Transcript Loss Reserve Adequacy and the Underwriting Cycle Casualty Actuarial Society General Meeting Montreal, Canada November 16, 2004 Michael E.

Loss Reserve Adequacy and the Underwriting Cycle
Casualty Actuarial Society
General Meeting
Montreal, Canada
November 16, 2004
Michael E. Angelina, ACAS, MAAA
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Agenda
 2004 Observations
 Reserve Adequacy
 Charges, drivers, management estimates
 Underwriting Cycle
 Causes, observations
 Correlation vs. Observations
 Reserve Adequacy revisited
 External influences
 Other Thoughts
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Industry Observations - 2004
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2004 at a Glance
 Early forecasts
 continued premium growth
 Combined ratio below 100%
 Record results through 2Q
 Despite reserve increases by several companies
 Worst hurricane season in 50 years
 Continued medical malpractice crisis
 Spitzer allegations turn the industry on its head
Source: A.M. Best, ISO.
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Net income (1991-2004*)
$36,819
$30,773
$30,800
$24,404
$20,598
$19,316
$23,600
$21,865
$20,559
$14,178
$10,870
$5,840
$3,046
$ Billions
-$6,970
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003 2004*
Source: A.M. Best, Insurance Information Institute.
* First six months of 2004
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Reserve Adequacy
Calendar year reserve hits
(U.S. Property/Casualty industry)
$ in Billions
Total
All Lines
Year-end
2001
$12 B
2002
$22 B
2003
$14 B
About half due
to asbestos
Context: Industry total reserves = $ 350 B
Industry total premium = $ 400 B
Industry total surplus = $ 300 B
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A “few” companies account
for much of the adverse development
 Calendar Year 2002: 30 companies accounted for 80%
of the one-year development
 Calendar Year 2003: 30 companies accounted for 90%
of the one-year development
 Not all the same companies as prior year
 The 30 companies (each year) held 20 – 25% of the
industry’s surplus
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For the industry composites,
the first estimate of ultimate losses over/
underestimates ultimate losses in a cyclical pattern
Current Ultimate/Initial Ultimate
1.3
1.2
1.1
1.0
0.9
0.8
0.7
1980
1985
1990
1995
2000
Accident Year
All Lines
WorkComp
Source: Composite Schedule P.
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There are many process related drivers of
reserve development
 External environment
 Asbestos, pollution, construction defects
 Runaway juries
 Shock losses
 WTC, Enron, Mutual Funds, Vioxx(??)
 Methodologies
 Chain-ladder, expected loss estimates
 Data quality
 TPA handled claims, poor systems
 Knowledge of underlying exposure
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There are also decision-based questions that
can influence reserve adequacy
 When to move off of an expected loss estimate (peg)?
 Before IBNR is negative
 How bad can a given year really be?
 400% loss ratio is bad, 550% is worse
 When is noise really an underlying trend ?
 The “but for” rule
 What can we afford to take/release?
 Low end of talked down range
 Can you say bias
 Book the medium since reserves only go up
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Underwriting Cycle
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Underwriting gain/loss (1975-2004*)
$ Billions
$10
$0
($10)
($20)
($30)
($40)
($50)
($60)
1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004*
* First six months of 2004
Source: A.M. Best, Insurance Information Institute.
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Combined ratio (1991-2004*)
115.8
115.7
110.0
108.8
108.5
106.9
106.5
107.7
105.8
107.2
105.6
101.6
100.1
99
94
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E2004*
2004 E based on first six months of 2004; * 2004 is after the impact of the hurricanes
Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute.
