Current Loss Reserving Developments

CAS Annual MeetingNovember 15, 2005

Chuck Emma, PinnacleTom Ryan, MillimanJohn J. Kollar, ISO

ISO Study of Loss and Loss Adjustment Expense Reserves

A. Industry Schedule P (Net)B. Analysis of Direct Losses

CAS Annual Meeting

November 15, 2005

John J. Kollar, ISO

A. Industry Loss Reserve Analysis

• More than 900 insurer groups

• Year-ended 12/31/04

• Schedule P data compiled by A. M. Best

• More than 95% of LLAE reserves for studied lines

Lines studied

• PP Auto Liability• HO/Farmowners• Com. Auto Liability• Other & Products Liab.

Claims-Made• Other Liab. Occurrence• Com. Multi-Peril

• Med Mal Occurrence• Med Mal Claims-Made• Products Occurrence• Reinsurance (Non-

Proportional Liability)• Workers Compensation

Some Key Points• Excludes reserves for environmental

and asbestos (E&A) claims– Possibly $30B to $50B deficient

• Analysis assumes incurred losses from 9/11 were fully developed at year-end 2004– Estimated direct insured losses: $20B to

$30B– U.S. net insured losses: $6B to $9B

• Adjustments have been made for other major catastrophes

Methodology

• Paid link-ratio technique

• Case-incurred link-ratio technique

• Consistent with ISO study of 2003 data

Factors affecting analysis

• Data quality

• Development factors

• Tail factors

• Professional judgment

Conventions

• Each deficiency/redundancy expressed as percentage of indicated undiscounted reserve as estimated by ISO– Positive percentages indicate deficiencies– Negative percentages indicate

redundancies

Summary Preliminary Indications of Reserve Deficiencies

Paid Case Incurred

• Lines Studied + 2% + 7%

• All Other Lines + 3% + 3%

• Total – all lines + 2% + 7%

• In Dollars $9B $31B– (excluding E & A )

Perspective

• Reserve adequacy has improved for 3 consecutive years– Reserves were about 3 percentage points

more adequate at year-end 2004 than at year-end 2003

– Reserves were about 11 percentage points more adequate at year-end 2004 than at year-end 2001

Preliminary Indications by Line

• Lines with deficiencies Paid Case

Inc.

• Products Occurrence + 7% +12%• Com. Multi-Peril + 1% + 4%• Workers Comp + 9% +15%• Reinsurance (Non-Prop.) +25% +33%

Preliminary Indications by Line

• Other Lines Paid Case Inc.

• Priv. Pass. Auto Liability - 4% - 6%• Homeowners/Farmowners -16% -10%• Commercial Auto Liability -10% - 1%• Other Liability Occurrence - 3% + 5%• Claims Made Other & Prod. - 8% + 1%• Medical Malpractice – Occ.* - 3% +12%• Medical Malpractice – C-M.* -11% - 9%

*ISO still investigating whether reserve adequacy is overstated consequent to data anomalies.

LALAE Ratios: Accident Year vs. Calendar Year

6065707580859095

100

1996 1997 1998 1999 2000 2001 2002 2003 2004

Accident Year Calendar Year

Reserve adequacy deteriorated for at least 6 years but then improved in 2002, 2003 & 2004.

Loss Reserve Changes vs. Industry Profitability, All Lines

-5

0

5

10

15

20

25

30

35

'71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04

%

Change in LLAE Reserves / Paid LLAE

GAAP Return on Average Net Worth

Changes in reserves arecorrelated with profitability.

-10-505

1015202530

1996 1997 1998 1999 2000 2001 2002 2003 2004

Paid Link Ratio Case-Incurred Link Ratio

Compound Discount Factor

Retrospective Estimated Deficiencies &Economic Discount, All Studied Lines

Discounted reserves wereinadequate from 2000 to 2003.

B. Analysis of Direct Losses

• Segment Analysis– State/coverage/class group/etc.

• Reserving/Benchmarking– Comparable mix of business

• Tail Factors

• Confidence Intervals

Schedule P Lines with

• Homeowners/Farmowners

- Homeowners

• Private Passenger Auto Liability/Medical

• Commercial Auto/Truck Liability/Medical

• Commercial Multiple Peril

- Commercial Multiple Peril Liability

- Commercial Multiple Peril Property

ISO Distributions

Schedule P Lines with

• Medical Malpractice - Occurrence- Hospitals- Physicians- Surgeons

• Other Liability - Occurrence• Products Liability - Occurrence• Auto Physical Damage

- Commercial Auto Physical Damage- Private Passenger Auto Physical Damage

ISO Distributions (Cont’d)

Schedule P Lines withISO Distributions (Cont’d)

• Special Property

- Fire

- Allied Lines

- Inland Marine

Segment Analysis – Link RatiosPeriod 1 To Ultimate

Chain Ladder Link Ratios

0

2

4

6

8

10

12

14R

atio

Sch. POth. Liab.

Occ.

