Basic Track III 2001 CLRS September 2001 New

Basic Track III 2001 CLRS September 2001 New Orleans, Louisiana Slide 1

THIS SESSION WILL DISCUSS I. Expected Loss Ratio Technique II. Allocated Loss Adjustment Expenses (ALAE) (Defense and Cost Containment) III. Unallocated Loss Adjustment Expenses (ULAE) (Adjusting and Other Expenses) IV. Schedule P - Part 1 Summary Slide 2

EXPECTED LOSS RATIO TECHNIQUE EXPECTED LOSS RATIO (ELR) The anticipated ratio of projected ultimate losses to earned premiums. Sources: » Pricing assumptions » Historical data such as Schedule P » Industry data Slide 3

EXPECTED LOSS RATIO TECHNIQUE EXAMPLE OF ELR USING PRICING ASSUMPTIONS Commissions 20% Taxes General Expenses 5% 15% Profit (2%) Total 38% Amount to pay for loss & loss expense ---- 62% of premium Slide 4

EXPECTED LOSS RATIO TECHNIQUE Slide 5

EXPECTED LOSS RATIO TECHNIQUE Estimating Reserves Based on ELR Earned Premium x ELR = Expected Ultimate Losses - Paid Losses = Total Reserve - Case Reserve = IBNR Reserve Slide 6

EXPECTED LOSS RATIO TECHNIQUE Estimating Reserves Based on ELR - Example Earned Premium Expected Loss Ratio Paid Losses Case Reserves Total = $100, 000 = 0. 65 = $10, 000 = $13, 000 = ($100, 000 x 0. 65) - $10, 000 Reserve = $65, 000 - $10, 000 = $55, 000 IBNR = $55, 000 - $13, 000 Reserve = $42, 000 Slide 7

EXPECTED LOSS RATIO TECHNIQUE Estimating Reserves Based on ELR Use when you have no history such as: – – – New product lines Radical changes in product lines Immature accident years for long tailed lines Can generate “negative” reserves if Ultimate Losses < Paid Losses Slide 8

EXPECTED LOSS RATIO TECHNIQUE Reserves Based on ELR and Reported Incurred (Bornhuetter-Ferguson Approach) (Earned Premium x ELR) x (IBNR Factor) = (IBNR Reserves) Where IBNR Factor = (1. 000 - 1. 000/LDF*) Reported Incurred + IBNR Reserve = Ultimate Losses Case Reserve + IBNR Reserve = Total Reserve *LDF is the cumulative Loss Development Factor to ultimate based on incurred losses. The IBNR Factor is the percent of expected losses unreported. Slide 9

EXPECTED LOSS RATIO TECHNIQUE Slide 10

EXPECTED LOSS RATIO TECHNIQUE Slide 11

EXPECTED LOSS RATIO TECHNIQUE Slide 12

BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE Given the following, how many home runs will Ken Griffey, Jr. hit this year? ¬ He has hit 20 home runs through 40 games There are 160 games in a season Three pieces of information are need to perform a Bornhuetter-Ferguson (B-F) projection: ¬ Expected Ultimate Value Cumulative Loss Development Factor ® Amount Incurred To Date Slide 13

BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE The three pieces of information for our example : ¬ Before the season started, how many home runs would we have expected Ken Griffey, Jr. to hit? Expected Ultimate Value = 40 To project season total from current statistics, multiply the current statistics by 4 since the season is 1/4 completed. Cumulative Loss Development Factor = 4. 000 ® He has already hit 20 home runs. Amount Incurred To Date = 20 Slide 14

BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE B-F Projection: Ultimate Value = (Expected Value*IBNR Factor)+(Inc. to Date) IBNR Factor = 1. 000 - (1. 000/LDF) = 1. 000 - (1. 000/4. 000) =. 75 (In Other Words, 75% of the season is left to be played) Ultimate Value = (40 *. 75) + 20 = 50 The B-F Method projects that Ken Griffey, Jr. will hit 50 home runs this year. Games 0 -40 Games 41 -80 Games 81 -120 Games 121 -160 20 Home Runs 10 Home Runs Slide 15

BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE Comparison of B-F with Two Other Methods ¬ Incurred Loss Development Method Ultimate Value = Incurred To Date * Cumulative LDF = 20 * 4. 000 = 80 Home Runs Games 0 -40 20 Home Runs Games 41 -80 20 Home Runs Games 81 -120 20 Home Runs Games 121 -160 20 Home Runs Expected Loss Ratio Method Ultimate Value = Expected Value = 40 Home Runs Games 0 -40 10 Home Runs Games 41 -80 10 Home Runs Games 81 -120 10 Home Runs Games 121 -160 10 Home Runs Slide 16

EXPECTED LOSS RATIO TECHNIQUE Reserves Based on ELR and Reported Incurred (BORNHUETTER-FERGUSON) ASSUMPTIONS SAMPLE PROBLEMS Premium accurate measure of exposure Pricing inconsistency Expected loss ratio predictable Instability in accident year loss ratios Constant reporting, reserving and settling Introduction of automated claim system Backlog in processing Slide 17

EXPECTED LOSS RATIO TECHNIQUE Reserves Based on ELR and Reported Incurred (BORNHUETTER-FERGUSON) ADVANTAGES DISADVANTAGES Compromises between loss development and expected loss ratio methods Assumes that case development is unrelated to reported losses Avoids overreaction to unexpected incurred losses to date Relies on accuracy of expected loss ratio and reporting pattern Suitable for new or volatile line of business Less responsive to losses incurred to date Can be used with no internal loss history Relies on accuracy of earned premium Easy to use Slide 18

