The notes talk about pricing XL contracts using ILFs and then go on to talk about pricing XL treaty contracts using ILFs. In the two approaches they switch between multiplying the difference in the ILFs (at the relevant points for the layer being priced) from using the basic limit loss cost to the original limit loss cost. What is the difference between these two limit loss cost. I think my misunderstanding is in how original and basic refers to different limits in the contract. Simple numerical example would be very helpful and an explanation of what basic and original limits refer to. Thanks you!
Hi LastHurdles The basic limit (b) is some limit for which the loss cost is known. The ILFs are then all calculated relative to this basic limit and known loss cost and they tell you what the loss cost should increase by if the limit is increased to another value (l) say. In Section 3.4 we now have an original policy written with a limit (l) and we have an XL reinsurance treaty that we are trying to price which runs from D to D+L. Formula 3.6 expresses the cost of this XL RI Treaty in terms of the cost of the underlying layer with original limit (l). It is obtained by substituting equation 3.5 into equation 3.3.
