Chaper Four: Mehodology 1 Assessmen of isk Managemen Sraegy Comparing Is Cos of isks 1.1 Inroducion If we wan o choose a appropriae risk managemen sraegy, no only we should idenify he influence ha risks would affec an insurance corporaion isk idenificaion and analysis, bu also we should assess wheher he risk managemen sraegy could benefi insurance corporaion. Bu he quesion is, how do we assess a risk managemen sraegy? From Equaion (2.2) menioned before, we know ha as long as coss are defined o include all he effec on value of risks and risk managemen, minimizing he cos of pure risks is he same hing as maximizing firm value. So i means ha, when we assess a risk managemen sraegy, firs we should evaluae wheher i can decrease is cos of risks or no. Before we analysis he cos of risks for risks managemen sraegy of CC, we should realize how o use CC srucure o reduce our non-life insurance indusry s risk. General speaking, our non-life insurance indusry may use wo ypes of CC mechanism o manage heir underwriing risks. One is securiizaion, using CC as a Special-urpose-Vehicle(SV), such as company-specific loss raio securiies 1 or cap bonds ec. The oher is using CC as a ren-a-capive mechanism. 1 S Bouriaux and D. ussell (2002) 3
If we wan o adop risk securiizaion, we should consider he following hree elemens: (1) wo-side capial marke, (2) proper pricing and (3) feasible issue cos. Bu if we consider he size of insurance companies, excep a few large insurance companies, we would see ha mos of hem are no suiable for adoping risk securiizaion o cover he issue cos. 2 So I sugges ha Taiwan non-life insurance indusry may consider CC as ren-a-capive mechanism o managemen heir underwriing risks. In he following we will focus on comparing commercial reinsurance mechanism wih CC as ren-a-capive. In his paper we will compare wo risk managemen sraegies, commercial reinsurance and CC as ren-a-capive, and analyze which risk managemen sraegy can decrease cos of risks more effecively. We use hisorical daa 3 and Discouned Cash Flow Mehod o simulae and analysis wheher commercial reinsurance or CC srucure as ren-a-capive one could decrease is cos of risks more effecively when an insurance company manages is underwriing risks under he same ceding condiion. In order o analyze he effecs of risk managemen decisions ha involve cash flows over muliple periods, i is necessary o discoun he expeced ne cash flows o presen value. In his paper, we will use discouned cash flow analysis o evaluaion he cos of risks for he wo sraegies over muliple periods. 2 Evaluaion he cos of risks for CC and Commercial 2 C. Chen (2000), 151-153 3 In his paper, hisorical daa includes direc wrien premium income, direc claim paid, invesmen income ec., excludes reinsurance premium ceded and claim recovered from reinsurance. Because we simulae ha each he insurance company cedes heir risks under following simulaion. 4
einsurance 2.1 Evaluaion he cos of risks for commercial reinsurance If one insurance company adops commercial reinsurance mechanism o manage is underwriing risk, he major componens of is cos of risks include 1 Expeced loss on ne reenion he self reained losses of he insurance company 2 Acually paid reinsurance premium Acually paid reinsurance premium means he ne amoun ha he cedan acually paid o he reinsurance premium o reinsurer. 4 So acual paid reinsurance premium will equal o G = N + C + A 4.1 A = G C = N + A 4.2 Where G Gross ceded reinsurance premium N Ne ceded reinsurance premium A Acually paid reinsurance premium C einsurance commission A Adminisraion expense of reinsurance According o he law of large numbers, as long as risk exposure is large enough, he expeced loss covered by reinsurance will end o equal o acual loss covered by reinsurance. And he calculaion of Acually aid einsurance remium also will be N = EL L. 4.3 A = EL + A L + A.. 4.4 4 In pracice, including Quoa Share and Surplus Treay, cedans usually deduc he reinsurance commission firs, and hen pay he ne amoun of reinsurance premium o reinsurers. So, for reinsurers, he real amoun ha reinsurers received is he ne reinsurance premium (reinsurance commission deduced) 5
