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Reserving in Other Countries

Reserving in Other Countries. Peter A. Royek Toa Reinsurance Company of America Casualty Loss Reserve Seminar Minneapolis, Minnesota September 18, 2000. Why This Session ?. “Affiliate” Membership & “Mutual Recognition” Consolidations / Communication

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Reserving in Other Countries

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  1. Reserving in Other Countries Peter A. Royek Toa Reinsurance Company of America Casualty Loss Reserve Seminar Minneapolis, Minnesota September 18, 2000

  2. Why This Session ? • “Affiliate” Membership & “Mutual Recognition” • Consolidations / Communication • One Actuary’s recent experience - it could happen to you!

  3. Broad Overview of Session • General Discussion of Differences Involving Reserving Among World Markets • Reserving in the United Kingdom • Reserving in Mexico

  4. General Discussion of Differences Involving Reserving Among World Markets • ) Dimensions for Differentiation • ) International Reserving Example

  5. Dimensions for Differentiation • Methods • Reserve Categories • Data • Accounting Rules • Role of the Actuary

  6. Dimensions for DifferentiationMethods • Japan • Strict formula for IBNR calculation • Automobile • Earned Premium for current year X 3% • Personal Accident, Liability, and WC • Earned Premium for current year X 8% • All Other Lines • 0 • Need for change in the future? • Europe (Outside the UK) • Tendency toward a more theoretical, statistical approach

  7. Dimensions for DifferentiationMethods • Others • New IBNR or IBNER requirements or other strict rules for their calculation • Clearly “Standard” Methods are Not Currently Used in these Markets

  8. Dimensions for DifferentiationMethods Rate Inadequacy => Reserve InadequacyTwo Companies Writing the “Same” Risk • Company A - Charges Tariff Rate • Premium = 1,000 • IBNR = 80 (8% x 1,000) • Company B - Deviates Off Tariff Rate • Premium = 700 • IBNR = 56 (8% x 700)

  9. Dimensions for DifferentiationReserve Categories • Premium Deficiency Reserve - Canada • Amount by which UPR is insufficient to cover future loss and expense, liability (if any) must be posted • Appointed Actuary must opine on the adequacy • Similar to Unexpired Risk Reserve in the UK • GAAP adjustment in the US

  10. Dimensions for DifferentiationReserve Categories • Contingency (or Extraordinary Loss) Reserve - Japan • Pre-event loss fund with strict rules for build-up and draw-down • Somewhat similar to Catastrophic Reserve in Mexico • Coming to the US?

  11. Dimensions for DifferentiationReserve Categories • Equalization Reserve - Germany • Can be used for smoothing of results • Like “Topside” or “Corporate” reserves in US companies(?), but these are NOT a separate statutory item • Somewhat like Extraordinary Loss Reserve due to the tax-free feature of these reserves, but NOT the strict rules to build-up or draw-down • Prevision Reserve - Mexico

  12. Dimensions for DifferentiationData • Benchmarks • Not as publicly-available as in the U.S. • AM Best,RAA,etc. • “Private” collections do exist • Consultants • Companies • Canada • Some industry data for Auto • Runoff exhibit in Annual Return NOT by LOB, unlike Schedule P • Japan

  13. Dimensions for DifferentiationData • Other Issues • Not enough data • How to reserve for small or incidental foreign exposure with lack of benchmarks? • Too much data • A “stew” of otherwise-heterogeneous data in a single reserving class • Due to credibility concerns or ceding company reporting?

  14. Dimensions for DifferentiationAccounting Rules • Tax Rates • Basis of Accounting • Different Statutory Statement Items • Fiscal Year/Reporting Frequency • “Combined Ratio”

  15. Dimensions for DifferentiationAccounting RulesTax Rates on Underwriting Income • Japan - 30% • Recent History • 1998 - 34.5% • 1990 through 1997 - 37.5% • 1989 - 40% • United Kingdom - 30%

  16. Dimensions for DifferentiationAccounting RulesTax Rates on Underwriting Income • USA - 35% • Canada - 28% Federal, plus … • Federal Surtax - 1.12%, plus... • Provincial Rates • Ontario - 14.5%, for example, for a combined 43.62% • Federal to lower to 21% by 2005 (excl surtax) • Ontario to lower to 8% by 2005

  17. Dimensions for DifferentiationAccounting RulesBasis of Accounting • Differences when comparing to US Statutory or US GAAP Accounting • Examples in Japan • Valuation of Assets in Japan • Impacts the calculation of “Surplus” • Due to change to “market-based” valuation in 2000/2001 • Consolidation • Companies are making US GAAP Adjustments • Some previously-mentioned items go away • Allows for level comparison of companies

  18. Dimensions for DifferentiationAccounting RulesDifferent Statutory Statement Items • Examples: • Premium Deficiency Reserves • Extraordinary Loss Reserves • Runoff Exhibit in Canadian Annual Return

  19. Dimensions for DifferentiationAccounting RulesFiscal Year / Reporting Frequency • Accounting year-end dates • Japan - 3/31 • Australia - 6/30 • In some markets, results are reported (and IBNR is calculated) only at fiscal year-end

