PC reserve cycle Reserve changes and communication by
P&C reserve cycle Reserve changes and communication by the P&C Actuary Benny Yuen and Phil Natoli 29 July 2016
What is the reserve cycle?
What is the reserve cycle? Reserve cycle: cyclical behavior observed when measuring reserve development of prior accident years by calendar year. ► Reserve development on prior accident years ($000) - workers' compensation 4 000 Prior year reserve development ($000) 3 000 2 000 1 000 0 -1 000 -2 000 -3 000 -4 000 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Calendar year Source: Aggregated NAIC Annual Statement filings Page 3 29 July 2016 P&C reserve cycle
Accident years tend to develop in one direction from initial estimate Consistent upward development from initial estimate of ultimate loss ► Development of 2002 accident year - workers' compensation 21 500 000 99 180 64 670 147 101 100 114 21 000 91 584 168 588 Reserves ($000) 279 026 268 888 20 500 000 87 663 20 000 19 500 000 19 000 2002 2003 2004 2005 2006 2007 Calendar year Source: Aggregated NAIC Annual Statement filings Page 4 29 July 2016 P&C reserve cycle 2008 2009 2010 2011
Accident years tend to develop in one direction from initial estimate Consistent downward development from initial estimate of ultimate loss ► Development of 2005 accident year - workers' compensation 28 000 1 772 175 Reserves ($000) 26 000 1 455 443 24 000 549 380 281 796 169 100 22 000 95 370 107 823 189 477 53 419 20 000 2002 2003 2004 2005 2006 2007 Calendar year Source: Aggregated NAIC Annual Statement filings Page 5 29 July 2016 P&C reserve cycle 2008 2009 2010 2011
In a given calendar year, similar directional development is exhibited by many prior accident years Prior accident years tend to move together in years with adverse/favorable development Causes of adverse/favorable development impact multiple accident years ► ► Count of favorably/adversely developing accident years – workers’ compensation 4 000 8 3 000 Count of accident years 6 2 000 4 1 000 2 0 0 -2 -1 000 -4 -2 000 -6 -3 000 -8 -10 -4 000 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Calendar year Favorable Source: Aggregated NAIC Annual Statement filings Page 6 29 July 2016 P&C reserve cycle Adverse PY Dev Prior year reserve development ($000) 10
Differentiation between underwriting cycle and reserve cycle Underwriting cycle: cyclical behavior observed when measuring profitability of insurance products by calendar year. ► Underwriting profit – workers’ compensation 10% 5% Underwriting profit 0% -5% -10% -15% -20% -25% 1996 1997 1998 1999 2000 2001 2002 Source: Aggregated NAIC Annual Statement filings Page 7 29 July 2016 P&C reserve cycle 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Underwriting cycle illustrated by historical rate changes ► Similar to underwriting and prior year reserve development, we observe cyclical behavior Source: The Council of Insurance Agents & Brokers. Chart Prepared by Barclays Research Page 8 29 July 2016 P&C reserve cycle
Differentiation between underwriting cycle and reserve cycle Rate changes are reactive to the profitability of a given insurance product ► Workers' compensation UW profit and rate change 10% 30% 25% 5% 20% 15% -5% 10% -10% 5% 0% -15% -20% -10% -25% -15% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Calendar year Underwriting profit Source: Aggregated NAIC Annual Statement filings Page 9 29 July 2016 P&C reserve cycle Rate change 2011 2012 2013 2014 2015 Rate change Underwriting profit 0%
Underwriting cycle vs. reserve cycle: correlation vs. causation ► ► Prior year reserve development directly impacts underwriting profit in a given calendar year and can fuel rate increases/reductions Unclear whether underwriting cycle can prompt prior year reserve change activity 4 000 5% 3 000 2 000 0% 1 000 -5% 0 -10% -1 000 -15% -2 000 -4 000 19 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 -25% 98 -3 000 97 -20% Calendar year Underwriting profit ► Correlation = -50% Source: Aggregated NAIC Annual Statement filings Page 10 29 July 2016 P&C reserve cycle PY reserve dev Prior year reserve development ($000) 10% 96 Underwriting profit Workers' compensation UW profit/PY reserve dev
Potential causes of the reserve cycle Page 11 1 January 2014 Presentation title
Causes of reserve cycle 1. Market events ► ► ► Page 12 Late recognition of changes in frequency or severity trend Unanticipated effects of social, economic and legal trends Development of unanticipated latent claims 29 July 2016 P&C reserve cycle
Workers’ compensation frequency change – late recognition ► Late recognition of frequency increase post recession resulted in reserve actions taken by many WC carriers Source: NCCI State of the Line 2015 https: //www. ncci. com/Articles/Documents/II_AIS-2015 -SOTL-Article. pdf Used with permission from NCCI Page 13 29 July 2016 P&C reserve cycle
Private passenger auto frequency – higher than expectation ► Frequency has continued its upward trend, related to continued economic improvement Source: Seasonally Adjusted Employed from Bureau of Labor Statistics; Rolling Four-Qtr Avg. Frequency from Insurance Services Office; Insurance Information Institute. http: //www. iii. org/presentation/p-c-insurance-industry-outlook-for-2016 -and-beyond-focus-on-texas-markets 071416 Page 14 29 July 2016 P&C reserve cycle