where EL Expeced Loss covered by reinsurance L Acual loss covered by reinsurance. And according o he equaion 4.4, he raio of einsurance Adminisraion Expense Loading will be A N = A EL EL A EL L According o above equaion and he Saisics of Taiwan No-life Indusry for recen 20 years, If reinsurance adminisraion expense loading is measured annually agains unis of exposure, we can ge ha he raio of reinsurance adminisraion expense loading is around 15 3 Toal cos of capial expeced rae of reurn if he capial has no been used for reinsurance We measure he rae of invesmen reurn on he capial by he oal inves ne income of domesic non-life insurance companies dividing oal working capial of domesic non-life insurance companies. For example, in 2002 5, he opporuniy cos of capial(per dollar) of Taiwan domesic non-life insurance indusry is around 3.5%. Then oal opporuniy cos of capials equal o oal capial imes 3.5%. So we ge he equaion of cos of risks for commercial reinsurance mechanism is C = NL + A + CC = NL + EL + A + CC 4.5 Where C cos of risks for commercial reinsurance 5 In 2003, oal working capial of Taiwan domesic non-life insurance is NT$137,234million, and he oal ne invesmen income of Taiwan domesic non-life insurance is NT$4,801million. Source Non-life Insurance Associaion of he.o.c.and Insurance Insiue of he epublic of China. 6
NL CC Expeced loss on ne reenion Toal cos of capial expeced reurn if he capial has no been used for reinsurance 2.2 Evaluaion he cos of risks for using CC as a ren-a-capive If he insurance company use CC as a ren-a-capive mechanism o manage is underwriing risk, he major componen of is cos of risks includes 1 Expeced loss on ne reenion he self reained claim amoun of he insurance company 2 Capive reinsurance premium Is capive reinsurance premium will equal o C = EL + A.. 4.6 where C Capive einsurance remium EL Expeced Loss covered by capive reinsurance A Expense Loading of CC Expense loading of CC, including funding fee, operaing cos and managemen cos ec., will be affeced by he domicile of CC. For example, if our domesic insurance company wan o se up a capive cell in he domicile of Guernsey, he esimaed funding cos is around 26,100 a he firs year and he annual operaing cos (per cell) is around 206,000 each year. 3 Invesmen income from CC When he insurance company ses up a cell for CC, i needs he CC manager o mange is seup capial, and he CC manager s business plan 7
should agree wih cell paren. The relaion beween CC manager and cell paren would be like a rus. The invesmen income of CC should payback o he cell paren according o cell paren s share of CC hrough dividend. The reurn raio will depend on is invesmen objec. If our sraegies of invesmen focus on safey and liquidiy, he average rae of reurn will be around 2~4%. To be conservaion, in he following research we will assume he rae of reurn of CC is 2%. The invesmen income is a negaive erm for cos of risks. 4 Toal cos of capial Expeced reurn if he capial has no been used for CC : Again, oal opporuniy cos of capials equal o 3.5% imes amoun of capial. So we ge he equaion of cos of risks for CC as follows C NL + C I + CC = NL + EL + A I + CC = 4.7 Where C NL I CC cos of risks for CC Expeced loss on ne reenion Invesmen income from CC Cos of capial expeced rae on reurn if he capial has no been used for CC 2.3 The cos of risks which CC can decrease In order o consider he effec of muliple periods, i is necessary o discoun he expeced ne cash flows o presen value. Thus, compared wih commercial reinsurance, he presen value of oal cos of risks which CC can decrease would 8
be: DC C, C,...(4.8) T DC C ) V = 1 (, T V ( C, ) = 1 (4.9) where C, = cos of risks for Commercial einsurance in year, C, = cos of risks for CC in year, DC he cos of risks which CC can decrease in year, DC he presen value of oal cos of risks which CC can decrease. If DC 0, i means ha using CC as a ren-a-capive mechanism can decrease he cos of risks more han using reinsurance mechanism, vice versa. I also means ha CC can add up he firm value more han reinsurance mechanism And hen: T DC = V( NL, + EL, + A, + CC, = 1 T = 1 V + ) ( NL, + EL, + A, I, CC, )..(4.10) If ceded erms and ceded raio of insurance company hrough CC and reinsurance are he same, i means ha NL, = NL, EL, = EL, hen he above equaion will equal o T DC = V ( A, + CC, ) V ( A, I, + CC, = 1 T = 1 ) (4.11) Where he subscrip represens he year ( =1,2,,5 ) 9
