Discussion of Loss Reserve Standard

1. Discussion of Loss Reserve Standard Raji Bhagavatula Ralph S. Blanchard III Mary Frances Miller May 16 2005

2. Agenda • Background • Why do we need a reserve standard? • Who is drafting the standard? • Proposed standard • Purpose and Scope • Analysis of Issues and Recommended Practice • Communications and Disclosure • Next Steps • Q&A

3. Why do we need a standard? • No standard currently exists for developing a reserve estimate • The IAA is expected to develop a standard in conjunction with the IASB work - ASB wants to be proactive • The Reserving Principles rewritten

4. Who drafted the standard? • The sub-committee on reserves of the ASB Casualty committee • The members of the sub-committee are: • The sub-committee’s views on the proposed standard: • Codifies current practice as far as reserve estimation is concerned • Raises the bar on Communications / Disclosure Raji Bhagavatula, Chairperson William H. Belvin Terrence M. O'Brien Ralph S. Blanchard Chandrakant Patel Edward W. Ford David S. Powell Louise A. Francis Jason L. Russ Margaret Wendy Germani Lee R. Steeneck Mary Frances Miller Chester J. Szczepanski

5. Goals of the sub-committee • Standard should be developed concurrent with the amendment of the Reserving Principles • Keep the scope manageable so that a standard can be developed within a two year time frame

6. Scope of the standard • Provide guidance to actuaries when estimating loss and loss adjustment expense reserves for property/casualty coverages • Applicable when estimating claim liabilities for all classes of entities (e.g. governmental entities, self insureds, insurance companies) • Applicable when developing incurred claim liability for events that have already occurred as of a specified date. • Examples where standard not applicable: • Estimation of losses in a ratemaking context • Estimation of claim liability for losses that have not occurred for policies in force • Estimates of liabilities for renewal of policies currently in force

7. What actuarial communications are covered by the reserve standard? • Written communications (e-mail or other electronic communication, PowerPoint included) where the actuary’s results are conveyed to the principal or principal’s agent. • Does not apply to oral communications • Does not apply to informal communications (e.g., preliminary calculations done while in a meeting) • When in doubt the standard applies unless the actuary states otherwise • Applies to the actions taken by the actuary (actions taken by the principal are beyond the scope)

8. Analysis of Issues and Recommended PracticeOutline • Scope • Context • Familiarity with claim liability cause(s) • Reserve Analysis • Issues • Methods • Assumptions • Data • Recoverables (incl. collectibilities, gross vs. net) • External conditions, changing conditions • Reasonableness tests • Uncertainty

9. Analysis of Issues and Recommended PracticeScope of the Estimate • Is it net or gross? Gross or net of what? • If net, does it include collectibility analysis? • Basis of estimate: central, selected percentile, median, etc. • Basically, know what you’re supposed to be estimating • DEFAULT ASSUMPTION – what should it be ?! • Expected value (mean?) • Problem is that many traditional methods aren’t consistent with statistical definitions of “mean”, “mode” or “median”. • Should reflect tails of the distribution on a conceptual level, even if an actual probability distribution isn’t estimated or even estimable. • Selected default – Central estimate

10. Analysis of Issues and Recommended PracticeMean, Mode Median, Central Estimate Central estimate – uses methods and assumptions neither optimistic nor pessimistic; Requires consideration of the tail. • Expectations phrased in statistical terms cannot be met (in statistical sense) by many methods • If principal expects mean, median or mode, communicate how the expectation was addressed • “When producing a result categorized as a ‘central estimate’, the actuary should produce an estimate that is conceptually in line with a mean rather than a median or a mode.” • Doesn’t require producing a loss distribution or statistical analysis

11. Analysis of Issues and Recommended PracticeContext of the Estimate • What is the purpose or expected use of the estimate • Examples include external fin’l reporting, internal management reporting, etc. • The purpose may dictate certain rules • In short, know the context and the resulting implications • If resource constraints create a “significantrisk” to the analysis, notify the principal.