Asbestos and environmental loss development – continued burden on carriers ► Emerged in early 90 s and again in 2000 s ► Insurers always concerned about the “next asbestos” ► Comes down to underpricing the initial expected loss ratio Asbestos calendar year net incurred loss and LAE 9 000 8 000 7 000 6 000 5 000 4 000 3 000 2 000 1 000 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Calendar year Source: Aggregated NAIC Annual Statement filings Page 15 29 July 2016 P&C reserve cycle 2007 2008 2009 2010 2011 2012 2013 2014 2015
Potential causes of the reserve cycle 1. Market events ► ► ► 2. Late recognition of changes in frequency or severity trend Unanticipated effects of social, economic and legal trends Development of unanticipated latent claims Actuarial methods and assumptions ► ► Page 16 Actuarial tendencies can feed into cyclical behavior Lag in response to market events 29 July 2016 P&C reserve cycle
Actuarial methods and assumptions as drivers of reserve development ► ► ► Actuaries have a tendency to select favorable assumptions in profitable periods, unfavorable assumptions in unprofitable periods Actuaries have a tendency to react to favorable news more quickly than adverse news Lag in adjusting assumptions to most recent activity ► ► ► Can result in playing “catch up” Important to stay ahead of deteriorating situation Impact of critical assumptions on initial expected loss ratio Page 17 29 July 2016 P&C reserve cycle
Current position in reserve cycle by line of business Page 18 1 January 2014 Presentation title
Reserve cycle impact by line of business ► ► ► Casualty line cycles correlated Common underlying drivers: economic, social, legal trends Diversification by line of business only partially mitigates impact of market effects Prior year reserve development by line of business Res dev on prior AY / PY reserves 15% 10% 5% 0% -5% -10% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Calendar year WC Med prof Source: Aggregated NAIC Annual Statement filings Page 19 29 July 2016 P&C reserve cycle Other + prod liab Comml auto liab Prv auto liab
Medical professional – reserve releases continue ► ► Favorable development exhibited since 2004; however, reserves appear to be weakening since 2010 Reserve releases more significant on claims made business in late 2000 s Res dev on prior AY / PY reserves* Prior year reserve development by line of business 10% 5% 0% -5% -10% -15% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Calendar Year Med prof occurrence Med prof claims made *Denominator does not include A&O reserves when separating CM/Occ; MCIC Vermont excluded from 2014 calendar year Source: Aggregated NAIC Annual Statement filings Page 20 29 July 2016 P&C reserve cycle 2013 2014 2015
Private and commercial auto – a challenging phase for auto lines Auto carriers challenged by recent period of prior year adverse development Higher than expected frequency likely driving uptick ► ► Prior year reserve development by line of business 10% Res dev on prior AY / PY reserves 8% 6% 4% 2% 0% -2% -4% -6% -8% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Calendar year Comml auto liab Source: Aggregated NAIC Annual Statement filings Page 21 29 July 2016 P&C reserve cycle Prv auto liab 2009 2010 2011 2012 2013 2014 2015
Other liability – adverse development in 2015, continued impact of asbestos liabilities 2015 exhibited adverse prior year development, driven by large commercial writers Materially impacted by continued asbestos liability development ► ► Prior year reserve development by line of business Res dev on prior AY / PY reserves* 15% 10% 5% 0% -5% -10% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Calendar year Other liability occurrence *Denominator does not include A&O reserves when separating CM/Occ Source: Aggregated NAIC Annual Statement filings Page 22 29 July 2016 P&C reserve cycle Other liability claims made 2010 2011 2012 2013 2014 2015
Products liability – continued impact of asbestos liabilities Materially impacted by continued asbestos liability development ► Prior year reserve development by line of business Res dev on prior AY / PY reserves* 40% 30% 20% 10% 0% -10% -20% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Calendar year Products liability occurrence *Denominator does not include A&O reserves when separating CM/Occ Source: Aggregated NAIC Annual Statement filings Page 23 29 July 2016 P&C reserve cycle Products liability claims made 2011 2012 2013 2014 2015
Workers’ compensation – three straight years of reserve releases ► ► Favorable prior year development observed in last three calendar years after adverse prior year development of the previous four calendar years Higher than expected indemnity claim frequency after recession Prior year reserve development by line of business Res dev on prior AY / PY reserves 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Calendar year WC Source: Aggregated NAIC Annual Statement filings Page 24 29 July 2016 P&C reserve cycle
Future cycles could be shorter and less drastic Page 25 1 January 2014 Presentation title