2.4 Illusraion of comparing he cos of risks of CC wih Commercial einsurance To illusrae he difference of cos of risks beween CC and reinsurance, we use a simple case o explain he difference of cos of risks beween CC & reinsurance Assume ha here is an AAA Company which wans o evaluaion he feasibiliy of CC. The annual direc premium is NT$3,000M. In he pas, AAA Company use reinsurance under he erm of Aggregaed Excess Loss einsurance NT$1,500M xs NT$4,500M, AAA Company has an Incurred Loss 2,500M each year. We assume ha remium o Surplus aio is 2 o1, equal 50% solvency raio 6 i means ha paid up capial should no be less han half of premium income of roeced Cell Company. We assume he funding fee and he relaive cos of CC is around 26,100 NT$1.47M 7 in he firs year and he annual operaing cos (per cell) is around 206,000 NT$11.63M each year 8. The rae of reurn of CC is 2% and he opporuniy cos of capial (per capial) of AAA Company is 3.5% Besides, Boh CC and reinsurance also have oher cos of risks such as cos of residual uncerainy, cos of risk conrol, ec. Bu we consider ha hese wo sraegies have no significan variance on such cos of risks. To simplify i, we 6 Besides minimum capial requiremen, CC should also consider is solvency margin. In his paper we assume ha if CC considers is solvency margin, is premium o surplus raio should be 2 o1, equal o 50% solvency raio. 7 The official web sie of Guernsey Financial Services Commission hp://www.gfsc.guernseyci.com/insurance/index.hml 8 Willis Group 2003, Capive Managemen in Guernsey hp://www.williscapives.com/capives/ documens/capivemanagemenbrochure.pdf 10
ignore such cos of risks in he following analysis. Their difference of cos of risks beween CC & reinsurance are illusraed as Table 4-1, and from he illusraion of Table 4-1, we can ge ha 1. If we ignore he uncerainy of loss and possibiliy of insolvency of CC, i is apparen ha using CC as ren-a-capive can decrease he cos of risks more han commercial reinsurance. 2. Like oher risk reenion mehods, he longer we use CC as ren-a-capive, he more we can save is cos of risk. 3. Alhough using CC as ren-a-capive can decrease he loading of ceding premium when compare wih commercial reinsurance, however, i will increase he opporuniy cos of capial because i need he cerain amoun of paid-up capial. 11
Table 4-1 Cos of risks of AAA Company when i adops CC srucure as a ren-a-capive Uni NT$ million Year 1 Year 2 Year 3 Year 4 Year 5 aid-up Capial 1,500.00 Expeced Loss on Ne eenion Expec Loss covered by CC 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00 Loading of CC 13.1 11.63 11.63 11.63 11.63 Ne remium of CC 1,013.10 1,011.63 1,011.63 1,011.63 1,011.63 eain Earnings by Invesmen Income Aggregaed eain Earnings Opporuniy cos of capial 30.00 30.60 31.21 31.84 32.47 30.00 60.60 91.81 123.65 156.12 87.96 86.86 85.79 84.69 83.58 Cos of isks 2,571.06 2,567.89 2,566.21 2,564.48 2,562.74 I Noes ( + ) 2% 1 I =,,, = ( + EL + A I ).,,,, 1 CC Where, =aid-up capial 3.5% 12
Table 4-2 Cos of risks of AAA Company when i arranges commercial reinsurance Uni NT$ million Year 1 Year 2 Year 3 Year 4 Year 5 aid-up Capial 0 Expeced Loss on Ne eenion Expec Loss covered by reinsurance Loading of einsurance Acually paid reinsurance premium eain Earnings by Invesmen Income Opporuniy cos of capial 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00 150.00 150.00 150.00 150.00 150.00 1,150.00 1,150.00 1,150.00 1,150.00 1,150.00 0.00 0.00 0.00 0.00 0.00 40.25 40.25 40.25 40.25 40.25 Cos of isks 2,690.25 2,690.25 2,690.25 2,690.25 2,690.25 13
