Transcript Reserve Adequacy and the Underwriting Cycle Stephen T. Morgan CAS 2004 ANNUAL MEETING Montreal – November 15, 16, 17 General Session.

Reserve Adequacy and the
Underwriting Cycle
Stephen T. Morgan
CAS 2004 ANNUAL MEETING
Montreal – November 15, 16, 17
General Session
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Reserve Adequacy and the Underwriting Cycle
Moderator: Steve Morgan ACAS, MAAA
Vice President
Clarendon Insurance Group
Panelists: Meyer Shields FCAS, MAAA
Analyst
Legg Mason Wood Walker, Inc.
Mike Angelina ACAS, MAAA
Consulting Actuary
Towers Perrin
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Reserve Adequacy and the Underwriting Cycle
Key indicators that RAUC is significant issue:
 Many companies issuing news releases noting significant reserve
increases;
 Many published reports on industry reserve inadequacy/adequacy (S&P,
A.M. Best, Morgan Stanley, and Fitch);
 Legislative enactments with implications for reserving (Sarbanes-Oxley);
 Regulatory actions with implications for reserving (reserve opinions,
data testing requirement, department audits and oversight); and
 Actuarial response (training, improved reserving techniques, and
software).
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Reserve Adequacy and the Underwriting Cycle
Key questions to be asked about reserving:
? Have actuarial techniques kept up with the times?
? Are current regulatory guidelines sufficient to ensure a reasonable
probability of reserve adequacy?
? Are current ethical guidelines and policing for actuaries sufficient?
? Do companies have sufficient internal controls? and
? Is data quality or lack thereof a hidden cause of missing the reserving
mark?
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Reserve Adequacy and the Underwriting Cycle
Have actuarial techniques kept up with the times?
 Techniques developed BC (Before Computers) may not be up to
reasonably projecting reserves in such a complex environment;
 Sampling theory teaches us how to determine the probability of pulling
a red or blue ball from a population of what we think only includes red
and blue balls. What happens when we pull a purple ball or even a
black ball? How can we know ahead of time?;
 Can actuarial techniques ever be successfully used to estimate reserves
when they are impacted by factors like case law and legislation?;
 Does history really ever repeat itself? and
 Can all the things that go wrong with data be picked up in actuarial
techniques?
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Reserve Adequacy and the Underwriting Cycle
What others are saying:
A.M. Best (October 4, 2004)
 “Despite the considerable reserve charges [through year-end 2003], which
totaled almost $47 billion over the past three calendar years, A.M. Best believes
the industry’s overall carried reserve position remains deficient.”
 “….reserves are up to $67 billion deficient….$38.5 billion is related to unfunded
asbestos and environmental….”
 “While actuaries use their best professional judgment in estimating reserves,
there is a wide degree of variability inherent in loss reserves.”
 “Management teams may weaken reserves… with the intention of strengthening
reserves….when conditions improve.”
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Reserve Adequacy and the Underwriting Cycle
What others are saying (continued):
Morgan Stanley (May 12, 2004)
 ….we think the days of big-bath reserve charges are quickly fading.”
 “At $80 billion, our estimated industry shortfall is at its lowest level in several
years.”
 “….insurers have been harvesting the gains of the hard market more quickly than
in cycles past.”
 “….nearly $5 billion of reserves from accident year 2002 were released in
calendar year 2003.”
Fitch Ratings (November 19, 2003)
 “….that property/casualty was sharply underpriced….[and]…..companies do not
have a firm handle on underwriting loss costs….”
 “Fitch believes….reserving shortfalls….are attributable to a failure in the actuarial
process as opposed to purposeful “cheating”……”
 “Often despite best efforts, management is simply wrong because current
established actuarial processes are unable to assess ultimate loss costs…..”
 “Although “cheating” is highly troublesome,….reserving shortfalls have
increasingly been the result of the actuaries simply being wrong,…and that
generally actuaries do a relatively poor job in predicting future trends not yet
evident in historical loss patterns.”
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Reserve Adequacy and the Underwriting Cycle
What others are saying (continued):
Standard & Poors (May 10, 2004)
 “Insurers tend to under-report reserves during soft pricing periods and then
build up reserves as markets harden.”
 “While some reserving error is explained by simple uncertainty, a good deal is
caused by deliberate earnings management.”
 “….cycle-driven reserving management ‘is a longstanding phenomenon,’…..
 “Insurance companies also often swap fund between reserves.…to manage
earnings rather than establish adequate reserves.”
Standard & Poors (November 19, 2003)
 “Actuaries are signing off on reserves that turn out to be wildly inaccurate…It’s
an abysmal record.”
 “But reserve shortfalls don’t just happen overnight. What happened to all of
those reserve opinions….?”
 “Analysts also point to the convenient discovery….of a reserve surplus in one line
of business that masks deficiencies in another.”
 “It [S&P] has also generally found its own “relatively simplistic models are more
reliable than legions of actuaries.”
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Reserve Adequacy and the Underwriting Cycle
“The data is in the details.”
Apologies to Anonymous
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