Buckeye Actuarial Continuing Education April 26, 2011

1. Buckeye Actuarial Continuing Education April 26, 2011

2. Construction Defect Claim Management and Reserving • Presented by: • Nathan Voorhis, FCAS, MAAA • Robin Leibrock, JD • Steven Jokerst, FCAS, MAAA 2

3. What is a Construction Defect Claim? • CGL Policy – completed operations • Builder, developer, contractor, subcontractor • Construction, repair, remodel • Residential and commercial buildings • Resultant BI or PD, not the work itself • Types of defects • Faulty design, workmanship or material • Roofing, flashing, soil preparation, framing, waterproofing, doors & windows, carpentry • Construction defect • Multiple defendants, defects and policies 3

4. Where is this a Problem? • Rapid growth and poor construction • Litigious environment and highly organized plaintiff bar • Continuous trigger occurrence • California and other western states • Certain states in northeast and southeast 4

5. Legal Decisions and Statutes • (1995) Montrose vs. Admiral – known and progressive loss a covered occurrence • (1996) Stonewall Ins. Co. vs. City of Palos Verdes Estates - Montrose applied to CD claims • (1997) Calderon Process / (2002) Steinberg Bill – establish procedures for filing CD claim • (2001) Presley Homes vs. American States – broad duty to defend • California Statute of Limitation and Repose • Patent defect – 3 years if reasonably apparent • Latent defect – 10 years if not apparent • (2004) L-J, Inc. vs. Bituminous F&M – no coverage for “your work” 5

6. Coverage Endorsements • Revise policy language to clearly reflecting intended coverage • Occurrence • Known or continuous loss (Montrose) exclusion – must first become aware during policy period • Prior work exclusion – no coverage for work completed prior to stated date • Redefine “occurrence” • Exclusions for specified hazards and operations • EIFS, mold, subsidence, imported drywall • Roofing, residential construction 6

7. Coverage Endorsements • Additional insured endorsement – subcontractor policy covers GC for work performed on his behalf • Other insurance endorsement • Failure to complete your work • Subrogation against third parties • Abandoning the project 7

8. CD Claim Adjustment/Adjudication • Claim made by owner, developer, builder, general contractor • Multiple Tenders • Named insured; additional insured • Co-carrier for Named Insured • Indemnitee • Document intensive • HO Matrix • Notice of Completion dates, Close of Escrow dates • Multiple policies, contracts, job and correspondence files • Trigger of Coverage 8

9. Liability Claim vs. CD Claim • Liability Claim • One or few plaintiffs • Few defendants • Known loss date • Few damages / injuries • One policy period triggered • Shorter Statute of Limitation (BI 1-6 years; PD 1-10 years) • Typically the primary focus is on Liability, rather than Coverage or Damages 9

10. Liability Claim vs. CD Claim • CD Claim • Multiple plaintiffs – sometimes 100’s of homeowners • Multiple defendants – design professional, developer, general contractor, multiple subcontractors • Undetermined loss date • Multiple damages • Multiple policy periods • Longer Statute of Limitation (breach of contract 3-20 years) • Typically the primary focus is on Damages and Coverage, rather than Liability 10

11. Contracts, Coverage and Allocation • CD claims typically involve multiple contracts (design professional/owner; owner/developer; developer/builder; builder/GC; GC/sub; Sub/sub) • The coverage available and priority of coverage must be analyzed for each contract and each policy triggered • Allocation of claim costs • Defense expenses – each policy is obligated to answer so most courts require cost sharing by equal shares; some courts allow sharing on a prorata basis • Loss – time on risk; prorata by limits; combination 11

12. Difficulties with Traditional Actuarial Methods Very long reporting lag – Pure IBNR dominates Not ideal to combine with other book of general liability claims. Even if premises/operations claims are excluded, development pattern is different from typical products/completed operations pattern If construction defect triangles broken out separately, exposure base for Bornhuetter-Ferguson approach is subjective as there is no “construction defect” premium since triangles broken out by cause of loss. Most companies do not have sufficient accident year data to capture tail. Tail estimation is very subjective. Legislation has calendar year effect, affecting all accident years along a given diagonal. 12

13. General Liability Claim Count Accident Year Reported Development – CD vs NonCD 13

14. General Liability Accident YearIncurred Loss Development – CD vs NonCD 14

15. General Liability Accident YearPaid Loss Development – CD vs NonCD 15

16. Incurred But Not Enough Analysis • Case Development Existing Claims • Incurred loss development approach organized in a report year format. • Significantly reduced tail • Must allocate estimated report year IBNR to accident year • Can choose among various methods including incurred losses, case reserves, construction contractors premium, or other basis • Multiple methods can be used; for simplicity this demonstration uses only an incurred development approach. 16

17. Incurred But Not Enough AnalysisReport Year Construction Defect Loss Development 17

18. Incurred But Not Enough AnalysisReport Year Summary of IBNE ($ Millions) 18

19. Incurred But Not Enough AnalysisAllocation of IBNE to Accident Year ($ Millions) 19

20. Pure Incurred But Not Reported Analysis • Accident year analysis of reported claim counts • Selected Loss Severity • Selected ALAE / Loss Ratio • Selected Claims Closed with Pay 20

21. Pure IBNR AnalysisAccident Year Claim Count Development 21

22. Pure IBNR Analysis - Summary of IBNR Claim Counts (000’s) 22

23. Pure IBNR AnalysisSelected Loss Severity • Review past historical average paid loss and/or incurred loss severity ratios • Exclude unusual claims or years • Incorporate IBNE into incurred severity calculation 23

24. Pure IBNR AnalysisSelected ALAE / Loss Ratio • Review past paid ALAE to paid loss and/or incurred ALAE to incurred loss ratios • Ratios above 100% not uncommon • Alternatively, severity analysis separately for ALAE 24

25. Pure IBNR AnalysisSelected Claims Closed without Pay • Review past claims closed without pay to total closed ratios • Ratios above 75% not uncommon; significant variability by policy year 25

26. Pure IBNR Analysis - Summary of IBNR 26

27. Summary of Construction Defect Losses ($ Millions) 27

28. Recent Years • Most recent three years or so still very green • Possible approaches • Hold loss ratio (use earned premium exposure summarizing only construction contractors classes) • B/F accident year approach (use earned premium exposure summarizing only construction contractors classes) • Same approach as described if large and stable enough book of data 28

29. Q & A 29

30. Buckeye Actuarial Continuing Education April 26, 2011