Reserving for Asbestos Pure IBNR

CAS Casualty Loss Reserve Seminar

September 11, 2001

Kevin M. Madigan MHL/Paratus

Reserving for Asbestos Pure IBNR

High Excess (Re)Insurers:

May have significant Asbestos pure IBNR exposure Have significant policy data issues  e.g., old policies/slips not in systems Lack valuable qualitative information

Reserving for Asbestos Pure IBNR

How to Deal With These Issues?

Research known asbestos defendants Match against policy database  May take significant effort to build DB Use historical experience to project IBNR

Reserving for Asbestos Pure IBNR

Using Experience to Project Pure IBNR

We have developed 2

report year

methods inspired by:  [1]

Cross, Susan L. and Doucette, John P.

, “Measurement of Asbestos Bodily Injury Liabilities”,

PCAS

, Vol LXXXIV, Nos. 160 and 161, pgs 187 -300  [2]

Haidu, Jim

, “Estimating a Reinsurer’s Liabilities for Asbestos and Environmental Losses”, 1996 CAS CLRS

Reserving for Asbestos Pure IBNR

Using Experience to Project Pure IBNR

Both methods use (report year) actual or modeled losses to arrive at a factor that is applied to exposed policy limits We are implicitly assuming the existence of modeled losses at the account or policy level We are modeling GROSS losses

Reserving for Asbestos Pure IBNR

Using Experience to Project Pure IBNR

Method 1 uses

account

experience Method 2 uses

policy

experience

Should any of the historical experience be excluded?

Reserving for Asbestos Pure IBNR

Method I:

“Pricing” Approach  Allocate experience to layers  Calculate burn rates  Apply to potential IBNR policies

Reserving for Asbestos Pure IBNR

Method I:

 Allocate experience to layers  Each account has an actual (closed accounts) or modeled (open accounts) annual loss distribution

Reserving for Asbestos Pure IBNR

Method I:

 Calculation of Burn Rates  Example for Report Year 19XX

Account: Annual Loss: Layers $0 $500,000 $1,000,000 $5,000,000 $500,000 $1,000,000 $5,000,000 $10,000,000 $10,000,000 $20,000,000 $30,000,000 $20,000,000 $30,000,000 $40,000,000 ABC Asbestos Co.

$35,000,000 $500,000 $500,000 $4,000,000 $5,000,000 $10,000,000 $10,000,000 $5,000,000 Insulations R Us $16,000,000 $0 $0 $0 $0 $0 $10,000,000 $6,000,000 Acme Widgets $250,000 $250,000 $0 $0 $0 $0 $0 $0 TOTAL $51,250,000 Burn Rate $750,000 $500,000 $4,000,000 $5,000,000 $10,000,000 $20,000,000 $11,000,000 50.00% 33.33% 33.33% 33.33% 33.33% 66.67% 36.67%

Reserving for Asbestos Pure IBNR

Method I:

 Calculation of Burn Rates  Ideally want burn rate confidence intervals, from which baseline confidence intervals can be selected for each layer

Burn Rate Confidence Intervals $0 $500,000 $1,000,000 $5,000,000 $10,000,000 $20,000,000 $30,000,000 Layer $500,000 $1,000,000 $5,000,000 $10,000,000 $20,000,000 $30,000,000 $40,000,000 RY 1990 45% 44% 42% 23% 70% 68% 64% 45% 15% 2% 1% 34% 16% 10% RY 1991 46% 46% 25% 12% 67% 67% 52% 40% 1% 0% 0% 5% 0% 0% RY 1992 40% 40% 40% 35% 80% 80% 80% 78% 30% 12% 3% 75% 46% 37%

Reserving for Asbestos Pure IBNR

Method I:

 Apply Burn Rates to potential IBNR policies  Requires assumptions regarding: • Reporting Pattern(s) • Trend Assumptions – e.g., 2% annual decay in burn rate • Exposed Policy Limits

Method I:

 Apply Burn Rates Reserving for Asbestos Pure IBNR

Lower limit of C.I. of Burn Rate for Layer: Exposure in Layer: Year 1 2 3 4 5 6 15 16 17 18 19 20 7 8 9 10 11 12 13 14 % Reported 10.4% 9.4% 8.5% 7.7% 7.1% 6.4% 5.9% 5.4% 4.9% 4.5% 4.2% 3.8% 3.5% 3.3% 3.0% 2.8% 2.6% 2.4% 2.2% 2.0% Trend Factor 0.980

