Data Integrity: Garbage Out can be CostlyData Validation in Reserve Analysis and Loss

Forecasting

September 11, 2013

Sound Familiar?From your underwriter………

“Due to market conditions and your recent claims experience, we are increasing your rates by 7%”

From your actuary…….

“Total unpaid losses increased by approximately $300,000 due to adverse loss development”

From your broker…….

“The carrier has increased your collateral requirement by $2 million and the LOC needs to be in place in 30 days”

From your owner…….

“Section 16 of the Construction management agreement clearly states that the construction manager shall bear the cost of all deductibles”

From your DCAA auditor…..

“Your charge for self insurance is disallowed as it is not based on Projected Average Loss as defined under CAS 416”

Session Overview

Background & basicsSection 1: Loss ForecastingSection 2: Reserve analysisSection 3: Collateral

Commercial Insurance has Evolved

Guaranteed Cost1960s

Retrospectively

Rated

Programs1980s

Large Deductible

/ SIR2000+

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• Insurance company data only• Manual process / paper loss runs• GC focus on premium minimization• 100% fixed cost allocation

• Carrier loss data required to support retro adjustments

• Initial use of RMIS • Profit sharing imbedded in

allocations• Increasing pressure to assume

risk/ reduce premiums

• