Intermediate Track I

1. Intermediate Track I Considerations in Evaluating Reserves 2001 CLRS New Orleans, Louisiana

2. Introduction • Purpose: Discuss a number of topics or concepts that are important beyond the rote application of simple techniques to reserving data • Intermediate Tracks II through IV will provide additional insights and techniques useful in addressing several of these issues

3. Considerations • Timing • Loss adjustment expense • Operations • Limits and deductibles • Extrapolation/Interpolation • Model diagnostics

4. Considerations • Timing 1. Average Closed Value is not the same as Average Open Value 2. Closed Savings are not the same as Open Redundancy 3. Early Reported Claims are not the same as Late Reported Claims • Loss adjustment expense • Operations • Limits and deductibles • Tail factors • Model diagnostics

5. Consideration #1 The average value of claims currently closed is often a poor estimator of the ultimate average settlement value of claims still open.

6. Consideration #1 (cont.) Accident Year 1986 Why might this frequently be true?

7. Consideration #1 (cont.) • Claims that close early are often smaller • For example in Workers Compensation: • The cases that close quickly are for minor injuries, and may involve just medical-only costs. • The cases open for a long period represent severe injuries and may include: • Major Medical Expenses • Lifetime Pension Benefits

8. Consideration#2 Savings on closed claims may be a poor estimator of case reserve adequacy for open cases.

9. Consideration #2 (cont.) Examples include: • Often cases that are more adequately reserved settle more quickly (a closer “meeting of the minds”) • Back injuries for Workers Compensation • Changes in Case Reserves Before Settlement

10. Consideration #3 The average costs for late reported claims may differ materially from those reported earlier.

11. Consideration #3 (cont.) Reason: Often, late reported claims have a very different nature than those reported early. (1) General Liability: • Product Liability cases are often reported later • Product cases are often more complex, requiring expert testimony and lengthy litigation • Product cases reported very late may involve latent injury or cumulative exposure, cases which are difficult to define in terms of date of loss, party at fault, number of occurrences, and type or extent of injuries

12. Consideration #3 (cont.) (2) Workers Compensation: Most Workers Compensation cases are reported within the first 18 months. However, when there are late reported claims they often involve occupational diseases, rather than trauma that is quickly identified and assignable to a single accident date and/or policy.

13. Considerations • Timing • Loss adjustment expense 4. The ratio of Paid Allocated Loss Expense (ALAE) to Paid Loss increases over time 5. Segregate ALAE into Components • Operations • Limits and deductibles • Interpolation/extrapolation • Model diagnostics

14. Consideration #4 For an accident year, the future ratio of ALAE to loss may be materially higher than has been true for payments to date.

15. Consideration #4 (cont.) Reasons: 1) Cases open for lengthy periods often involve costly litigation. 2) Legal payments are occasionally disbursed later than loss payments.

16. Consideration #4 (cont.)

17. Consideration #4 (cont.) • This pattern by company can be influenced by many factors, such as the mode of payment of legal bills, which may vary by company between: • Interim Case Billing • End of Case Billing • Other influences can include: • Geographical Differences • Use of Staff Counsel vs. Outside Counsel • Classes of Business • Primary vs. Excess Contracts

18. Consideration #5 Where ALAE costs are rising, it may be useful to split ALAE into components such as: • Outside Attorney Fees • In-House Attorneys • Other Legal • Expert Witnesses • Medical Audits/Reviews

19. Consideration #5 (cont.) Reasons: (1) Legal expense are typically the fastest growing component of ALAE, with a growth rate exceeding trends in loss costs. (2) Many companies have attempted cost savings steps such as: • Use of staff counsel, rather than independent attorneys, in some situations • Use of companies which audit legal bills • More vigorous defense (which may slow payment patterns on loss side) • Initiating contact with the claimant sooner

20. Consideration #5 (cont.) The recent change in the definition of ALAE and ULAE may result in distortions in ALAE development. This recent definition re-defined ALAE to include expenses associated with defense, litigation or medical cost containment expenses, whether internal or external.