3 Empirical analysis he difference in cos of risks beween CC as ren-a-capive and commercial reinsurance 3.1 Inroducion According o above illusraion, i seems ha CC can save he loading and hen decrease is cos of risks. Bu is CC always beer han commercial reinsurance? I seems ha i is no always he case. In his paper we simulae and calculae he cos of risks by assuming ha he domesic non-life insurance companies buy single excess loss raio reinsurance reay based on he hisorical daa. Besides, we simulae and calculae he cos of risks if domesic non-life insurance companies adop he risk managemen sraegy of CC as ren-a-capive in 1998. Then we compare he differen cos of risks beween hese wo sraegies, reinsurance and CC, under he same ceding erm and hisorical daa o analyze which one is he opimal risk managemen sraegy for domesic non-life insurance companies. To focus on he comparison of differences beween hese wo coss of risks, we assume ha all he sample companies are under he same ceding erms and condiion wheher we adop CC as ren-a-capive or commercial reinsurance. 9 9 The following analysis assumes all he insurance companies cede heir risks under single excess loss raio reinsurance reay. I is differen wih pracice and acual operaion environmen. In pracice, insurance company usually buys several ypes of reinsurance reaies, by line/layer, by proporional or non-proporional, o decrease heir risk uncerainy due o insufficien marke daa and loss experience. Bu in his paper, o simplify and compare heir difference of cos of risksbeween commercial reinsurance and roeced Cell Company used as ren-a-capive. We simulae and assume all he insurance companies cede heir risks under he same ceding erms and condiions. 14
In he following of his paper, in order o observe he effec of differen independen variables, we will simulae eigh scenarios o analyze which circumsance ha we adop CC as ren-a-capive will be he opimal risk managemen sraegy, 3.2 esearch assumpions Before he analysis, here are seven assumpions ha we should noice 1. Ceding erms and condiion As we menioned before, o simplify he analysis, his paper assumes ha wheher we adop commercial reinsurance or using CC as ren-a-capive, all insurance companies are under he same erm and condiion Excess of Loss raio reinsurance 10. We iniially assume ha all he insurance company have he same Excess of Loss raio reinsurance reay Excess of Loss raio reinsurance, Cover is for 90% of losses in excess of a 70% paid loss raio on his underlying porfolio of reaies up o a 120% paid loss raio 11 scenario 1. Then, in order o find ou he opimal siuaion for CC as ren-a-capive, we will also analyze wheher differen ceding erms and condiions would affec is cos of risks 10 Among several ype of reinsurance reaies, non-proporional reinsurance reay is he simples way o calculae is expense loading of reinsurance premium. And among several ype of non-proporional reinsurance reaies, excess of loss raio reinsurance reay is more suiable for us o simulae because we only need he loss raio and wrien premium in curren 5 years, no complicae risk profile, o calculae o is ne reinsurance premium(burning cos) 11 C. Chen (1999), 278-279, and such erm and condiion are widely used in pracice. 15
2. Calculaion of ne reinsurance premium In his paper, we adop burning cos o calculae he ne reinsurance premium (pure loss cos). We hereby calculae he burning cos based on he claim experience a leas he las five years (C. Chen 1997. The calculaion on burning cos is EL B = = (4.12) Where, B = burning cos EL = layer-claims expecaion = proec premium volume 12. Then, B ( 1+ ρ ) = G r = A r Where, ρ = loading of reinsurance r = reinsurance premium rae G = GNI(gross ne premium income ) A r = Acual reinsurance premium 13 I is noable ha, o focus on he comparison of difference beween hese wo coss of risks we should use he same ceding condiion wheher we adop CC or commercial reinsurer. Thus heir burning cos should be he same. Following he above ceding erms and condiions, we use hisorical daa 14 12 Swiss e 1997, roporional and non-proporional reinsurance, 31 13 Swiss 2000, Non-proporional reinsurance accouning, 54 14 In his paper, hisorical daa includes direc wrien premium income, direc claim paid, invesmen 16
