Asbestos Valuation

1. Asbestos Valuation 2004 Casualty Loss Reserve Seminar Las Vegas, Nevada September 13, 2004 Claus S. Metzner, FSA, FCAS, MAAA, Aktuar – SAV Actuary, Milliman, Inc.

2. Asbestos Valuation • Asbestos Reserve Valuations have received and are receiving a great deal of publicity • Asbestos Reserve Valuations have led to substantial restatement of reserves for many companies – both primary insurers and re-insurers – “surprises” are commonplace • Asbestos Reserve Valuations are an on-going concern of rating agencies and regulators • Why this level of concern? This level of uncertainty? What are our options? • Complexity of valuation – “black box” effect - increases uncertainty and anxiety • What can we learn from the “Asbestos” Experience?

3. Asbestos Valuation What are we faced with? • a large number of claimants • multiple defendants • long latency periods • a number of coverage years • different coverages (products; premises/ops, etc.) • varying policy limits • limited information • complex financial arrangements What are we to do?

4. Asbestos Valuation • Develop techniques to deal with: • A gigantic allocation problem between • The manufacturer/installer/distributor: the insured defendant • The insurers of the manufacturer, etc • The re-insurer • The retrocessionaire • Need to obtain/quantify expert knowledge from claim and legal staff to master the problem • Need to develop monitoring/reporting tools that help avoid “surprises” and mitigate the “black box” effect

5. Asbestos Valuation • Step I: The Insured • Develop the “Universe” of claims for each insured • Consider the type of claim: products versus premises/operations, etc. • Consider the length of the reporting period • Consider legal costs • Consider inflation (all kinds) • Consider issues of bankruptcy

6. Asbestos Valuation • What do we know/what can we find out for Step I? • Historical reporting patterns • Historical frequency and severity • Claim knowledge • Legal knowledge • Goal: develop a set of assumptions and a model for the projection of the ultimate claims and the allocation to coverage period • Quantifying the “expert knowledge” • Developing Monitoring Tools • Claims function • Management function

7. Asbestos Valuation • After we have all the assumptions, how do we model the results ?(the assumptions are developed with the help of claim and legal experts!) • Assumptions are generally not just a best estimate • Assumptions have a distribution, a range, of possible outcomes • Model on a stochastic basis (note: less than perfect approximations are useful – the output of the model provides information as to the sensitivity of key assumptions) • The assumptions form the basis for monitoring: “actual” versus “expected”

8. Asbestos Valuation • Step II: The Insurer • Once we have obtained the model output (note – this is a range of outputs!) can apply coverage charts to obtain the range of ultimate losses • Policy limits important • Primary versus excess • Other special coverage conditions (manuscript forms)

9. Asbestos Valuation • Having developed the range of ultimate losses for each insured, can now subtract the payments to date to obtain a range of reserves for each insured • Note 1: pay special attention to validation routines on an account by account basis – the “smell test” – using the collective knowledge of claim and legal experts • Note 2: consider if a covariance adjustment is appropriate – i.e. will everything go bad at the same time? - if no co-variance adjustment is used, the range may be misstated on the high side; if complete independence assumed, the range may be misstated on the low side • Each company’s mix of business by state, by type of insured, etc. should be considered

10. Asbestos Valuation • “Smaller” insureds with reported asbestos claims – some alternatives for the valuation • Use the information gained from the modeling process for large accounts to group small accounts • Treat each group as if it were a single account and model • Use a review of emerging claims to assess products and premises/operations coverage • Use a review of the types of accounts to evaluate potential impact of policy limits

11. Asbestos Valuation • IBNR • A very difficult subject but note the following • Major asbestos defendants have long since been identified and are presumably already modeled – see Step I • Minor defendants are emerging - model how many additional accounts may report claims in the future and apply frequency/severity assumptions per account – in the alternative, model number of emerging claims (note that policy limits may not apply – c.f. reinsurance impact) • Consider where you are on the “reporting” curve • May want to consider issues of “modeling risk” as part of IBNR

12. Asbestos Valuation • Step 3: Assess Reinsurance Recoverable • Reinsurance Program for each coverage/underwriting year can be applied to each outcome of the ultimate losses to develop a range of reinsurance recoverable consistent with the gross ultimate losses • Consider: dimunition/exhaustion of coverage due to other types of claims and previous payments • Consider: facultative/treaty/etc. • Consider: what accounts are generating IBNR and will the emergence of the IBNR claims even trigger reinsurance • Consider: creditworthiness

13. Asbestos Valuation • The previous steps have taken us through the process of developing a gross and a net liability for the primary insurer • Now we come to the re-insurer

14. Asbestos Valuation • What are some key differences between the primary insurance valuation problems and the reinsurance valuation problem? • Re-insurer has less information than the primary insurer • Potentially more heterogeneous book of business • Generally higher attachment points • Generally longer lags until claims are reported • Potential that primary companies’ reserving problems lead to a (massive) understatement of reinsurance recoverable by primary companies and understatement of re-insurer’s liability

15. Asbestos Valuation • Possible remedies for the lack of data • For primary companies representing a large portion of the exposure, investigate who the major insured accounts were for the years in question – then follow primary process with superimposed reinsurance program • Adjust reported data for • Perceived reserve inadequacies • For better/worse than average reporting of data • Quality and timeliness and relative case basis reserve adequacy are important • Consider the limits profile of the primary company • Consider the source of the primary company’s IBNR (products vs non-products; size of claim anticipated)

16. Asbestos Valuation • Retrocessionaire Issues • Even less data available • Longer report lags • “Spiral” may be critical – e.g. London Excess Market • IBNR very important, but the least amount of information is available • Consider if the market under review – e.g., LMX – can be viewed as a pool

17. Asbestos Valuation • Management Information/Monitoring • Assumptions provide the basis for monitoring on a quarterly basis • Monitoring doesn’t mean changing the answer • Monitoring means assessing when we should “drill down” • Monitoring means an on-going information flow and dialogue with • Claim/legal experts • Management • Others • Explanation of “what’s going on”

18. Asbestos Valuation • Monitoring Tools • Actual versus expected payments • Actual versus expected newly reported accounts • Actual versus expected number of new claimants • Actual versus expected average values • Etc.

19. Asbestos Valuation • Summary • Key issues • Long latency period • Multiple coverage years • Complex legal issues • Complex financial structures • Lack of data

20. Asbestos Valuation • Summary • Key Approaches • Gain as much information as possible • Use expertise of claim and legal staff to develop assumptions • Model results stochastically • Assumptions are documented • Can measure impact of change in environment as reflected in revised assumptions • Use consistent underlying assumptions to model primary, excess, reinsurance layers

21. Asbestos Valuation • Summary • Expect to be “surprised” • Keep monitoring and updating • We are engaged not just in a loss reserve project but in financial reporting • Remove the “black box” effect • Stay in close contact with claim and legal professionals • What Else Do We Know • Similar reserving problems in other areas: Construction Defect, for example • Similar approaches to reserving may be our best opportunity to stay current with emerging liabilities