Loss Reserving

1. Anatomy of a claim 12/15/99 Auto accident 12/20/99 Insured reports accident to agent 1/7/00 Claim recorded 2/3/00 $10,000 reserve set 1/8/01 Pay $3000 medical expenses; offer $15,000 settlement; $15,000 reserve set 7/2/01 Offer refused 9/8/01 Lawsuit files 4/1/02 $20,000 reserve 1/6/03 $40,000 reserve 10/6/04 Court awards $32,000 Incurred loss development Accident Year 1999 1999 IBNR 2000 $10,000 2001 $18,000 2002 $23,000 $43,000 2004 $32,000 Loss Reserving

2. Definitions Individual claim file estimates Paid loss development Considers only loss payments Paid loss development factors Incurred loss development Paid plus case reserves Incurred loss development factors Loss adjustment expenses Allocated Unallocated

3. Loss reserve methods Unsophisticated methods: Case reserve plus Expected loss ratio method More accurate methods: Chain ladder or loss development triangle method Bornhuetter-Ferguson method Frequency and severity estimates

4. Cumulative Loss Payments Accident Development Age (Months) Year 12 24 36 48 60 72 84 96 1997 5445 8602 11052 12464 13064 13416 13847 14032 1998 5847 9333 10699 11547 12592 13646 14015 1999 5981 10835 12783 15337 17017 17506 2000 7835 12288 16176 19511 21599 2001 9763 16280 19843 23827 2002 10745 16929 21478 2003 14137 22253 2004 15162 Assume that no further losses are paid after 96 months.

5. Paid Loss Development Factors Accident Link Factors Year 12-24 24-36 36-48 48-60 60-72 72-84 84-96 1997 1.580 1.285 1.128 1.048 1.027 1.032 1.013 1998 1.596 1.146 1.079 1.090 1.084 1.027 1999 1.812 1.180 1.200 1.110 1.029 2000 1.568 1.316 1.206 1.107 2001 1.668 1.219 1.201 2002 1.576 1.269 2003 1.574 Ave. 1.625 1.236 1.163 1.089 1.047 1.030 1.013 Age- 2.779 1.710 1.384 1.190 1.092 1.043 1.013 Ultimate

6. Estimated Loss Reserves Based on Average Paid Loss Development Factors Age to Accident Paid to Ultimate Ultimate Loss Year Date Factor Losses Reserve 1997 14032 1.000 14032 0 1998 14015 1.013 14197 182 1999 17506 1.043 18259 753 2000 21599 1.092 23586 1987 2001 23827 1.190 28354 4527 2002 21478 1.384 29726 8248 2003 22253 1.710 38053 15800 2004 15162 2.779 42135 26973 Total 149872 208342 58470

7. Expected Loss Ratio Method Estimated Ultimate Losses = Expected Loss Ratio x Earned Premium Estimated Loss Reserve = Estimated Ultimate Losses - Losses Paid to Date Example 2004 Earned Premium = 65,000 Expected Loss Ratio = 60% Estimated Ultimate Losses = 39,000 Losses Paid to Date = 15,162 Estimated Loss Reserve 23,838

8. Bornhuetter-Ferguson Method2004 Accident Year Estimated Loss Reserve = Total Expected Losses x % of Losses to Be Paid in Future % of Losses to Be Paid in Future = 1-(1/Age-Ultimate Factor) Example: 12 Month-Ultimate = 2.779 % of Losses Paid After 12 Months = 1-1/2.779=.640 Total Expected Losses = 65,000 x .60=39,000 Estimated Loss Reserve = 39,000 x .640 = 24,960

9. Results of Different Loss Reserve Methods – Accident Year 2004 Paid Loss Development 26,973 Expected Loss Ratio 23,838 Bornhuetter-Ferguson 24,960

10. Frequency and Severity Estimates Calculate Incurred Claim Counts Determine Loss Frequency = # Claims/Exposure Determine Average Payment per Claim or Average Incurred Loss per Claim (Severity) Trend Frequency and Severity Separately Combine to Determine Ultimate Incurred Losses

11. Incurred Loss Development Similar to paid loss development, but includes case loss reserves

12. Additional Reserving Requirements Loss Adjustment Expense Allocated Sometimes included with losses Unallocated