SOP 97 3 and Other Balance Sheet Reserves

SOP 97 -3 and Other Balance Sheet Reserves CLRS 2004 Las Vegas, Nevada September 13, 2004 Claus S. Metzner, FSA, FCAS, MAAA, Aktuar – SAV Actuary, Milliman, Inc. Milliman

Other Balance Sheet Reserves Ø Reserves § Premium Revenue Recognition Reserve § Retro Rated Premium Reserve § Reserves for Contingent Commissions § Premium Deficiency Reserves § Policyholder Dividend Reserves Ø Will be discussing these reserves/assets from the insurer perspective and the insured perspective Ø “Impacts” if Reserve not Set Appropriately Ø Remember § Materiality is, as always, a consideration § Consider “consistency” between loss reserving assumptions and assumptions underlying “Other” reserves Milliman 1

Other Balance Sheet Reserves Premium Revenue Recognition Reserve • Arises from delays in premium reporting – Estimated premium is higher/lower than final premium since exposures (payroll, sales) initially estimated • Impacts: Insurer – Mismatch of revenue/expense » B-F loss ratio implications » Combined Ratio too low/high – Balance Sheet – Asset (general situation) is missing » Capital understated due to missing asset • Impacts: Insured – Mismatch of revenue/expense – Balance sheet – liability (general situation) is missing » Capital overstated Milliman 2

Other Balance Sheet Reserves Retro Rated Premium Reserve • Arises from loss reporting/loss settlement pattern – Interim adjustments lead to premium recorded to date that is higher/lower than final contractual premium since losses are not yet fully settled • Impacts: Insurer – Mismatch of revenue/expense » B-F loss ratio implications » Combined Ratio too low/too high • Impacts: Insured – Mismatch of revenue/expense – Balance sheet – liability is missing Milliman 3

Other Balance Sheet Reserves Contingent Commission Reserve • Arises from Agency contracts – May be based on “revenue” targets – May be based on “profit” targets – May be a combination of various targets • Impacts: Insurer – Mismatch of revenue/expense » Combined Ratio too low/too high » Capital misstated (note: specific contract terms should be reviewed and the contingent commission program could be modeled in relation to the underlying loss ratio performance) • Impacts: Agency – Mismatch of revenue/expense – Capital misstated Milliman 4

Other Balance Sheet Reserves Premium Deficiency Reserve • Projection of Loss arising from obligations entered into but where premium has not yet been earned – Considerations » By Line? » By Business Unit? » By Company? – Source of Data » Calendar/Accident Year » Policy Year • Impacts: Insurer – Capital misstated (note: loss ratio performance, adjusted for the premium revenue recognition reserve, is critical; a good paper on this evaluation, is Ralph Blanchard’s article in the 2000 Fall CAS Forum) Milliman 5

Other Balance Sheet Reserves Dividend to Policyholder Reserve • Need to consider the impact of – Premium Revenue Recognition Reserve – Reflection in Variable Dividends of Loss Ratio changes due to » Premium Revenue Recognition Reserve » “knowledge” gained from Premium Deficiency Reserve evaluation • Impacts: Insurer – Capital misstated Milliman 6

Other Balance Sheet Reserves Ø Summary § Other Balance Sheet Reserves are important • To the Insurer and to the Insured • May need to be considered within the scope SOP 97 -3 for non-insurers (materiality? ) § Other Balance Sheet Reserves are probably impacted by Loss and Loss Adjustment Reserve Evaluations – need to assure consistency Milliman 7