Reinsuring Commercial Umbrella

2008 Seminar on Reinsurance
Reinsuring Commercial Umbrella
Brian E. Johnson, ACAS, MAAA
Agenda
Basic Review of Commercial Umbrella

Umbrella vs Following Form Excess
How is an Umbrella policy written and priced?
Discuss
the more common ways an Umbrella

portfolio can be reinsured
Quota Share (Cessions)
Excess of Loss
Things to consider
Market
Slide 2
Trends
Basic Umbrella Review

Sometimes
a primary insurance company will

write an excess liability policy.
Excess
liability policies take two main forms
Umbrella
Following Form Excess
Both
types of excess policies are written on

top of underlying policy usually with a
requirement that the insured maintain the
underlying coverages.
Other
Slide 3
than where noted, these two coverages

can be priced using similar methodologies.
Slide 4
A Following Form Excess does just what it says.

It follows an underlying policy and provides for
additional limit. All the same coverages and
exclusions on the underlying policy are
applicable to the Following Form Excess policy.
An umbrella policy is a little different. In addition

to adding limits to an underlying policy (ies), it
may drop-down to cover losses not covered by
the underlying policy unless it is specifically
endorsed to follow the underlying in coverage.
An umbrella policy may also cover certain loss

adjustment expenses not covered by the
underlying policy (drop down coverage).

Example of drop-down:
Tatooine Cantina buys a $1M GL policy that
excludes liquor liability. They also buy a $2M
umbrella policy on top of it (attaching at $1M).
The umbrella does not have the liquor
exclusion. The bartender on duty continues to
serve alcohol to a patron after he was visibly
drunk. That patron gets into a bar fight and
cuts off the arm of another customer, Bob. Bob
sues Tatooine and wins $500K. Even though
this loss is below the $1M retention, the
umbrella drops down to pick up the loss.
Slide 5
Slide 6
In commercial lines, excess or umbrella policies

are priced by applying factors to the premium of
the underlying policy. Manual or net premium
could be used.
These factors are derived from severity curves

(ILFs) but include a load for the insurers profit
and expenses.
Typically the first $1M of Umbrella is priced as a

percentage of the premium for the underlying
lines (these are called umbrella factors).
Additional layers are priced as a percent of the

first $1M of umbrella or a percent of each
preceding layer.
Slide 7
In addition to the excess factors, there are

usually minimum premiums per $1M in limit
and/or policy applicable.
Quite often, the underwriter also has some

flexibility to apply discretionary credits/debits
to the umbrella factors or final umbrella
premium.
An insurance company can write an umbrella

policy over their own underlying policies or
over another insurance companys policies.
(supported vs unsupported).
Reinsuring an Umbrella
Portfolio: Quota Share
Slide 8
Typically reinsurance on umbrella policies is

provided on a proportional basis.
The quota share cession percentage can be the

same for all limits or vary by layer.
If there is enough credible information, a

reinsurer pricing this business would be able to
do an ELR analysis by trending umbrella
premium and trending and developing
umbrella losses.
There will not be many losses in the layer. A

loss ratio analysis based on experience rating
would not be credible.
There are a few important things that must be

considered in order to successfully experience
rate an umbrella portfolio.
Historical individual umbrella losses with
attachment point for every loss (also excess vs
drop-down) and historical umbrella premium.
Underlying rate changes
Umbrella rate changes
Changes in umbrella factors
Changes in amount of discretionary pricing.
Excess loss development factors
Slide 9
Drift in limits distribution
Another way to estimate the profitability of an

umbrella quota share (ELR) is to split the
analysis into two pieces:
Using ground-up data, estimate the adequacy
of the underlying premium
Estimate the adequacy of the umbrella
factors in comparison to some industry or
reinsurance company yardstick
The theory is that the ELR of the umbrella
policy would be affected by both the
adequacy of the underlying premiums and
excess factors.
Slide 10
Lets illustrate this with an example.
Cortana Re has been given a chance to reinsure a book of
commercial umbrella business written by Covenant Insurance.
Covenant writes either $1M limit or $2M limit umbrellas over
their own $1M GL policies. You have the following information
about the account. You also use a pareto distribution to
develop the following limited severity curve. Estimate the ELR
onERL
theon
Umbrella
Covenant'sportfolio.
GL policies:
75%
Umbrella factor for 1st Mill:
Umbrella factor for 2nd Mill:
% umbrella policies at 1M:
% umbrella policies at 2M:
Slide 11
Limit
1,000,000
2,000,000
3,000,000
20% of underlying $1M policy

