Transcript Slide 1

Interpreting Financial Ratios and Using Financial
Ratios for Decision Making on Retention Levels,
Setting Target Equity Levels and Dividend
Reimbursements
CAJPA 2006
Fall Conference and Training Seminar
September 20 – 22, 2006
South Lake Tahoe
Presented by:
Mujtaba Datoo, ACAS, MAAA
Actuarial Practice Leader
ARM Tech
23701 Birtcher Drive, Lake Forest, CA 92630
(949) 470-4343 • FAX (949) 470-4340 • www.armtech.com
Discussion Points
• Conceptual framework
• Variability
 Need for surplus
 Confidence level, contingency margin
• Target surplus level
• Equity position
• Dividend release
• Summary
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So how do you get
to your goal?
Different people get there differently, or not…
The English Plan
Depending on the wind, the striker’s position may vary…
The German Plan
Radical, efficient, unstoppable… (ball’s speed may reach 180 mph)
Pooling and Self-Insurance,
Insurance mechanism
• Essentially the business is an insurance
enterprise
Pay generally fixed premium up front
for a promise to pay claims later
Claims will not be known for a
while and are subject to variation
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Balancing Formula
Premium + inv income = losses + expenses
fixed
minimal
variable
fixed
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Variance…
• Losses estimates are inherently variable
• Confidence Level is a statistical measure
• Varies by coverage
 Excess Liability – very variable
 WC – indemnity less variable than medical part
 Auto Liability – generally more stable
• The greater the SIR, the greater the potential for
variability
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Sources of variation
• Process risk
 risk associated with projection of future contingencies
that are inherently variable
• Parameter risk
 risk associated with selection of parameters of the
model, e.g. selecting the wrong LDF
• Model risk
 Misidentifying a process model, e.g. Poisson for
frequency
Surplus provides primary protection
against adverse deviation
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Surplus is key measure
• Assets minus Liabilities = Surplus
• Surplus a.k.a.




Net assets
Pool equity
Retained earnings
Policyholder’s Surplus
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What are your assets
•
•
•
•
•
•
Cash
Bonds
Other investments
Real estate
Accounts receivables
Etc.
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What are your liabilities
• Claims payable




Case reserves
Case reserve development
Incurred But Not Reported (IBNR) reserves
Allocated loss adjustment expense (ALAE)
• Unallocated loss adjustment expense (ULAE)
• Other expense payable
• Etc.
Outstanding Losses are the largest
component of liabilities
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Reasons for Surplus
• Absorb adverse loss development – KEY reason
• Reinsurers may become insolvent
 Contingent liabilities
• Use for rate stabilization
• Rating agencies
• Make pool more attractive to
 Prospective members
 Reinsurers
• Required by state regulators (private sector)
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Determining Surplus Adequacy,
the considerations
• Lines of coverage
 Long tail, short tail
 Amount of reserves
• Retention level, i.e. SIR
• Annual contribution (premium) volume
• Strategic plan
 Competitive environment
 Target levels
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Financial Measures
• Used by private sector to determine
 Financial solidity
 Developed to weed out financially troubled companies
 Many measures from simple to complex
• IRIS ratios: Premium to Surplus (3:1), etc.
• Risk Based Capital (RBC) requirements
• Basic building blocks are the same
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How much Surplus?
• Set key financial measure targets
 Premiums Contributions to Surplus
 Reserves to Surplus
 SIR to Surplus
• Financial ratios based on private sector
experience
 Applies to public entities – same risk measure concept
 Not quite apples to apples, say apples to oranges!
• Benchmark range is still a good guide
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Premium-to-Surplus
• Premium-to-surplus
ratio well within usual
range of less than 3:1
AM Bests – Workers Comp
3.5
3.0
2.5
2.0
Increase membership
0.0
benchmark
0.5
2004
Return dividends,
2003
1.0
2002
Increase retention,
2001
1.5
2000
Able to:
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Loss Reserves-to-Surplus
• Reserve-to-surplus ratio
well within usual range
for WC of 3 (to 4):1
AM Bests – Workers Comp
4.0
3.5
3.0
2.5
2.0
1.5
1.0
benchmark
2004
2003
2002
0.0
2001
0.5
2000
Able to
withstand
adverse
development
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Retention Levels Depends on:
• Amount of Surplus
• Subjective willingness to bear risks
 The “flinch test”
• Excess insurance pricing
 Market availability
• Other benchmarks, measures
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Freakonomics
Risk = hazard + outrage
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SIR-to-Surplus
• SIR-to-surplus ratio well
above 10:1
12.0
10.0
8.0
6.0
4.0
benchmark
2005
0.0
2004
2.0
2003
Able to withstand
more large claims
(up to retention
levels)
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Ratios are relativity concepts
• Financial ratios are all relative measures
 Relative to other companies
 Data adjusted to common levels
• Discounted vs. undiscounted
• Market value of investments
• Absolute measures do not exist!
 No one right answer
 Use reasonable ranges
 Compare to your similar entities
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The Italian Plan
Iron defense, small ideas in midfield, passes to striker..and…Penalty
The Brazilian Plan
… no comments!
The Australian Plan
They manage to lose the game by themselves, no help needed.
The Dividend Decision
• How much income is available for release?
• Relate to Surplus target levels
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