12. Analysis of Issues and Recommended PracticeFamiliarity with Cause(s) of Claim Liability • Some familiarity is needed • Required familiarity will vary with the particular liability estimated and its intended use • Requirement not based on hindsight analysis

13. Analysis of Issues and Recommended PracticeReserve Analysis - Issues • The analysis will vary with • Intended use and context • Nature of claims, exposures • Historical development patterns • Expectation of future conditions • Resource constraints (e.g., time, people, data)

14. Analysis of Issues and Recommended PracticeReserve Analysis - Methods • Number of methods are available - selection based on facts & circumstances (including the “issues” mentioned earlier) • “actuary should consider whether the implications of more than one method should be examined …” Not saying that more than one method should be used Instead saying – Look into it • Don’t have to use same method as the past • Evaluate the appropriateness of chosen method(s) even if same method as the past

15. Analysis of Issues and Recommended PracticeReserve Analysis - Assumptions • Assumptions may be implicit or explicit • Consider reasonableness of assumptions underlying method • Assumptions should have no deliberate or conscious bias to under estimation or overestimation (whatever the basis of the estimate) • Consider sensitivity of estimate to reasonable alternative assumptions. (If very sensitive, understand why, communicate) • Okay to use assumptions dictated to you, but communicate if you believe them to be unreasonable

16. Analysis of Issues and Recommended Practice, Reserve Analysis - Data • Actuary directed to ASOP 23 – Data Quality • Data considerations are in current CAS Reserving Principles • New version of “Principles” removed that discussion • Proposed standard discusses data: • Organization • Elements • Aggregation • No explicit requirement to reconcile data to financials

17. Analysis of Issues and Recommended PracticeReserve Analysis – Recoverables, etc. • Actuary should consider if material recoverables/offsets exist • unless scoped out • Disclose whether collectibility is in the scope. Be clear. • Gross vs. Ceded vs. Net • Consider facts and circumstances when choosing which components to estimate • But make sure the estimates of the pieces are consistent

18. Analysis of Issues and Recommended PracticeReserve Analysis – External conditions, Changing conditions • Consider external conditions that may have a material effect, “to the extent they are generally known and amenable to estimation” • Consider significant changing conditions likely to be insufficiently reflected in the data or assumptions

19. Analysis of Issues and Recommended PracticeReserve Analysis – Reasonableness Do a reasonableness test on the estimate

20. Analysis of Issues and Recommended PracticeReserve Analysis – Uncertainty • Actuarial estimates are inherently uncertain • Two types of uncertainty – • Uncertainty in the estimate • Uncertainty in the actual final result • Actuary may determine a range of reasonable estimates “range of estimates that could be produced by appropriate actuarial methods or alternative sets of assumptions that the actuary judges to be reasonable” • Range of reasonable estimates ≠ range of all possible outcomes, or even all reasonable outcomes

21. Communications & Disclosures • General Guidance: ASOP 41 Actuarial Communications • Principal & Scope, Form & Content, Timing, etc. • An actuarial report may be required • More Specific Documentation requirements:ASOP 9, Documentation and Disclosure in Property and Casualty Insurance Ratemaking, Loss Reserving, and Valuations • Documentation should be sufficient for another actuary practicing in the same field to evaluate the work

22. Communications & Disclosures Specific to the Proposed Standard • Clearly define the scope of the estimate • Clearly convey the context and intended use • More than one intended use? • Any compromises in order to produce a single work product for multiple intended uses?

23. Communications & Disclosures Presentation • Consider the intended use • Multiple possible presentations (not an exhaustive list): • Point estimate • Range of estimates • Point estimate + margin for adverse deviation • Probability distribution

24. Communications & Disclosures Ranges • What is the range intended to convey? • For example: • a range of estimates of the central estimate; • a range representing a confidence interval within the range of outcomes produced by a particular model or models; • a range representing a confidence interval reflecting both process and parameter risk; • some other clearly defined range

25. Communications & Disclosures Uncertainty • The actuarial communication should include discussion of the uncertainties in the estimated claim liability • This discussion should include both the uncertainty in the estimate and the uncertainty of actual results varying from the estimate

26. Communications & Disclosures Significant Events & Assumptions • Include explicit discussion of any significant assumptions or events underlying the estimate that may not be obvious to the intended audience, including significant assumptions regarding the accounting basis or application of an accounting rule • Where the final work product reflects a material assumption or methodology that differs from what the actuary believes to be reasonable • Disclose the dependency of the final result and • Disclose the source

27. Communications & Disclosures Material Changes • If the analysis is an update, disclose any material changes in assumptions • Disclose the reasons for the change • Not required to quantify the effect

28. Next steps • ASB Casualty committee to vote on the standard in May • If approved by the Casualty Committee the standard will be presented to the ASB • The proposed standard is still on the drawing board • ASB may make changes, some of which may be substantive • If approved by the ASB, the standard will be exposed to the actuarial community in the summer of 2005