75% of 1st Mill of umbrella
40%
60%
Avg Sev
16,000
19,084
21,555
Essentially
Using
the Umbrella factors are the ratio of umbrella premium to underlying premium:
your severity curve, you promulgate an excess loss factor for each layer:
premumb
premund
lossumb
lossund
Slide 12
A ratio of the two factors (umbrella adequacy factor)

multiplied by the underlying ELR equates to the
umbrella loss divided by the umbrella premium.
lossumb
lossund
lossund
premund
lossumb
premumb
premumb
premund
Slide 13
Using a simple Excel spreadsheet you can estimate

the weighted average adequacy factor and ELR for
an umbrella portfolio.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Slide 14
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
1,000,000 1,000,000
xs
xs
Underlying 1,000,000
1st
2nd
Umbrella layer:
GL ISO % of underlying:
19.3%
12.9%
ISO Total Limits:
19.3%
32.2%
Cortana % of underlying:
20.0%
15.00%
Cortana Total Limits:
20.0%
35.00%
Umbrella Limits Dist:
40.0%
60.0%
Umbrella Adequacy Factor:
93.3%
ERL on Covenant's GL policies:
75.0%
Umbrella ELR:
69.9%
Based on ISOTruncated Pareto with client specific exposure distribtions

Cumulative of (1)
Given
Cumulative of (3)
Given
= wtg average of (2) / wtg average of (4)
Given
= (6) x (7)
Slide 15
In practice, umbrella policies are typically

written over multiple underlying coverages (i.e.
GL, AL, and EL).
The analysis for these situations is the same

with multiple underlying ELRs and umbrella
factors.
Umbrella layer:
GL ISO % of underlying:
CAL ISO % of underlying:
Avg ISO % of underlying:
XYZ % of underlying:
Premium Dist:
Umbrella Adequacy Factor:
GL L&ALAE Ratio:
AL L&LALAE Ratio:
Avg. AL/GL L&ALAE Ratio:
UMB ELR on 1st $5M:
Slide 16
1,000,000
xs
Underlying
1st
13.17%
11.08%
12.60%
16.01%
58.37%
73.2%
72.2%
91.1%
77.4%
56.6%
1,000,000
xs
1,000,000
2nd
3.93%
3.91%
3.93%
8.01%
22.14%
1,000,000
xs
2,000,000
3rd
2.29%
2.22%
2.27%
4.00%
7.54%
1,000,000
xs
3,000,000
4th
1.55%
1.48%
1.53%
2.00%
3.38%
1,000,000
xs
4,000,000
5th
1.14%
1.07%
1.12%
1.00%
8.57%
Some things to consider if using this method:

You must consider the proper method to load
for excess ALAE versus ground-up ALAE
You must factor in the effect of discretionary
pricing
You
must also factor in the effects of the

minimum premiums.
The actual excess factor obtained because
of your minimum premiums may be far
greater than the filed excess factors.
Slide 17
This is sometimes very hard to do because it

requires the cedant to keep premiums by layer
in the system.
The reinsurer must also be very aware of

shifting limits (or attachment) points.
Some layers may be more or less adequate
than others.
A shift to higher or lower limit umbrella
policies may affect the adequacy factor.
Slide 18
Once an ELR is determined the reinsurer can

determine what commission can be paid the
cedant.
There must also be some consideration what

load to add for drop-down coverage.
Portfolio: Excess of Loss
Another way to reinsure an umbrella portfolio is

reinsure it on an excess of loss basis.
This type of treaty can come in two varieties:

A cedent decides to include their umbrella
portfolio into their mainframe XOL treaty.
Typically the limit and attachment points are
with respect to first dollar i.e. $5M xs $1M
A cedent who writes unsupported umbrellas
may choose to keep a fixed retention on every
umbrella regardless of the attachment.
Slide 19
One of the biggest concerns is how a shift in

limits or attachment points could change the
expected loss in your reinsured layer.
Lets start with a scenario where every umbrella has the same
attachment point, limits vary and the excess of loss cover is
Limited
$4.0M xs $1.0M from the ground:
Prem
Limit Attachment
Distr. XS Factor
Limit
Severity
500,000
18,147
4,500,000
1,000,000
25.0%
95.3%
1,000,000
21,623
1,500,000
1,000,000
10.0%
100.0%
1,500,000
23,604
3,000,000
1,000,000
35.0%
100.0%
5,000,000
1,000,000
30.0%
91.5%
2,000,000
24,946
Wavg:
96.3%
2,500,000
25,940
3,000,000
26,719
3,500,000
27,353
4,000,000
27,884
4,500,000
28,338
5,000,000
28,733
5,500,000
29,081
6,000,000
29,391
Given an umbrella ELR of