o simulae and calculae he burning cos of each sample insurance company if i cedes is risks under single excess of loss raio reay rae from 1998 o 2002 as Table4-3 as follows. Table 4-3 The burning cos for each domesic non-life insurance company 1998~2002 Name of insurance Company Ne Burning Cos Year 1998 Year 1999 Year 2000 Year 2001 Year 2002 Taiwan Chung Kuo Tai ing Fubon Zurich Taian Mingai Cenral Firs Kuo Hua Union Shin Kong Souh China Noes Under Excess of Loss raio reinsurance for 90% of losses in excess of a 70% loss raio up o a 120% paid loss raio income ec., excludes reinsurance premium ceded and claim recovered from reinsurance. Because we simulae ha each he insurance company cedes heir risks under single excess of loss raio reay. 17
3. Cos of capial For differen insurance companies, here should be differen cos of capial. To calculae he opporuniy cos of capial of each company, we calculae is acual ne invesmen income of each insurance company and hen divide i by is acual working capial. The acual opporuniy coss of capial of each company from 1998 o 2002 are lised in Table 4-4 as follows 18
Table 4-4 Acual opporuniy cos of capial of each company from 1998 o 2002 Name of insurance cos of capial Company Year 1998 Year 1999 Year 2000 Year 2001 Year 2002 Taiwan ChungKuo Taiing Fubon Zurich Taian Mingai Cenral Firs KuoHua Union ShinKong SouhChina Source Insurance Insiue of OC We should noe ha if he opporuniy cos of capial of one company is negaive, i means ha a ha ime one company s acual reurn of invesmen is below zero. If he opporuniy cos of capial of one company is higher, i means ha is opporuniy cos of capial is expensive. If here are wo projecs of which 19
expeced rae of reurn are he same, bu he former capial requiremen is higher han he laer, he laer projec may be declined by shareholders. 4. aid-up capial roeced Cell Company, like oher capive, also needs he minimum level of capial ha mus be injeced in o a capive when he minimum capial is required by he regulaory wihin CC domiciles. 15, Take Guernsey for example, he minimum capial requiremen of each capive is 100,000. In his paper, we assume he CC is se up in Guernsey and he minimum capial required is 100,000 around NT$6,000,000. In addiion o minimum capial requiremen, CC should also consider is solvency margin. In his paper we assume ha if CC considers is solvency margin, is premium o surplus raio should be 2 o1, equal o 50% solvency raio 16. In his paper we will simulae wo siuaions: One is he minimum capial required by he regulaory wihin CC domiciles, he oher is ha, considering solvency margin of a capive, we assume ha premium o surplus raio should 2 o1. 5. Technical reserves. Like radiional insurance companies, capives engage in one of wo ypes of reserve managemen mehods for financing he claims arising from heir 15 Direcory of world capive domiciles, Business insurance, march 15,2004, 36 16 Bawcu 1987 suggess ha for a capive in he early years of operaion i is recommended ha he solvency margin, which is he percenage of capial-free reserves over he ne premiums reain by he capive, be kep a a comparaively high level i may be pruden o esablish a 50% solvency raio. 20
liabiliies. One is he capializaion mehod and he oher is he compensaion mehod. In his paper we assume ha he CC manages loss reserve under he capializaion mehod, even if no claim occurred a ha year. All he underwriing profi should be reserved for he fuure claims 17. 6. Earned surplus For CC as en-a-capive, his paper assumes ha here are wo condiions will affec he earned surplus of CC 1 he invesmen income of CC and 2 he underwriing loss (aggregaed) which is ne reained by CC. Earned surplus is negaive of cos of risks. 7. Discoun rae In his paper we use annual average inerbank overnigh call-loan rae as discoun ae. 8. ure capive We assume ha CC as ren-a-capive is a pure capive, and each cell only akes is paren company business. I means ha if CC suffers loss ha exceeds is paid-up capial and echnical reserves, he defaul risk will be born solely by is paren company. Due o a pure capive, if any one cell of CC runs ino insolvency, we assume no indirec financial disress cos (such as legal fee, cour fees) would occur. 17 J. Banniser (1999) 21
