Construction Defects

1. Construction Defects Casualty Loss Reserve Seminar September 24, 2002 Panelist: Carolyn Yau, ACAS

2. Overview • Background • Actuarial Issues • Methodologies • Current Issues

3. Background • Montrose Decision • Continuous trigger theory applied to pollution case • Stonewall Insurance Company vs. City of Palos Verdes Estates • Carriers respond to claims on prorata basis • Frequency rises • Severity falls • Insureds coverage is generally maximized • Reinsurers less exposed • Indemnity apportioned based on time on risk • Expense apportioned based on number of carriers

4. Example: $3 Million Claim

5. Actuarial Issues • Uncertain determination of accident date • Varies by company and frequently within a company • Uncertain determination of future development pattern • Appears to be lengthening • Influx of claim activity along recent accident year diagonals • Uncertain determination of tail factor selection • One assumption to use is no more development after 13 years for California • Not sure if it will hold

6. Methodology: Obtain Program Knowledge • What is exposure mix (general contractor, designer/builders, subcontractors) • Is exposure residential or commercial construction • Which states have construction defect exposure • Is exposure information available • What is the definition of a construction defect claim • How is accident date determined • What reinsurance agreements are in place

7. Methodology: Data Organization • California vs. Non California (or other specific states) • General Contractors vs. Subcontractors • Accident year vs. report year data • Separate ALAE

8. Methodology: Analysis • Accident Year Methods • Report Year Methods • Exposure Based Methods

9. Methodology: Accident Year Analysis • Traditional Loss Development Method is not appropriate • Montrose Adjustment Method • Aids in selection of development factors and tail selection • Transactional Count / Incremental Paid Loss Method • Count times Severity Approach • Key is estimating the ultimate reported counts

10. Methodology: Report Year Analysis • Estimate Development on Known Claims and Pure IBNR separately • Pure IBNR • Count times Severity Approach • Estimate reporting pattern of the remaining claims • Fitted Distribution • Empirical Distribution

11. Methodology: Exposure Analysis • Ideal method if data is available • Develop list of policy holders • Compare policy holders with list of claimants to determine remaining exposure • Determine future reported claims by extrapolation or market share analysis • Earned GL premium for contractors is also useful

12. Issues in Construction DefectsOne Year Ago • Frequencies • 1994 – 1999 rising • 2000 flat • Severities • 1994 – 1999 stable • 2000 flat to declining • ALAE to loss ratios • Rising over time • Recommend monitoring separately from loss as still evolving

13. Issues in Construction DefectsToday • Mold Claims (Texas) • Schools and public buildings • Statute of limitations is shorter • Additional Insured ALAE (Southern California) • Presley Homes, Inc. v. American States Insurance Company (2001) • As general contractors reach their polity limits or go bankrupt, they are looking for coverage under the subcontractor policies where they are listed as an “additional insured” • Sharing of defense costs among insurers

14. Issues in Construction Defects Other States • Areas of rapid increase in population • Baby boomers retiring – NV, FL, TX, AZ, CO • Seen increase in activity but legal landscape is different • Statute of limitations shorter • Minimal use of continuous trigger theory • Claim frequency is rising