0.960

0.941

0.922

0.904

0.886

0.868

0.851

0.834

0.817

0.801

0.785

0.769

0.754

0.739

0.724

0.709

0.695

0.681

0.668

26% $500,000,000 Projected Ultimate Losses $13,200,299 $11,717,663 $10,424,130 $9,291,765 $8,297,446 $7,421,905 $6,648,983 $5,965,055 $5,358,567 $4,819,680 $4,339,976 $3,912,226 $3,530,194 $3,188,488 $2,882,427 $2,607,937 $2,361,460 $2,139,885 $1,940,481 $1,760,847 TOTAL: $111,809,413

Reserving for Asbestos Pure IBNR

Comparison of Methods:

Method I computes an annual ‘rate’ for each layer, and ‘charges’ the exposed policies the corresponding ‘price’. Method II computes one factor to be applied to the limits of each policy

Reserving for Asbestos Pure IBNR

But wait!

We have a wide assortment of attachment points and policy limits, so it hardly seems right to apply the same factor to each policy.

Does a $25M x $200M policy have the same exposure to loss as a $4M x $1M policy?

Of course not!

Reserving for Asbestos Pure IBNR

Method II:

Exposed policy limits are ‘adjusted’ as follows: Adjusted exposure = TPE * Pr( GUL > AP) where: TPE = Total Policy Exposure GUL = Ground-Up Loss AP = Policy Attachment Point

Reserving for Asbestos Pure IBNR

Method II:

 Calculate historical ratios of loss to adjusted exposure for each report year (let’s call them loss cost factors)  Select a base line confidence interval for the loss cost factors  Make assumptions regarding reporting pattern(s) and cost trend(s)

Reserving for Asbestos Pure IBNR

Method II:

 Calculate ratios of loss to adjusted exposure  Example: RY 19xx Policy Att Point $1,000,000 $1,000,000 $5,000,000 $10,000,000 $15,000,000 $20,000,000 $25,000,000 Pr(GUL > AP) 40.0% 40.0% 30.0% 20.0% 10.0% 5.0% 1.0% Policy Limit $500,000 $1,500,000 $4,000,000 $15,000,000 $5,000,000 $5,000,000 $25,000,000 Adjusted Exposure $200,000 $600,000 $1,200,000 $3,000,000 $500,000 $250,000 $250,000 Policy Loss $2,500 $2,500 $0 $0 $5,000,000 $0 $1,000 TOTALS: $6,000,000 $5,006,000 LOSS COST FACTOR: 0.834

Method II:

 Select a base line for the loss cost factors

Year 1 2 3 4 5 9 10 11 12 13 14 15 16 17 6 7 8 18 19 20

Reserving for Asbestos Pure IBNR

Baseline Loss Cost Factor: 0.834

% Reported 10.4% 9.4% 8.5% 7.7% 7.1% 6.4% 5.9% 5.4% 4.9% 4.5% 4.2% 3.8% 3.5% 3.3% 3.0% 2.8% 2.6% 2.4% 2.2% 2.0% Trend Factor 0.980

0.960

0.941

0.922

0.904

0.886

0.868

0.851

0.834

0.817

0.801

0.785

0.769

0.754

0.739

0.724

0.709

0.695

0.681

0.668

Trended Projected Loss Cost Factor: Product 0.102

0.090

0.080

0.071

0.064

0.057

0.051

0.046

0.041

0.037

0.033

0.030

0.027

0.025

0.022

0.020

0.018

0.016

0.015

0.014

0.860

0.717

Reserving for Asbestos Pure IBNR

Method II:

 Make assumptions regarding reporting pattern(s) and cost trend(s)

Trended Projected Loss Cost Factor: Potential Policies Att Point Pr(GUL > AP) $25,000,000 1.000% $40,000,000 $75,000,000 $125,000,000 $250,000,000 0.800% 0.600% 0.400% 0.325% TOTALS: Limit $5,000,000 $10,000,000 $25,000,000 $25,000,000 $50,000,000 $115,000,000 Adjusted Exposure $50,000 $80,000 $150,000 $100,000 $162,500 $542,500 0.717

Projected Losses $35,850 $57,360 $107,550 $71,700 $116,513 $388,973

Reserving for Asbestos Pure IBNR

Other Issues:

Loss trend may be (probably is?) positive, or trend rate may not be constant Policy “buy backs” Distinguish products liability from other liability Not only source of “pure” IBNR Commutation strategy Reinsurance collections/collectibility