4 Definiions of variables To properly measure he circumsance under which CC as ren-a-capive can increase is firm value, we consider 4 facors 1. Ceding erm and condiion I seems ha i is no always he case ha CC is beer han commercial reinsurance. We hink ha i should depend on ceding erm and condiion basis because of he wo reasons 1 If i doesn have a cerain amoun of ceding premium, i canno cover CC seup and operaion expense 2 CC and oher reenion mehods are no suiable for aking peak risks business arkinson 2002. In his paper we basically assume ha all insurance companies have he same erm and condiion Excess of Loss raio reinsurance. A he iniial scenario, he reinsurance cover is for 90% of losses in excess of a 70% loss raio on his underlying porfolio of reaies up o a 120% loss raio (Chi-Yao Chen. 1996). Then we also simulae oher ceding erms and condiions as follows o analyze he effecs of differen ceding erms and condiions, (a) Cover is for 90% of losses in excess of a 80% loss raio on his underlying porfolio of reaies up o a 130% paid loss raio. (b) Cover is for 90% of losses in excess of a 60% loss raio on his underlying porfolio of reaies up o a 120% paid loss raio. 22
2. erocession The capive is iniially designed o ake he burning cos and eliminaing he peak risks o preserve sabiliy and proec he capive s balance. CCs, like oher capives, may be considered no suiable for aking peak risk business. In his paper we will use he facor rerocession o analyze wheher rerocession can decrease CC s cos of risks. 3. Operaion eriod The auhor assumes ha, like oher risk reenion mehods, he longer we use CC as ren-a-capive, he more we can save is cos of risk. So, in his paper, we analyze separaely is cos of risks under differen operaion periods 3 years and 5 years o find wheher he longer we use CC as ren-a-capive he more we can save is cos of risk. 4. aid-up Capial To analyze which amoun of paid-up capial of CC is opimal for insurance company. We also simulae wo siuaions, (1) he minimum capial required by he regulaory wihin CC domiciles. For example, like Guernsey, he minimum capial requiremen of each capive is 100,000, (2) o mee he solvency margin of a capive, we assume ha premium o surplus raio is 2 o1, hus paid up capial should no less han half of premium income of CC. 23
5 Daa Collecion In his paper we use cash flow analysis o empirically analyze he cos of risks compared commercial reinsurance wih CC used as ren-a-capive. We use he hisorical daa of non-life insurance companies of recen five years 1998~2002 o simulae, analyze and compare he differen cos of risks beween hese wo sraegies, reinsurance and CC. Before we calculae is cos of risks, firs we should ge 1 reinsurance premium loading and 2 opporuniy cos of capial(per capial). Thus we use hisorical daa of reinsurance premiums ceded, claims recovered from reinsurers o calculae o reinsurance premium loading we refer o he recen 20 years of hisorical daa and he hen we use hisorical daa 1998~2002 of financial income and working capial o calculae is opporuniy cos of capial(per capial) Nex we use hisorical daa of direc wrien premium and direc claim o simulae each sample company s loss on ne reenion, burning cos and ne ceding premium, CC s underwriing profi(loss) and echnical reserves, CC s rerocession premium if CC arranged rerocession, capial required (if he solvency raio is considered). Excep burning cos and rerocession premium we refer he daa from 1988 o 2002 18, all of above simulae we refer o he daa from 1998 o 2002 18 To appropriaely calculae he burning cos (ne reinsurance premium), we need a leas 5 years of he hisorical daa. Besides, o evaluae he rerocession premium (1998~202), we should evaluae CC s risk porfolio from 1993~1997, and o calculae he CC s risk porfolio from 1993~1997, we also need hisorical daa from 1988~1992. Thus, in his paper we used hisorical daa of direc premium and claim from 1988~2002 o calculae he burning cos and rerocession premium. 24
