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Liquidity: How to Fix It

In the recent presentation, Chet Szczepanski, Chief Actuary for the Pennsylvania Insurance Department, discusses critical liquidity issues facing insurance firms. Emphasizing reserve deficiencies and the impact of rating downgrades, he explores the lessons learned from historical crises. Szczepanski advocates for improved risk assessment and proactive measures to enhance liquidity management. By moving beyond traditional balance sheet approaches and adopting innovative strategies, the insurance industry can navigate future challenges effectively while ensuring financial stability.

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Liquidity: How to Fix It

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  1. Liquidity: How to Fix It Chet Szczepanski Chief Actuary Pennsylvania Insurance Department

  2. Pennsylvania Experience • PIC • Reliance • PHICO • Legion • ?

  3. Pennsylvania Experience PIC: • Medical malpractice writer • Discounted reserves • Reserve deficiencies • Downgraded • Doctor’s did not care • Speed Up in Court Decisions (Liquidity!) • RBC caught them!

  4. Pennsylvania Experience Reliance • Multi-line writer • Business is rating sensitive • Heavily leveraged by reinsurance • Heavily leveraged by holding company debt

  5. Pennsylvania Experience Reliance (continued) • Unicover • Reserve deficiencies • Downgraded • Liquidity, liquidity, liquidity

  6. Pennsylvania Experience PHICO • Medical malpractice writer • Rapid expansion into new markets • Reserve deficiencies • Downgraded • Doctors did not care • Liquidity not a problem

  7. Pennsylvania Experience • Legion • Multi-line writer • Business is rating sensitive • Heavily leveraged by reinsurance • Downgraded • Reserves? • Liquidity, liquidity, liquidity

  8. Pennsylvania Experience Common Themes: • Reserve deficiencies • Ratings downgrades • Reinsurance • Liquidity

  9. P&C Industry Asset Distribution for 2001

  10. P&C Industry Invested Asset Distribution for 2001

  11. Reinsurance Leverage

  12. Reinsurance Leverage • Add rating sensitive business • Mix in a downgrade • $1,000,000,000 or more in Statutory Deposits • $500,000,000 in one Stock • Liquidity?

  13. Reinsurance Leverage

  14. Reinsurance Leverage Let’s define two ratios: • Premium Leverage = Gross Premium Written / Net Premium Written • Reserve Leverage = Gross Loss & LAE Reserves / Net Loss & LAE Reserves

  15. Premium Leverage

  16. Reserve Leverage

  17. Risk Based Capital

  18. Risk Based Capital

  19. Risk Based Capital

  20. Risk Based Capital

  21. Risk Based Capital

  22. IRIS Ratio 1: Gross Premium to Policyholders’ Surplus Usual Range < 900%

  23. IRIS Ratio 3: Surplus Aid to Policyholders’ Surplus Usual Range < 15% Focus on Ceded Commissions

  24. IRIS Ratio 7: Liabilities to Liquid Assets Usual Range < 105% Focus on Net not Gross Leverage

  25. Conclusions? • Risk Based Capital tends to be Balance Sheet centered • Risk Based Capital does not measure reinsurance leverage and liquidity • IRIS also tends to be Balance Sheet centered (7 of 11 ratios) • IRIS also does not adequately measure reinsurance leverage and liquidity

  26. Graph Theory and The Latest Crisis

  27. The Actuarial Profession’s Response: • Take the initiative to identify risks and recommend solutions • Greater diligence in reserve reviews and ASOP’s • Move beyond the balance sheet

  28. Conclusion: • Regulation is at a crossroad • We face a challenge and an opportunity • We must be proactive and move beyond the balance sheet • Must learn from each crisis

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