21. Considerations • Timing • Loss adjustment expense • Operations 6. Rate adequacy can impact reserving 7. Positive Development does not mean a Claim Department problem 8. Operational changes affect reserving • Limits and deductibles • Interpolation/extrapolation • Model diagnostics

22. Consideration #6 Loss ratios based on prior years’ experience, used in reserving, must be adjusted for any material changes in rate adequacy.

23. Consideration #6 (cont.)

24. Consideration #7 Upward case development does not necessarily demonstrate something “needs fixing” in the Claims Department.

25. Consideration #7 (cont.)

26. Consideration #8 Internal company changes can dramatically affect patterns in reserving data, and distort the result of basic reserving methodologies.

27. Consideration #8 (cont.) For example, suppose the company changed TPA’s 12 months ago, and now has the following triangles:

28. Consideration #8 (cont.) Paid to Reported Ratios are an example of a diagnostic tool which can be used to check for: • Case reserve strengthening (this example) • Case reserve weakening • Change in rate of payment Later sessions will discuss methods, such as the Berquist & Sherman approach to correct for these kinds of changes.

29. Considerations • Timing • Loss adjustment expense • Operations • Limits and deductibles 9. Higher limits mean more future development 10. Higher attachment points mean more future development • Interpolation/extrapolation • Model diagnostics

30. Consideration #9 When reinsurance retentions and/or policy limits increase, the portion of ultimate losses that are reported at each given maturity tends to decrease.

31. Consideration #9 (cont.)

32. Consideration #10 When attachment points increase for reinsurance, excess, umbrella or self-insured coverages, then the percentage of ultimate dollars that is reported at each given maturity tends to decrease.

33. Consideration #10 (cont.)

34. Considerations • Timing • Loss adjustment expense • Operations • Limits and deductibles • Interpolation/extrapolation 11. Incomplete accident years can be deceiving 12. Tail development is important • Model diagnostics

35. Consideration #11 Estimating ultimate losses for an incomplete accident year requires special adjustments.

36. Consideration #11 (cont.)

37. Consideration #11 (cont.)

38. Consideration #12 “Tail Development” can have a dramatic effect on reserve needs.

39. Products Workers Compensation Medical Malpractice Complex issues (Who’s liable? How to prove injury was caused by product? Date of loss?) Occupational Disease Life pension cases, with escalation clauses in some states’ benefit structures Medical costs on life pension cases Child injured at delivery reaches legal age Delayed manifestation, with subsequent complex issues Consideration #12 (cont.) Some examples of when development occurs beyond 10 years

40. Consideration #12 (cont.) Techniques To Derive Tail Factors 1. Examine broader data sources e.g. ISO, NCCI, RAA, AM Best (Caution: Learn the limitations of such data) 2. Curve Fitting 3. Generalized Bondy Method

41. Consideration #12 (cont.) - Broader Data Sources

42. Consideration #12 (cont.) - Example

43. Consideration #12 (cont.) -- Curve Fitting • There are numerous types of curves which are typically used to project tail factors. • One of the common ones is the POWER MODEL: y = abX where: Y = Loss Development Factor X variable = Time (in months) a, b are constants • a and b can be estimated using linear regression techniques by taking the logs of each side of the equation twice.

44. Consideration #12 (cont.) y = abX a = 2,003.6 b = 0.9571

45. Consideration #12 (cont.) -- Bondy Method

46. Considerations • Timing • Loss adjustment expense • Operations • Limits and deductibles • Tail factors • Model diagnostics

47. Consideration #13 Reserving models are just that -- models. As such, modeling assumptions should be identified and the assumptions should be tested.

48. Consideration #13 (cont.) • For example the typical development factor model: • Cumulativet = bCumulativet-1 • This is a regression through the origin. We can test if the intercept of this regression is zero, e.g.:

49. Consideration #13 (cont.) Industry Total GL, Source: Best’s Schedule P

50. Conclusions It is seldom sufficient to simply manipulate the numbers.The actuary must actively seek a thorough understanding of... • ...the loss and claims process • ...the business and the exposures involved • underwriting • pricing • reinsurance • …techniques and models to deal with the available data