What If…Reinsurance Renewal Pricing Changes Were Easier?

Introduction

It’s easy to find articles about the many benefits of ceded reinsurance software systems with robust calculation engines: increased productivity, improved accuracy, enhanced profitability, steadfast audit and compliance, and improved operational control and flexibility typically all top of the list. However, one important benefit is usually overlooked: automated “what-if” scenarios that can take the guesswork out of renewal pricing for reinsurance contracts. The robust calculation engines of the latest ceded reinsurance software systems can help underwriters for reinsurance arrangements remove most of the guesswork from renewal pricing changes by creating fictitious terms and conditions (T&Cs) in multiple scenarios to quickly determine probable results.

The Art and Science of Renewal Pricing Adjustments

“What-if” analysis has been around since the late 1990s. It does not require automated calculation engines and can be done manually, if you have experts on your staff with a week or two to spare! More importantly, vendor calculation engines are much more powerful and flexible today. However, only about five percent of American insurance companies have invested in sophisticated ceded reinsurance vendor systems. The rest are using in-house solutions, some with calculation capability relating to ceded reinsurance. For the vast majority of reinsurers, robust calculation engines would be a very new tool. Most continue to rely on Excel spreadsheets and other manual procedures. In essence, this practice says, “Let’s change X to see how it works on this contract next year, and maybe we’ll apply it to others if the result is positive!”

That’s not necessarily a bad way of doing things, but there is no need for this kind of guesswork today. Advanced core component systems with powerful calculation engines have opened a whole new world of “what-if” analysis capabilities that require just a few minutes to run, and don’t always require a data expert. No matter how large the contract – or how many contracts are involved – simply plug in the T&C changes, enter the premium amount, and click to run the calculation engine.

Some Scenarios

Robust calculation engines are especially useful for reinsurance, where pricing is much less regulated, and therefore much more negotiable. Let’s say an insurer has five million policies in their auto book. Testing a simple change or two in the T&Cs on a reinsurance program for all these policies using a robust calculation engine takes a few minutes. How long would that take manually?

The most important aspect of “what-if” analysis is probably ensuring that reinsurance arrangements are optimized for pricing. For instance, a P&C firm may have a reinsurance program consisting of five or six treaties, with perhaps five different reinsurers on a claim of, say, $10,000. The firm needs to see how this claim flows through the program, which layers it attaches to, and which reinsurers need to be billed for what expenses. This is all based on contractual T&Cs that are not heavily regulated for the reinsurers.

Now let’s suppose the P&C firm wanted to find out the effect of changing the T&C relating to one layer of expenses, to pro-rated from included, before it inures to the next layer of reinsurance. The old way of determining the effect is to simply make the change on some contracts during renewal to see what happens, known as the field “experiment.”

Using a sophisticated calculation engine, the firm could quickly see the effects with just a few minutes of number crunching. This would reveal that under the included T&C, a $10,000 claim would break down into $10,000 in losses plus $2,500 in expenses, for a total cost of $12,500. Under a pro-rated T&C – the change in question – it would be $7,500 in losses and $2,500 in expenses. This is a very simple example. If there were inuring relationships, the calculation results would be much more complex. By simply changing one field of the system – expenses from pro-rated to included – and running the calculation engine, this P&C firm would quickly discover the effect of making this change.

The Final Word

In summary, change can be good…and profitable! There is no need for underwriters to suffer unproductive price change decisions by using select contracts as guinea pigs. Robust calculation engines incorporate much more science into the art of reinsurance renewal pricing adjustments and help avoid unnecessary guesswork and adverse results.