your pricing is doomed (duh!). Conversely, if your actuaries deploy overly conservative reserve estimates in pricing, the business may be lost.
Because we work in competitive markets, not all business is priced under ideal circumstances. Actively monitor what treaties (and % of your book) have been priced
- rigorously and with full margins (should be the majority of your book)
- aggressively (or with no/negative) margins
- with an approximate work-in-progress pricing model
- following the leader (you have no pricing expertise)
Make sure there is good rationale for pricing business under these conditions, and that the distribution of these pricing approaches is in line with internal targets you’ve set.
Create the habit of undertaking ‘debriefs’ with your team to review good/bad treaty outcomes. You can’t get alignment without giving constant feedback.
If you are a buyer of reinsurance, be nice to your reinsurer and provide him/her with as much data/risk insights as possible. Reinsurance pricing includes lots of flexibility in terms/conditions and pricing. If you are less than transparent to your reinsurer then its likely that you will not receive the best offer. Both parties should strive for a sustainable relationship, where the objectives of each party are not in conflict.
Warren Buffet gems
If you are sitting at a poker table for 30 minutes and can’t figure out who the patsy is, the patsy is you; this metaphor can be applied for a reinsurance panel
There is so much money to be made in the center, why go to the edges?
If an underwriter in accepting mispriced business and he is in the middle of a shark infested ocean without any forms of communication, a broker will swim out to find him.
Nicholas Taleb — author of the Black Swan & Fooled by randomness
There was once a turkey who was hatched on a cold winter’s morning. Luckily, he lived with his family in a warm coop, where he had plenty of corn to eat, and spent his time playing with all the other little turkeys.
In springtime, as he got older, he and his friends would go out and play together in the farmyard. They always had plenty to eat and shelter from the elements. On occasion nice people would come and clean the coop, refill the corn bins, and make sure the fences were secure to keep away the bad cats and foxes.
“Gosh we’re lucky,” our turkey would say to his friends on occasion. “What wonderful lives we have. We are fed and taken care of, and all we have to worry about is having fun.”
As the summer days got shorter and the evenings got colder, the turkeys continued to live the good life. The farmer turned on the heat in the coop, so the turkeys always had somewhere warm to go back to after playing in the yard. And since it was much colder now, they rarely went outside, and slowly they got fatter and fatter.
Our turkey continued to remark to his fellow fowl, “How lucky we are,” and they all agreed that they would rest up during the cold months so they could play hard again in the spring.
And then came Thanksgiving.
Conclusion
Like the farmer, not all participants/intermediaries within the insurance ecosystem are your friend.
The past may not be a guide to the future
It is never a good idea to price below burning cost
The name of the game is not more sales. It’s about profitable growth
Don’t let enthusiasm outrun analysis
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