Use confidence level measures
Accumulate surplus gradually to target levels
Release in staggered amounts
Wait for claims to close or sufficient period to
minimize variability
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Equity,
conceptually
Plus
Premium Contribution FY 2004/05
Investment income earned 2004/05
Less Program expenses 2004/05
Losses paid in 2004/05
Loss reserves
Other adjustments/dividend payable
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Equity calculation,
Funds available
Fiscal
Period
Ending
(1)
Contributions
Inv.
Income
accrued
Limited
Losses
Paid
Operating
Expenses
Dividends
Declared
Funds
available
(2)
(3)
(4)
(5)
(6)
(7) = (2)+(3) (4) - (5) -(6)
1997
$1,858
$45
$558
$1,143
$226
($23)
1998
2,274
197
496
1,090
381
503
1999
1,486
60
937
746
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(153)
2000
3,234
348
675
1,570
0
1,356
2001
3,082
314
803
1,109
0
1,485
2002
3,097
242
532
1,437
0
1,369
2003
3,174
160
505
1,339
0
1,489
2004
3,356
133
284
1,322
0
1,882
2005
1,250
41
81
608
0
602
TOTAL
22,815
1,545
4,875
10,367
624
8,493
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Equity calculation,
Equity above Confidence Level
Fiscal
Period
Ending
Funds
available
Outstanding
Losses
And ULAE
(1)
(2)
(3)
Equity
Confidence
Level
Target
Additional
Funds
For C/L
Equity
Above
C/L
(4)
(2) – (3)
(5)
(6)
(7)
(4) - (6)
1997
$(23)
$0
($23)
90%
$0
($23)
1998
503
10
492
90%
9
483
1999
(153)
0
(153)
90%
0
(153)
2000
1,356
6
1,329
90%
6
1,323
2001
1,485
156
1,329
90%
137
1,1,91
2002
1,369
670
699
90%
129
570
2003
1,489
612
877
90%
211
660
2004
1,882
903
978
90%
154
824
2005
602
516
85
90%
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53
8,493
2,876
5,616
680
4,915
TOTAL
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Equity calculation,
Target Equity Release
Fiscal
Period
Ending
Equity
Above
C/L
Target
Equity
Release
Equity
Above
C/L
(1)
(7)
(4) - (6)
(5)
(7)
(4) - (6)
1997
($23)
100%
($23)
1998
483
75%
362
1999
(153)
75%
(153)
2000
1,323
50%
661
2001
1,1,91
50%
595
2002
570
25%
142
2003
660
25%
166
2004
824
0%
0
2005
53
0%
0
TOTAL
4,915
1,752
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Equity release
• Use Fund Year Accounting
 Relates to members who participated in the same
years
• Accumulate gradually
 Through rate additions
 Assessments
• Release in staggered stages
 When all claims are closed, or
 Longer waiting and release time for long-tail lines
• Ensure overall financial targets are met
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The French Plan
In their plan, they try all possible hypotheses.
Oh No! Oui, Oui …they forgot the goal
Mujtaba’s Plan
Survey the field, build advancing strategies, and strike…..
The Big Picture…
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Projected Financial Position
As of June 30, 2005
Program at about 75% confidence level
$25
$20
Surplus $4 M
$15
$10
$5
$0
Assets
Expected
70%
90%
Investment Income
1.1
1.1
1.1
Confidence Level Margin
0.0
1.8
5.7
Discounted Liabilities
11.5
11.5
11.5
3.4
3.4
3.4
18.9
18.9
18.9
Other Liabilities
18.9
Assets Available
18.9
18.9
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What are your goals?
Understand underlying concepts,
assumptions
Surplus is cushion for adverse deviation, etc.
Set reasonable targets
Make gradual, incremental changes
Compare to peer group or entity
Monitor regularly, adjust if necessary
For a long-term, financially solid win…
Summary
• Losses are inherently variable
• Variability cushioned by surplus
• Set target financial measures
 Reserves, premium and SIR to Surplus
• Establish dividend release formula
 Calculate equity position by Fund Year
 Accumulate surplus gradually, release slowly
• Review plan periodically
 Details change, e.g. SIRs, membership, etc.
 Does it work and achieve equity?
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Questions?
Thank you.
Mujtaba Datoo, ACAS, MAAA
Actuarial Practice Leader
ARM Tech
(949) 470-4342
[email protected]
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