Case Study – Capital Modeling
Problem
A private self-insured corporation was evaluating whether it should increase its auto liability per-occurrence retention from $500,000 to $3,000,000. The company’s owners would ultimately be responsible for replacing any capital used to pay for exorbitant losses in a poor year.
RCS Action
RCS’s team conducted a capital modeling analysis to help management understand how much capital was at stake due to the increased retention options. Taking a holistic view of the corporation’s retained risk profile, RCS team members modeled not only its auto liability exposure, but also its workers compensation and general liability exposures. The analysis contemplated the diversification benefit of the three lines of coverage, as well as the correlation of these lines.
Outcome
Using the capital implied by the modeling, RCS was able to present the true economic cost of each retention option, taking into account the implied income sacrificed by keeping capital in secure assets. Ultimately, the client moved forward with the $3M retention, finding that the price for the lower retentions were too great given RCS’s estimates of the company’s future losses. In the first year, our model estimated that the company would save over 10% on the total Economic Cost of Risk by making this decision. Moreover, by completing this exercise, the company now had a framework established to determine capital tradeoff for future management decisions, including investments portfolio decisions and retaining catastrophe risk.