All of above hisorical daa source is from Yearbook of Insurance, published by Insurance Insiue of OC. Due o daa consrained, we only focus on domesic non-life insurance company. To appropriaely evaluae he burning cos as follow, we exclude he firms ha are newly se up afer 1988. We also exclude he firm which is merged by oher company wihin he period 1988~2002. Finally, here are 13 firms included in his sample. The daa of funding cos and annual operaing fee of CC-since we assume ha CC was se up in he domicile of Guernsey-are from he Guernsey Financial Services Commission 19. And our daa source of inerbank overnigh call loan rae (weighed average) is from Financial Saisics Monhly, published by Cenral Bank of epublic of China (Taiwan). 6 Simulaion of scenarios Scenario 1 is he basis, and hen we will add oher scenarios o analyze wheher differen independen variables would effec is benefi of CC. Scenario 1 basis 1. Ceding erm and condiion We assume and simulae ha no maer insurance companies adop CC and commercial reinsurance risk managemen sraegy, boh of hem arrange he same ceding erm and condiion Excess of Loss raio 19 hp://www.gfsc.guernseyci.com/ 25
reinsurance, cover is for 90% of losses in excess of a 70% loss raio on his underlying porfolio of reaies up o a 120% paid loss raio. 2. CC didn buy any rerocession reinsurance. 3. aid-up capial To mee he solvency margin of a capive, he premium o surplus raio is wo o one. 4. Operaion period from year 1998 o 2002 (5 years) 5. Cos of capial We ge each company s opporuniy cos of capial by calculaing is acual ne invesmen income and hen divide by is working capial. 6. 100% Technical reserves for underwriing profi of CC, bu if CC suffers loss and ges ino insolvency, he defaul risk will be born solely by is paren company pure capive. 7. Discouning rae Inerbank overnigh call-loan rae. Scenario 2 1. CC did buy rerocession reinsurance o proec is underwriing risk. 2. Oher assumpion are as he same as Scenario 1 Scenario 3 1. Boh CC and commercial reinsurance risk managemen sraegy arrange heir ceding erm and condiion, excess of loss raio reinsurance: cover is for 90% of losses in excess of a 80% loss raioup o a 130% paid loss raio. 2. Oher assumpion are as he same as Scenario 1. Scenario 4 26
1. Boh CC and commercial reinsurance risk managemen sraegy arrange heir ceding erm and condiion, excess of loss raio reinsurance: cover is for 90% of losses in excess of a 60% loss raio up o a 120% paid loss raio. 2. Oher assumpion are as he same as Scenario 1. Scenario 5 1. Boh CC and commercial reinsurance risk managemen sraegy arrange heir ceding erm and condiion, excess of loss raio reinsurance: cover is for 90% of losses in excess of a 60% loss raio up o a 120% paid loss raio. 2. CC did buy rerocession reinsurance o proec is underwriing risk. 3. Oher assumpion are as he same as Scenario 1. Scenario 6 1. Boh CC and commercial reinsurance risk managemen sraegy arrange heir ceding erm and condiion, excess of loss raio reinsurance: cover is for 90% of losses in excess of a 60% loss raio up o a 120% paid loss raio. 2. Operaion period From 1998 o 2000 (3 years) 3. Oher assumpion are as he same as Scenario 1. Scenario 7 1. Boh CC and commercial reinsurance risk managemen sraegy arrange heir ceding erm and condiion, excess of loss raio reinsurance: cover is for 90% of losses in excess of a 60% loss raio up o a 120% paid loss raio. 2. CC did buy rerocession reinsurance o proec is underwriing risk. 3. Operaion period From 1998 o 2000 (3 years) 27
4. Oher assumpion are as he same as Scenario 1. Scenario 8 1. Boh CC and commercial reinsurance risk managemen sraegy arrange heir ceding erm and condiion, excess of loss raio reinsurance: cover is for 90% of losses in excess of a 60% loss raio up o a 120% paid loss raio. 2. CC did buy rerocession reinsurance o proec is underwriing risk. 3. aid-up capial In his scenario, paid-up capial only mees he minimum capial required by he regulaory wihin CC domiciles. Solvency margin in his scenario is no considered. 4. Oher assumpion are as he same as Scenario 1. 28