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Commercial lines’ combined ratios have historically
been worse than personal lines
Commercial vs. Personal Lines Combined Ratios
125
10-YR AVG COMBINED RATIO
122.2
Commercial lines - 111.1
120
Personal lines - 105.2
115
112.5
110.3
112.3
110.2
109.7
110
111.5
109.9
110.9
110.2
107.6
105
103.9
104.5
104.9
103.5
105.3
104.5
103.9
103.0
102.7
99.8
100
97.5
95
90
93
94
95
96
97
98
Commercial--Net Basis
99
00
01
02
03E
Personal--Net Basis
Source: A.M. Best; Insurance Information Institute
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Like reserve adequacy, the underwriting cycle
is driven by many process-related factors
 Prior year(s) loss estimates
 Anticipated investment returns
 External environment
 Loss cost trend, inflation
 Shock losses
 Catastrophes
 Market conditions
 Terms and conditions
 Rate changes
 Underwriting criteria
 Reinsurance costs
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Underwriting Cycle - Observations
Underwriting Cycle Observations –
Measuring the impact of price monitoring
(1)
(2)
(3)
(4)
Terms &
Accident A-priori Loss Cost Rate
Conditions
Year
Loss Ratio
Trend
Change
Impact
1999
2000
2001
2002
2003
2004
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(5)
(6)
U/W
Impact
Expected
Loss Ratio
110.0%
10.0%
9.0%
8.0%
6.0%
4.0%
16.0%
18.0%
22.0%
12.0%
5.0%
1.5%
2.0%
2.5%
1.0%
0.0%
11.0%
110.0%
91.4%
82.8%
71.4%
66.9%
66.3%
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Underwriting Cycle Observations –
Measuring the impact of price monitoring
 The a-priori estimate
 When do we find out the estimate is adequate
 Test with diagnostics
 Prior and subsequent years
 What happens when the estimate is too low/high
 Feedback mechanism
 Control cycle
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Underwriting Cycle Observations –
Measuring the sensitivity of price monitoring
175.0%
150.0%
125.0%
100.0%
75.0%
50.0%
25.0%
0.0%
1999
Base Case
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Scen A
2001
Scen B
2002
2003
Scen C
2004
Scen D
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Underwriting Cycle Observations –
Testing the price monitoring assumptions
(1)
Accident Expected
Year
Loss Ratio
1999
2000
2001
2002
2003
2004
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110.0%
91.4%
82.8%
71.4%
66.9%
66.3%
(2)
Shock
Losses
2.0%
7.0%
1.0%
1.0%
4.0%
2.0%
(3)
(4)
Shock
Reserving
Adjusted
Ultimate
Loss Ratio Loss Ratio
112.0%
98.4%
83.8%
72.4%
70.9%
68.3%
112.0%
106.0%
92.5%
86.5%
79.0%
75.0%
(5)
Unexplained
Difference
0.0%
7.6%
8.7%
14.1%
8.1%
6.7%
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Underwriting Cycle Observations –
 Link pricing and reserving
 Control mechanisms
 Challenges assumptions
 Reflects trends, stability, newly emerged claims
 Feedback loop
 Understand the “difference column”
 Systematic bias
 Noise
 Unexplained differences
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Underwriting Cycle Observations –
Understanding the Difference Column
50.0%
25.0%
0.0%
1999
2000
2001
2002
2003
2004
-25.0%
-50.0%
Base Case
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Scen A
Scen B
Scen C
Scen D
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Reserve Adequacy - Revisited
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Reserve Adequacy - Revisited
 External Influences
 Rating Agencies
 Regulatory
 RBC threshold testing
 Triennial reviews
 Statutory opinions
 Moved from opining on net reserves to include
identification of other potential factors
 SarbOx
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Reserve Adequacy - Revisited
 Regulatory Reporting Requirements (last 10 years)
 Page 3 and Schedule P
 Schedule F
 Disputed Recoverables
 Note 33 (asbestos and pollution disclosure)
 Ceded Reinsurance Collateral
 Discounting Sensitivity (tabular plus non-tabular)
 Retroactive Reinsurance
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Reserve Adequacy - Revisited
 Statutory Opinion Requirements
 Gross versus Net
 Material Adverse Deviation
 Risk Factors
 Comments on IRIS tests
 Asbestos and pollution comments
 Discounting
 Ranges
 Reinsurance
 Data testing
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Other Thoughts
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Other Thoughts
 Reserving Actuary as business partner
 Part of control mechanism and feedback loop
 Reserving process and therefore pricing process can
incorporate
 Claims department
 Reinsurance accounting
 Pricing and underwriting
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