Under-Reserving Insolvency Link

1. Under-Reserving Insolvency Link Casualty Loss Reserve Seminar September 13, 2005 Chuck Emma, Pinnacle Tom Ryan, Milliman John J. Kollar, ISO

2. ISO Study of Loss and Loss Adjustment Expense ReservesA. Industry Schedule P (Net)B. Analysis of Direct Losses Casualty Loss Reserve Seminar September 13, 2005 John J. Kollar, ISO

3. A. Industry Loss Reserve Analysis • More than 900 insurer groups • Year-ended 12/31/04 • Schedule P data compiled by A. M. Best • More than 95% of LLAE reserves for studied lines • PRELIMINARY RESULTS

4. PP Auto Liability HO/Farmowners Com. Auto Liability Other & Products Liab. Claims-Made Other Liab. Occurrence Com. Multi-Peril Med Mal Occurrence Med Mal Claims-Made Products Occurrence Reinsurance (Non-Proportional Liability) Workers Compensation Lines studied

5. Some Key Points • Indications are PRELIMINARY; we have not yet selected final LDFs & ranges • Excludes reserves for environmental and asbestos (E&A) claims • Possibly $30B to $50B deficient • Analysis assumes incurred losses from 9/11 were fully developed at year-end 2004 • Estimated direct insured losses: $20B to $30B • U.S. net insured losses: $6B to $9B • Adjustments have been made for other major catastrophes

6. Methodologies • Paid link-ratio technique • Case-incurred link-ratio technique • Consistent with ISO study of 2003 data

7. Factors affecting analysis • Data quality • Development factors • Tail factors • Professional judgment

8. Conventions • Each deficiency/redundancy expressed as percentageof indicated undiscounted reserve as estimated by ISO • Positive percentages indicate deficiencies • Negative percentages indicate redundancies

9. Preliminary Summary Indications of Reserve Deficiencies PaidCase Incurred • Lines Studied + 6% +8% • All Other Lines + 4% + 4% • Total – all lines + 6% +8% • In Dollars $26B $34B • (excluding E & A )

10. Perspective (Preliminary) • Reserve adequacy has improved for 3 consecutive years • Reserves were about 3 percentage points more adequate at year-end 2004 than at year-end 2003 • Reserves were about 12 percentage points more adequate at year-end 2004 than at year-end 2001

11. Preliminary Indications by Line • Lines with deficiencies PaidCase Inc. • Products Occurrence + 7% +12% • Com. Multi-Peril + 1% + 5% • Workers Comp + 9% +15% • Reinsurance (Non-Prop.) +47% +39%

12. Preliminary Indications by Line • Other Lines PaidCase Inc. • Priv. Pass. Auto Liability - 4% - 6% • Homeowners/Farmowners -16% -10% • Commercial Auto Liability -10% - 1% • Other Liability Occurrence - 6% + 3% • Claims Made Other & Prod. - 8% + 1% • Medical Malpractice – Occ. - 9% + 2% • Medical Malpractice – C-M. - 15% -12%

13. LALAE Ratios: Accident Year vs. Calendar Year Reserve adequacy deteriorated for at least 6 years but then improved in 2002, 2003 & 2004.

14. Loss Reserve Changes vs. Industry Profitability, All Lines Changes in reserves are correlated with profitability.

15. Retrospective Estimated Deficiencies & Economic Discount, All Studied Lines Discounted reserves were inadequate from 2000 to 2003.

16. B. Analysis of Direct Losses • Segment Analysis • State/coverage/class group/etc. • Benchmarking • Comparable mix of business • Tail Factors • Confidence Intervals

17. Schedule P Lines with ISO Distributions • Homeowners/Farmowners - Homeowners • Private Passenger Auto Liability/Medical • Commercial Auto/Truck Liability/Medical • Commercial Multiple Peril - Commercial Multiple Peril Liability - Commercial Multiple Peril Property

18. Schedule P Lines with ISO Distributions (Cont’d) • Medical Malpractice - Occurrence - Hospitals - Physicians - Surgeons • Other Liability - Occurrence • Products Liability - Occurrence • Auto Physical Damage - Commercial Auto Physical Damage - Private Passenger Auto Physical Damage

19. Schedule P Lines withISO Distributions (Cont’d) • Special Property - Fire - Allied Lines - Inland Marine

20. Segment Analysis The Sch. P data is net, includes Composite Rated Risks (CRR), and is evaluated as of 12, 24, etc. months. The ISO data is direct, excludes CRR (except as noted), and is evaluated as of 15, 27, etc. months.

21. Benchmarking • Used aggregate direct data by segment • State/coverage/class/etc. • Paid/incurred/losses/claim counts/LAE • Weighted aggregate direct data by each insurer’s unique mix of business • Losses rather than link ratios • Separately for each accident year

22. Tail Factors • Modified Bondy Method The ultimate factor (UF) determined using the first prior factor (FF) and the second prior factor (SF) as follows: If SF > 1 and [ 0.8 * LN(SF) >= LN(FF) >= 0 ] or SF < 1 and [ 0.8 * LN(SF) <= LN(FF) <= 0 ] then UF = FF ^ { LN(FF) / [ LN(SF) – LN(FF) ] } Otherwise, UF = FF ^ 4 • Development beyond 10 years – up to 20 years using direct data

23. Development of Parameters for Confidence Intervals Estimated parameters for claim severity and frequency separately • By line • By settlement lag (valuation)

24. Development of an Insurer’s Confidence Intervals • An insurer’s loss and loss adjustment expense reserves - By line - By accident year (latest valuation) • Reinsurance arrangements - Retention - Coinsurance - Per claim limit • Scale factors to reflect differences in average severity

25. Confidence Interval and Aggregate Loss Reserve Distribution Expected Loss 50% Confidence Interval

26. Confidence Intervals for Loss Reserves – Effect of Reinsurance

27. Confidence Intervals for Loss Reserves – Effect of Size * A mix of Other Liability and Products Liability.

28. Applications • Benchmarking triangles • Combine segments using each insurer’s unique mix of business • Individual segment analysis • Tail Factors • Confidence intervals (ranges around expected)

29. Future Plans • Explore ways of improving reserve estimates • Credibility weighing an insurer’s data with larger data sets • Generation of more refined confidence intervals • Additional tail factor treatments • Correlations between lines/dependencies • What else would be valuable for loss reserving?