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DFA Insurance Company Case Study, Part I: - page 25 / 40

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Reinsurance Structure

Description

Net Loss Ratio

Standard Deviation of Net Losses

--

G ross

81.4

136,172

1

Current

82.9

118,807

2

Current w/$1M Ret.

82.8

119,517

3

Current w/$5M Ret.

84.7

121,849

4

Aggregate

83.7

91,027

Table 7: DFAIC's Net Loss Ratio and Standard Deviation of Net Losses (Acc Yr 2)

The holistic approach underlying structure 4 is primarily responsible for the improvement in net loss ratio standard deviations. That is, by focusing on the company's overall loss ratio and seeking to reinsure only those losses that in the aggregate (across LOBs), exceed acceptable limits, DFAIC improves the efficiency of its ceded reinsurance program. Exhibit 3 shows the variability in gross loss ratios by LOB and the corresponding reduction in variability of the overall loss ratio. Hence, DFAIC achieves most of its efficiency gain by merely recognizing the diversifying effect of writing more than one LOB and by purchasing reinsurance that recognizes this characteristic of their business.

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