With the success of commutations relying on having the right numbers at the right time it stands to reason that the use of state of the art data analysis software is crucial. Actuarial consultancy EMB talks to Barbara Hadley about how RePro, its reinsurance software, is being increasingly used by commutation specialists.
EMB is proud of the development of its specialist reinsurance software RePro but explains that its continued development has been very much one of responding to the needs of clients over the years. ‘RePro has evolved directly as a result of clients coming to us with specific problems and looking for a solution. We developed the solutions, however one of the key aims of EMB is to empower our clients with the tools and skills to tackle future problems for themselves. This gave rise to the concept of a tool to simulate IBNR reinsurance recoveries and present the results in an easy to interpret graphical form. Since that time we have found more and more uses for RePro and now it covers a multitude of inwards and outwards reinsurance scenarios,’ explains EMB partner Peter Matthews. ‘In fact RePro itself started out as a response to a specific request - SUM came to EMB nine years ago needing to estimate the IBNR on Lioncover’s outwards reinsurance programme (which was subject to a major claims dispute with its reinsurers) which included high exposure to US asbestos and pollution risks. And so RePro was born.’
The original idea was to develop software which would analyse a company’s inwards exposures, broken down into paid and outstanding losses, remaining cover and with various scenarios of IBNR (see Figure 1) then map through to the outwards programmes. The result then gave clients a detailed picture of how their gross IBNRs would impact on the reinsurance programme - something which had not commonly been done before, due mainly, says Peter, to the effort typically required to perform this type of exercise.
Having started in spreadsheet form, then quickly developing into a fully programmed application, RePro’s take up is increasing within the industry generally, and specifically within the commutation sector. The greater the move towards commuting reinsurance contracts the greater the need for cedants to have demonstrable data analysis to secure their bargaining position, points out Peter: ‘People are usually very diligent when it comes to electronically recording their inwards exposures but in the past not so diligent at electronically recording their reinsurance asset, relying on ad-hoc spreadsheets, reinsurance resumes and what is in the reinsurance manager’s head!’ Having developed a system that flows the inwards IBNR losses through to the outwards reinsurance, EMB quickly saw the potential of being able to view data in this way when it came to negotiating commutation deals. And it is at that point that the bolt-on aspects of RePro can really come into play; a variety of data parameters can be overlaid such as policy limits, legal wins, particular market knowledge, or even ‘real life’ data, e.g. those covers which are under dispute and necessitate discounting the price.
That’s all looking at it from a loss point of view. But, stresses EMB consultant Steve Mathews, the software can also generate extremely meaningful data from the security point of view, something which is equally important to the commutation. ‘The software can build hierarchical reinsurance structures which go underneath the top layers of security and show not just reinsurers, but any underlying reinsurer arrangements, including the individual brokers concerned, the breakdown of cover amongst participants in a pool etc.’
Basically, by dissecting and reassembling the data in this format, a company is able to see exactly where there are weaknesses, or even holes in their reinsurance arrangements. And if you overlay that data with professional market knowledge such as Standard & Poors, A M Best or Fitch, the picture becomes even more illuminating as shown in Figure 2. It is this sort of graphic image in fact, maintains Mathews, that brings home the reality of the situation for cedants and enables them to focus their attention on making sure they commute with the weaker security first, or target particular groups such as the XL reinsurers, by arming them with demonstrable IBNR assumptions versus outstandings. It also allows for clearly defined set-off between inwards and outwards programmes.
Of course the software can also be used to test existing reinsurance programmes for holes and weaknesses, or often to find mistakes in the original data input, plus give an accurate bad debt picture.
It is also a more than useful exercise for companies to undertake on a prospective run-off acquisition although as Peter Matthews says ‘it’s probably the last picture that a seller of a run-off wants you to see!’
The impact of all these software developments on commutations is immense, argues EMB, allowing for transparency between cedant and reinsurer and helping to justify a seemingly over-pessimistic IBNR multiple. It also gives both cedant and reinsurer a strong justification to shareholders of the rationale behind a deal and how realistic the numbers really are. ‘With the commutations market as it stands there are far too many soft numbers on IBNRs - and far too many being done on an incurred basis or by using crude IBNR multiples of outstanding case reserves. This way, although there needs to be time invested to understand the logic of how the reinsurance works, once you’ve locked it down in RePro it’s done - you don’t have to do it again,’ points out Peter.
One particular area where RePro is proving useful is in asbestos exposures, says Steve Mathews: ‘We had a client with direct asbestos exposure looking to commute their outwards reinsurance and so we worked with them to develop a model to estimate the asbestos liabilities and flow these through to the various outwards reinsurances.’
EMB feels that there is currently great potential for RePro in assessing inward exposures and is also working with Blem Information Management to integrate RePro with Blem’s XLRAS reinsurance administration software. But that is just one of the developments on the horizon. Andrew Gray of EMB Software and the person credited with driving the technical expertise behind RePro, has more stochastic ideas in store for the software, aimed at investigating the underlying variability in results: ‘Underneath RePro there is a very powerful reinsurance calculation engine, so it makes sense to bolt on more financial modelling, apply more parameter overlays and, ultimately, to apply probability distributions to the parameters themselves,’ he explains.
This article appeared in Run-off Business Magazine in June 2004