ALAE RESERVING METHODS ALLOCATED LOSS ADJUSTMENT EXPENSE (ALAE) Previous Definition : Expenses that are specifically assigned to an individual claim Currently Called: DEFENSE AND COST CONTAINMENT EXPENSE Slide 19

ALAE RESERVING METHODS DEFENSE AND COST CONTAINMENT EXPENSE Current Definition (effective 1/1/98) : Limits ALAE to internal or external expenses relating to the following · Defense · Litigation · Medical Cost Containment Therefore, the ability to assign a particular type of expense to a single claim is no longer the determining factor as to whether the expense is ALAE or ULAE “Loss Adjustment Expenses” other than allocated expenses are assigned to the group Unallocated Loss Adjustment Expense Slide 20

ALAE RESERVING METHODS 1. PAID ALAE DEVELOPMENT 2. CUMULATIVE PAID ALAE TO CUMULATIVE PAID LOSSES Slide 21

ALAE RESERVING METHODS Slide 22

ALAE RESERVING METHODS Slide 23

ALAE RESERVING METHODS ALAE Reserves Based on Paid ALAE Development ADVANTAGES DISADVANTAGES Similar to paid losses; easy & straightforward Ignores relationship to losses May work well for older AYs Heavily influenced by amount of highly volatile initial payments Slide 24

ALAE RESERVING METHODS Slide 25

ALAE RESERVING METHODS Slide 26

ALAE RESERVING METHODS Slide 27

ALAE RESERVING METHODS Slide 28

ALAE RESERVING METHODS ADVANTAGES DISADVANTAGES Recognizes relationship of ALAE to losses. Over or under estimation of losses reflected in ALAE estimates. Straightforward methodology, predictable. More complex than paid ALAE development. Provides tool for monitoring relationship of ALAE to losses. Heavily influenced by volatile initial ratios of ALAE to loss. Significant ALAE can be spent to close claims without payment. Changes in legal defense strategies may distort. Slide 29

ULAE RESERVING METHODS UNALLOCATED LOSS ADJUSTMENT EXPENSE (ULAE) Previous Definition : Expenses incurred in connection with settling claims which are not readily assigned to specific claims Currently Called: ADJUSTING & OTHER EXPENSE Slide 30

ULAE RESERVING METHODS ADJUSTING & OTHER EXPENSE Current Definition (effective 1/1/98) : Those expenses, other than allocated expenses, assigned to the expense group “Loss Adjustment Expense”. Unallocated expenses include but are not limited to the following : » Fees of adjustors and settling agents » Attorney fees incurred in the determination of coverage, including litigation between insurer and policyholder » Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators Slide 31

ULAE RESERVING METHODS THE “ 50/50” Rule Assumes 50% of ULAE is paid when the claim is opened, and 50% is paid when the claim is closed. Slide 32

ULAE RESERVING METHODS The “ 50/50” Rule • 3 year average of the ratio of calendar year paid ULAE to paid losses. • 50% of the ratio applied to known case loss reserves. • 100% of the ratio applied to IBNR reserves. • It may be necessary to separate the “broad” IBNR reserve into development on known case reserves and “pure” IBNR. Slide 33

ULAE RESERVING METHODS Consideration in Selecting Ratio of Calendar Year Paid ULAE to Paid Losses Average over 3 years may not produce appropriate factor: • ULAE payments may not completely correlate to the years’ loss payments May need to judgmentally select factor based on: • Steadily increasing or decreasing factors • Changes in expense allocation procedures Slide 34

ULAE RESERVING METHODS Slide 35

ULAE RESERVING METHODS Slide 36

ULAE RESERVING METHODS Assumptions in Applying “ 50/50” Rule l l l Age of claim does not affect the ratio of paid ULAE to Losses ULAE and Losses are paid at the same rate These assumptions should be reviewed for each situation where the “ 50/50” rule is used Slide 37

ULAE RESERVING METHODS Recent Developments in ULAE Reporting Effective with the 1997 Annual Statement, the “ 50/50” rule no longer underlies annual statement Schedule P reporting of paid unallocated expenses. Rather, unallocated loss expense payments and reserves should be allocated to the years in which the losses were incurred based on the number of claims reported, closed and outstanding in those years. An insurer is permitted to use the “ 50/50” rule or some other reasonable procedure when suitable claim information is not available. Slide 38

SCHEDULE P - PART 1 SUMMARY ANNUAL STATEMENT FOR THE YEAR 2000 OF THE TYPICAL P&C INSURANCE COMPANY Slide 39

DATA AVAILABLE FROM SCHEDULE P l Losses » » » l Direct+Assumed, Ceded Cumulative Paid Losses, Net of Salvage and Subrogation (columns 4 -5) Case Reserves Held (columns 13 -14) Bulk + IBNR Reserves Held (columns 15 -16) Incurred Losses = Paid + Case Reserves + IBNR Reserves Claim Counts » Reported (column 12) » Outstanding (column 25) » Closed = Reported - Outstanding l Loss Adjustment Expenses » Defense and Cost Containment (ALAE) and Adjusting and Other (ULAE) » Direct+Assumed, Ceded » Paid, Case Reserves, Bulk + IBNR Reserves l Earned Premium (columns 1 -3) Slide 40

SCHEDULE P TERMINOLOGY l Bulk + IBNR reserves include: » Reserves for claims not yet reported (pure IBNR) » Claims in transit » Development on known claims » Reserves for reopened claims Reserves = Liabilities = Accruals = Unpaid = Case Reserves + IBNR l Incurred losses may have various meanings! l Slide 41