2002 Casualty Loss Reserve Seminar Surety Reserving

1. 2002 Casualty Loss Reserve SeminarSurety Reserving Mike Rozema, ACAS, MAAA KPMG LLP

2. Overview • Reserving Considerations • One Loss Reserve Estimation Approach • Premium Deficiency Reserves • Considerations • Use of Bond Default Rates to estimate future losses

3. Reserve Estimate Approach • Gather data • Understand large claim potential • Assign probabilities and scenarios to claims with high bond limits • Estimate gross reserves for all other losses • Estimate ceded reserves • Simulation

4. Step 1 – Gather Data • Bond limits profile • Large claim information • Type of business mix • Reinsurance program

5. Step 2 - Understand the potentially large claims • Review all open claims with significant exposure • One principal, many bonds • Review claims files • Read the contracts • Do not ignore losses with low case reserves

6. Step 3 - Assign probabilities and scenarios to potentially large losses • Interview Claims Personnel • What would you settle these claims for? • What is our maximum exposure? • What is the claims handling strategy? • What is the subrogation potential? • What is the expected payment pattern? • Low, Medium, High, and Other Scenarios • Assign Probabilities and Severities

7. Step 4 – Estimate reserves for all other losses • Use traditional actuarial techniques • Development methods • Bornhuetter-Ferguson • Frequency/Severity • Development patterns affected by bond type • Expense • Subrogation • Statute (Workers Comp Self-insured Bonds)

8. Actuarial SOP No. 36 • Explanatory paragraph required when actuary believes that there are risks and uncertainties that could result in material adverse deviation. • Identify the amount judged to be material • Describe the major factors and particular conditions underlying the risks and uncertainties • Expected value estimate is better than the median or mode when expected value estimates can be significantly greater than other measures.

9. An Example

10. Step 5 – Reinsurance • Surety Treaty Provisions • Surety reinsurance is unique, usually separate from other lines of business • Facultative Reinsurance • Estimate ceded losses for each large loss and for all other claims for each scenario.

11. Step 6 – Simulation • Simulate Gross Losses • Use Large Loss Scenario Probabilities • Use triangle techniques to estimate aggregate reserve distribution for all other claims • Consider correlation between large loss scenarios and other reserves • Estimated Ceded Losses for each Simulation Result

12. Simulation Results • Net and Gross Aggregate Loss Distributions are helpful • Range of reasonable estimates • Identifying and quantifying risk of material adverse deviation • Effectively communicating risk to management • Quantifying reasonable risk loads by bond type

13. Premium Deficiency Reserves • SSAP No. 53 – Property Casualty Contracts - Premiums • When anticipated losses, loss adjustment expenses, commissions, and other acquisition costs exceed the recorded UPR, a premium deficiency reserve is required. • Insurance policies shall be grouped in a manner consistent with how policies are marketed, serviced, and measured.

14. Premium Deficiency Reserves • Considerations • Surety is generally marketed on its own and therefore should be segmented for PDR estimate • Non-cancelable contracts • Multiple year contracts – understand how premium is earned • Restrictive reinsurance market • Regulatory constraints to premium increases • Recession increases frequency

15. Premium Deficiency Reserves – Loss and ALAE estimates • Group principals homogeneously • Bond Type (e.g. Commercial, Contract) • Bond Limit • Financial Strength • Use rating agency corporate bond default rates to estimate claim frequency • Use historical data to estimate claim severity as a percentage of bond limit

16. PDR Loss Estimate - Example

17. Summary • Understand Bond Mix, Limits Profile and Reinsurance Provisions • Large Exposures need detailed analysis • Scenario/simulation approach is useful • Market/economic conditions may result in premium deficiencies