ISOPrem OpsAll TablesW. CRR

ISOPrem Ops

Table 1

ISOPrem Ops

Table 2

ISOPrem Ops

Table 3

ISOPrem Ops

Tables1, 2, & 3

The Schedule P data is net, includes Composite Rated Risks (CRR), and is evaluated as of 12, 24, etc. months. The ISO data is direct, excludes CRR (except as noted), and is evaluated as of 15, 27, etc. months.

Reserving/Benchmarking• Used aggregate direct data by segment

– State/coverage/class/etc.– Paid/incurred/losses/claim counts/LAE

• Weighted aggregate direct data by each insurer’s unique mix of business– Losses rather than link ratios– Separately for each accident year

• Applied link ratios based on aggregate data to an insurer’s data to calculate an indicated reserve

Triangles, Link Ratios, Averages

Triangle ofdeveloping

losses

LinkRatio

Factors

LinkRatio

Averages

Benchmarking of Reserves

Reserve Estimates with 10 Years of DataBased on Average Best 3 of 5 & Modified Bondy Method

0

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

Latest 10 Years

With CompanyFactors & Mix

With ISOFactors &Company Mix

Tail Factors

• Modified Bondy MethodThe ultimate factor (UF) determined using the first prior factor (FF) and the second prior factor (SF) as follows: If SF > 1 and [ 0.8 * LN(SF) >= LN(FF) >= 0 ] or SF < 1 and [ 0.8 * LN(SF) <= LN(FF) <= 0 ] then UF = FF ^ { LN(FF) / [ LN(SF) – LN(FF) ] } Otherwise, UF = FF ^ 4

• Development beyond 10 years – up to 20 years using direct data

Development 10 vs. 20 Years

Comparison of 10 & 20 Year Experience

0.0000

0.5000

1.0000

1.5000

2.0000

2.5000

3.0000

3.5000

All-Year Average 2-Year Average 3-Year Average 5-Year Average Average Best 3 of 5

10 Years:1994-2003

20 Years:1984-2003

Other Liability Occurrence Coverage Incurred Losses for BI & PD Combined

Relative Volatility of Tail Factors

Modified Bondy Method Tail FactorsBased on Average Best 3 of 5

0.960

0.970

0.980

0.990

1.000

1.010

1.020

1.030

1.040

1.050

1.060

Company Tail

Factors & Mix

ISO Tail

Factors &

Company Mix

Modifi ed Bondy Method

120 Months-To-Ultimate:1994-2003

240 Months-To-Ultimate:1984-2003

Other Liability Occurrence Coverage Incurred Losses & ALAE for BI & P D Combined

Development of Parameters for Confidence Intervals

• By line

• By settlement lag (valuation)

• Industry for severity

• By insurer size for frequency

Estimated parameters for claim severity and frequency separately

Reserve Risk:Average size and volatility of open claims increases over time

Big Claims Settle Slowly

0 1 2 3 4 5 6

Open After n Years

Cla

im A

mo

un

t

95th %Mean

Development of an Insurer’s Confidence Intervals• An insurer’s loss and loss adjustment

expense reserves- By line- By accident year (latest valuation)

• Reinsurance arrangements- Retention- Coinsurance- Per claim limit

• Scale factors to reflect differences in average severity

Measures of VariabilityFrequency/Severity/Reserves

Measure of variabilityin aggregate reserves

Measure of variabilityin frequencies

Measure of variabilityin severities

Measure ofvariability

in reserves byline and period

Confidence Interval and Aggregate Loss Reserve Distribution

Aggregate Loss Reserve Distribution

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800

Loss Reserves ($Millions)

Cu

mu

lati

ve P

rob

abil

ity

50% Confidence Interval

Expected Loss

Confidence Intervals for Loss Reserves – Effect of Reinsurance

Intervals for Small Products Liability Writer

5,000,000

15,000,000

25,000,000

35,000,000

45,000,000

70% 75% 80% 85% 90% 70% 75% 80% 85% 90%Confidence Intervals

Without Reinsurance With Reinsurance

Confidence Intervals for Loss Reserves – Effect of Size

Confidence Intervals for General Liability*(Relative to the Aggregate Mean)

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

70% 75% 80% 85% 90% 70% 75% 80% 85% 90%Confidence Intervals

Smaller Insurer Larger Insurer

Aggregate Mean = 40,292,261

Aggregate Mean = 604,383,911

(15 times the smaller insurer's volume)

* A mix of Other Liability and Products Liability.

Applications• Reserving triangles

– Combine segments using each insurer’s unique mix of business

• Individual segment analysis• Tail factors• Confidence intervals (ranges around

expected)• Benchmarking for CEO/CFO, Board,

investors, rating agencies, regulators, etc.

Future Plans

• Explore ways of improving reserve estimates

– Credibility weighing an insurer’s data with larger data sets

– Generation of more refined confidence intervals

– Additional tail factor treatments– Correlations between

lines/dependencies• What else would be valuable for loss

reserving?