65% the rate we would
charge would be 63% plus
load.
Slide 20
Slide 21
Lets look at a scenario where the umbrella attachment points
and limits vary and the excess of loss cover is $4.0M xs $1.0M
with respect to the ground:
Prem
Limit Attachment
Distr. xs factor
4,500,000
500,000
25.0%
1,000,000
1,500,000
10.0%
100.0%
3,000,000
1,500,000
35.0%
100.0%
1,500,000
3,000,000
30.0%
100.0%
Wavg:
91.8%
Slide 22
67.2% =(28733-21622)/(28733-18147)
Slide 23
Lets look at a scenario where the umbrella attachment points
and limits vary and the excess of loss cover is $4.0M xs $1.0M
with respect to the umbrella:
Prem
Limit Attachment
Distr. xs factor
4,500,000
500,000
25.0%
1,000,000
1,500,000
10.0%
3,000,000
1,500,000
35.0%
50.7% =(28338-25939)/(28338-23604)
1,500,000
3,000,000
30.0%
28.0% =(28338-27884)/(28338-26718)
Wavg:
38.3%
Slide 24
48.4% =(28733-23604)/(28733-18147)
0.0%
Slide 25
In
order to properly rate the XOL on umbrella

business the reinsurer will need data that may
not be readily available from the cedant.
A matrix distribution of limits by attachments
Historical information on how limits and
attachments have shifted over time
shift in the limits or attachment points could

make the average expected loss cost increase
or decrease significantly.
In
Slide 26
some cases it may make more sense to

charge a schedule of rates which vary by
attachment and limit as opposed to a single
rate.
The
reinsurer may also want to rethink the

appropriate load (for parameter risk) needed to
write this type of cover.
Using
an XOL load typically used when

reinsuring primary policies may not be
appropriate.
There
must also be some consideration what

load to add for drop-down coverage.
Slide 27
Portfolio: Market Trends
Like the rest of the market the rates have been

decreasing.
Decreasing manual rates
Decreasing discretionary mods
Decreasing umbrella factors
Increased use of umbrella credits
Umbrella on E&S business hit the hardest
Slide 28
More companies trying to purchase auto carveouts for their umbrella portfolio.
Companies are looking at the option of moving

from an umbrella quota share to an XOL.
Continued deterioration of terms and conditions

Little to no referral guidelines
Decreasing minimums per million
Slide 29
Increase in the umbrella limits primary companies

are willing to write.
More primary companies are willing to attach

higher (write the excess umbrellas as opposed to
lead umbrella) where it is perceived rates per
million are more adequate.
Increase in the number of companies willing to

offer SAM in the umbrella for certain classes (i.e.
social services)
More risks, typically written in the E&S markets,

are being written in the standard umbrella market
at standard umbrella rates.
Actuaries and UWs need to make sure they

understand the underlying umbrella form.
While there is a standard ISO form most
companies use a hybrid form
Recently the umbrella forms have been
broadening
Slide 30
Actuaries should also make sure umbrellas are

properly endorsed to reduce the chance of dropdown coverages (i.e. a driver is excluded on the
underlying but not on the umbrella)

Reinsuring Commercial Umbrella

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Reinsuring Commercial Umbrella

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2008 Seminar on Reinsurance

Reinsuring Commercial Umbrella

Brian E. Johnson, ACAS, MAAA

Basic Review of Commercial Umbrella

the more common ways an Umbrella

Basic Umbrella Review

a primary insurance company will

liability policies take two main forms

types of excess policies are written on

than where noted, these two coverages

Basic Umbrella Review

A Following Form Excess does just what it says.

An umbrella policy is a little different. In addition

An umbrella policy may also cover certain loss

Basic Umbrella Review

Basic Umbrella Review

In commercial lines, excess or umbrella policies

These factors are derived from severity curves

Typically the first $1M of Umbrella is priced as a

Additional layers are priced as a percent of the

Basic Umbrella Review

In addition to the excess factors, there are

Quite often, the underwriter also has some

An insurance company can write an umbrella

Typically reinsurance on umbrella policies is

The quota share cession percentage can be the

If there is enough credible information, a

There will not be many losses in the layer. A

There are a few important things that must be

Drift in limits distribution

Another way to estimate the profitability of an

Lets illustrate this with an example.

20% of underlying $1M policy

A ratio of the two factors (umbrella adequacy factor)

Using a simple Excel spreadsheet you can estimate

Based on ISOTruncated Pareto with client specific exposure distribtions

In practice, umbrella policies are typically

The analysis for these situations is the same

Some things to consider if using this method:

must also factor in the effects of the

This is sometimes very hard to do because it

The reinsurer must also be very aware of

Once an ELR is determined the reinsurer can

There must also be some consideration what

Another way to reinsure an umbrella portfolio is

This type of treaty can come in two varieties:

One of the biggest concerns is how a shift in

Given an umbrella ELR of

order to properly rate the XOL on umbrella

shift in the limits or attachment points could

some cases it may make more sense to

reinsurer may also want to rethink the

an XOL load typically used when

must also be some consideration what

Like the rest of the market the rates have been

Companies are looking at the option of moving

Continued deterioration of terms and conditions

Increase in the umbrella limits primary companies

More primary companies are willing to attach

Increase in the number of companies willing to

More risks, typically written in the E&S markets,

Actuaries and UWs need to make sure they

Actuaries should also make sure umbrellas are

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