Reserve levels have stabilized since early 2000 s With exception of commercial auto, most lines of business have stabilized compared to challenging early 2000 s ► Prior year reserve development by line of business Res dev on prior AY / PY reserves 15% 10% 5% 0% -5% -10% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Calendar year WC Med prof Source: Aggregated NAIC Annual Statement filings Page 26 29 July 2016 P&C reserve cycle Other + prod liab Comml auto liab Prv auto liab 2012 2013 2014 2015
Impact of Sarbanes-Oxley requirements ► ► ► Implemented in 2002 as part of fallout from Enron/World. Com Establishment of Public Company Accounting Oversight Board (PCAOB) Protection from accounting fraud, improved accuracy and detail of disclosures ► ► ► Justification of assumption changes Disclosure by accident year CEO/CFO sign off on financial statements with personal liability on the line Page 27 29 July 2016 P&C reserve cycle
Management understanding of reserve process has improved ► Reserve committees in place at many companies ► Due to increased disclosures, increased scrutiny of actuarial assumptions ► Transparency of process ► Page 28 Independent actuaries and state examiners increase visibility of results 29 July 2016 P&C reserve cycle
Reduction in likelihood of unreasonable players in marketplace ► One or two competitors taking unreasonable actions can impact all writers in a market ► Underpricing new business, low initial expected loss ratio assumptions may cause market to follow ► Sarbanes-Oxley reduces likelihood of competitors acting unreasonably ► Entry of hedge funds into insurance market increases competition, and rates are more likely to remain stable Page 29 29 July 2016 P&C reserve cycle
Communication of actuaries in times of increased transparency Page 30 1 January 2014 Presentation title
Actuaries must list key assumptions in layman’s terms ► In order to get buy-in from management, an actuary must communicate results in a clear and direct fashion ► Avoid use of actuarial jargon when communicating with management ► Balance transparency of actuarial processes while also staying high-level ► Add market context to results Page 31 29 July 2016 P&C reserve cycle
An actuary must convey both confidence in estimate, as well as inherent uncertainty ► Hallmark of actuarial work: our estimates are always changing as new information becomes available ► Separation of process uncertainty vs. parameter uncertainty ► ► ► Strength of justification of actuarial assumptions will limit process uncertainty Transparency around parameter uncertainty important Transparency and strong communication skills allow actuaries to maintain and improve standing among management Page 32 29 July 2016 P&C reserve cycle
An actuary must convey both confidence in estimate, as well as inherent uncertainty ► “what if” scenarios prepare management for alternative outcomes ► Scenarios should be based on alternative set of assumptions ► Simulation techniques can be used to develop range around central estimate Page 33 29 July 2016 P&C reserve cycle
In light of a change in estimate, actuaries will need to assuage management concern ► An actuary needs to remain objective and use actuarial techniques, skills and experience in producing unbiased estimates. ► Management needs to know what conditions caused the change in estimate. ► ► How could these changes in conditions have been anticipated? How have the actuary’s assumptions changed in light of the change in estimate? Page 34 29 July 2016 P&C reserve cycle
Communicating reserve releases ► Reserve releases sometimes considered easier to communicate, as it means improvement to the bottom line ► Management may ask the question: were we over-pricing in prior years? Important to stress uncertainty of actuarial methods ► Underwriters – may expand terms and conditions ► Claims department – reluctant to set high case reserves ► Actuaries – may tend toward optimistic LDFs and trend selections Page 35 29 July 2016 P&C reserve cycle
Communicating reserve strengthening ► Adverse development deteriorates bottom-line result ► Prepare management ahead of time for “bad news” ► Underwriters – likely to consider tougher terms and conditions ► Claims department – more likely to set high case reserves ► Actuaries – may tend toward conservative LDFs and trend selections Page 36 29 July 2016 P&C reserve cycle
Strategies for reporting of results ► Data visualization software can provide insights into results ► ► Can assist members of management who may prefer visuals rather than numerical results Consider length of time management has to review reserving results ► Page 37 Management must be given enough time to digest and understand results 29 July 2016 P&C reserve cycle
Reserve cycle consideration for an actuarial analyst ► Challenges ► ► ► Benefits ► ► ► Difficult to consider context of reserve cycle with few years of experience Conversations around reserves strength over time can be limited to executives Valuable to consider historical context in day-to-day work Observations prompt questions Cyclical activity can be seen in loss triangles Observations prompt questions not otherwise thought of “If we don’t learn from history, we are doomed to repeat it” As an analyst, it never hurts to ask a question to your supervisor Page 38 29 July 2016 P&C reserve cycle
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