Loss Reserving in Mexico

1. Loss Reserving in Mexico Eduardo Esteva Minneapolis, Minnesota September 18, 2000

2. Background of IBNR Estimation in Mexico Methodology Accounting Rules Data Prevision and Catastrophic Reserves Role of the Actuary Final Comments Index

3. In 1991 the Government began the deregulation of the Insurance Market. This allowed the companies more flexibility in some areas. E.g. relatively easy approval of technical notes for any product that the companies wanted to sell. Background of IBNR Estimation in Mexico

4. The rules regulating IBNR reserves had existed for a long time, but it was not until 1994 that the National Insurance and Surety Commission implemented the rules for estimating the IBNR Reserve. The Commission has chiefly been concerned with the solvency of the Insurance Companies. Background of IBNR Estimation in Mexico

5. The rules for the IBNR Reserve were part of the beginning of a deregulated Insurance Sector. For the first time a Company could choose a methodology for a reserve that must be approved by the Commission and did not need to follow a rule prescribing how to calculate the reserve, like the unearned premium reserve. Background of IBNR Estimation in Mexico

6. The Company needs the approval of the Commission to use or to make any change to the technical note to calculate the IBNR Reserve. In the case of a change, there is also a requirement for a study on the impact of the change, including an analysis of the change by an external appointed actuary. Background of IBNR Estimation in Mexico

7. For the creation of the reserves the companies had to book at least 50% of the amount of the reserve by December 1996 and 100% by December 1997 Background of IBNR Estimation in Mexico

8. Each Company may select its own methodology to estimate the reserve, but it needs to be mechanical. It can use different methods, but it must determine a rule for selecting all the factors and the ultimate loss amounts. (e.g. a volume-weighted average of the methods) Methodology

9. Concerning this constraint, it is not possible to make any selection of patterns or ultimate amounts, the only exception is the selection of the tail factor. Also, if the results include a series of report-to-report factors that go down and then up, the actuary must adjust the series. (e.g. if we have 1.2, 1.1, 1.15, the 1.1 must be adjusted) Methodology

10. At this moment the Commission does not allow the companies to have a negative IBNR Reserve, the reserve must be set equal to zero. It is not usual that a company estimates the IBNR Reserve net of Salvage and Subrogation. The insurance sector in general only uses the incurred loss development method, rather than both the paid and incurred methods. Methodology

11. In Mexico there are some differences in the accounting rules compared to the USA, that can affect the amount of the IBNR Reserve. Some of the more important differences are as follows: Accounting Rules

12. Reinsurance The Proportional contracts are the only ones considered as ceded premium, and the Non Proportional contracts are considered in the acquisition cost. For this reason, the net IBNR Reserve is typically only net of proportional contracts, booking a reserve net of the non proportional contracts is subject to approval by the commission. Accounting Rules

13. In Mexico there is not Case Reserve for ALAE and there are not any ULAE Reserves for the day to day claims. These are considered to be operational or claim costs for the company and must be paid by the cash flow of the company. The only required loss expense reserve is for ALAE related to the IBNR claims. Accounting Rules

14. In general you do not use the IBNR Reserve if you have a claim that is IBNR, you only adjust the reserve at the end of the accounting period. Accounting Rules

15. The information concerning the IBNR (Loss triangles) has been requested by the Commission on a quarterly basis since 1994 for paid claims and since 1997 for incurred claims. This information is requested separately by: LOB. Liability and Non Liability within the LOB. Currency (National and foreign) Data

16. On an annual basis other information has been required by the Commission since 1994, with some adjustments in 1997. The required report is similar to Schedule P, but one of the big differences is that the premium that is reported is the premium written in the year and not the earned premium. Data

17. Up to now the information reported by the companies is not available to the public or the insurance companies or consulting firms. We are not sure if and when it will be publicly available. Data

18. Prevision Reserve The purpose of this reserve is to have a liability in case the company has a significant deviation in loss ratio. The reserve is part of the Risk Based Capital and it is increased by a percentage of the written premium from the company. Prevision and Catastrophic Reserves

19. Prevision and Catastrophic Reserves • Catastrophic Reserve • This reserve is a liability created, at the moment, based on Earthquake risk. • This reserve is created net of reinsurance generally calculated using a model that takes into consideration the geographic location of the building and other factors.

20. Prevision and Catastrophic Reserves • For the release of these reserves, the Company needs approval from the Commission and also must make a program to constitute it again.

21. Background In Mexico an Actuary receives a degree in the University after studying between 4 and 5 years and needs to have an official governmental document as a professional credential. To be an appointed actuary, one must complete some additional requirements set by the Commission, including some professional exams or a special approval from the National College of Actuaries. Role of the Actuary

22. The Commission requires that the technical note describing the estimation of the IBNR reserve should be sent with the approval of an Actuary. In case of a modification of the technical note, it should also be presented with the approval of an external appointed actuary. Role of the Actuary

23. Each year, not later than 28 of February, each company must present to the Commission an external actuarial opinion for all the reserves. This report is signed by the appointed actuary. Role of the Actuary

24. It is clear, that up to now the rules for the estimation of the IBNR Reserve are not very flexible. There is also a lack of knowledge of the methods that actuaries should use to calculate and evaluate the reserves, inside the companies by the appointed actuaries and in the insurance sector. Final Comments

25. This lack of knowledge allows the Commission to make strict rules, but it is sure, if the actuaries in Mexico learn and have more experience with the valuation of the Loss Reserve that the regulation can become more flexible. Currently the Commission is open to analyze any case and may give special treatment if the company and its appointed actuary can justify it. Final Comments

26. The National College of Actuaries is working to better prepare the actuaries, so that collectively we will be better able to perform loss reserve analyses. Also, our profession in Mexico is developing a continuing education structure. Final Comments

27. As a final note it can be interesting to know that in Mexico the Life LOB can have a significant IBNR Reserve. Also, we do not have at this moment very long tails compared with other countries in North America, the longest tails can be in transport and in credit life or life for governmental workers. Final Comments