  20. Dimensions for DifferentiationAccounting Rules“Combined Ratio” • Incurred Losses+LAE/EP+Non-Loss Expenses/WP (differs elsewhere) • What does it really tell you about the strength/performance of a company? • Mix of business • Reserve adequacy • Return on equity, revenue, etc. • Potentially leads to bad reserving and underwriting decisions

  21. Dimensions for DifferentiationRole of the Actuary • Canada • Best Estimate • The “minimum” to be carried by the company • Margins above are disclosed • Contrast these with the US • Codification/Best Estimate Reserving coming to the US? • Discounting/PFADs • Discounting only allowed by OSFI for AB • CIA requires reserves be discounted and a Provision for Adverse Deviation (PFAD) be added • Discounted Reserve + PFAD must be >(or =) Company Carried

  22. Dimensions for DifferentiationRole of the Actuary • Canada (continued) • DCAT • Companies operating in Canada now subject • Opining on Premium Liabilities

  23. Dimensions for DifferentiationRole of the Actuary • Japan • Duties of the Actuary listed in “Insurance Business Law” • No Actuarial Judgment in Reserving • Now a Need for Rating Expertise

  24. International Reserving ExampleIntroduction • The “same” piece of business (Treaty/Certificate/Policy) will be run through 4 different scenarios in 3 different jurisdictions • The effects of local reserving rules and tax rates will be run against the same underwriting results

  25. International Reserving Example“Simplifications” • Each company writes only this one account • IBNR thus allocated to this account • Investment Income • Simplified Investment Income calculation, meant only to show that II will vary due to the effect of reserve rules + tax rates on cash available for investment • No variation of investment yield by country • No variation between tax rates on investment income and tax rates on underwriting income

  26. International Reserving Example“Simplifications” • All premium is earned in the first year • No UPR at year end > No “Premium Liability” Issues • Reserve discounting for tax purposes is NOT performed

  27. International Reserving ExampleFramework • LOB = Auto • Premium = 1,000 units • Expenses = 250 units, all paid on 1st day • Expense Ratio = 25% • Investment yield = 5% • Ultimate Loss Ratio = 70% • “Reasonable Range” (for US) is (65%,75%) • Account closed after 5 years • Account history in years 1 through 5 • Payment pattern - 100,100,200,200,100 • Case reserves held at year-ends - 100,100,100,50,0

  28. International Reserving ExampleFramework • Taxes paid at year end on annual underwriting + investment income • Investment income calculated on average cash funds held (oversimplified in this example) • Over- or Under-reserving (where applicable) is adjusted in year 5

  29. International Reserving ExampleFramework • All scenarios will produce an underwriting income of 50 • All scenarios will produce a loss ratio of 70%, an expense ratio of 25%, and a combined ratio of 95% • Net Income and Cash are the items which will vary

  30. International Reserving ExampleScenarios • Japan • IBNR = 30 at Year 1 • Released after Year 1 as all premium is earned • Tax rate = 30%

  31. International Reserving ExampleScenarios • Canada • Company sets loss ratio to the Best Estimate of 70% • IBNR is held to achieve 70% until final settlement • Initial tax rate used is Federal + Ontario provincial rate = 43.62%

  32. International Reserving ExampleScenarios • USA #1 • Company sets loss ratio to the high end of the range - 75% • IBNR is held to achieve 75% until final settlement • Tax rate = 35%

  33. International Reserving ExampleScenarios • USA #2 • Company sets loss ratio to the low end of the range - 65% • IBNR is held to achieve 65% until final settlement • Tax rate = 35%

  34. International Reserving ExampleResults • Japan • IBNR lowest Year 1, then 0 • Takes largest underwriting profit & pays most tax in Year 1. Takes largest U/W losses next 3 years • Overall pays least taxes (lowest rate) • Overall makes least II (while paying overall least taxes, paid a lot in Year 1) • Total Net Income = 60.04

  35. International Reserving ExampleResults • Canada • Sets loss ratio to the “correct”70%, incurs all loss in Year 1 • Earns II between the two US scenarios as it holds reserve level between the two • Overall pays most taxes (highest rate to start) • Total Net Income = 53.66

  36. International Reserving ExampleResults • USA #1 • Company sets high loss ratio 75% • Takes underwriting gain in Year 5 with downward adjustment in loss ratio • Most NI & tax in Year 5 • Overall makes the most II as it holds more reserves longer • Total Net Income = 62.31

  37. International Reserving ExampleResults • USA #2 • Company sets loss ratio - 65% • Takes underwriting loss in Year 5 with upward adjustment • Least NI & tax in Year 5 • II greater only than Japan • Total Net Income = 59.98

  38. International Reserving Example“Conclusion” • The differing reserving rules and tax rates among jurisdictions do impact the results of the “same” account. However: • Factors that were “simplified”or ignored in this example will affect the magnitude and can affect the comparative magnitude of the results • Factors that can vary from those in this example will also affect the magnitude and can also affect the comparative magnitude of the results

  39. Embrace the Differences ! • Know the rules of all the places in which you operate • Operate intelligently (and legally) across your worldwide markets

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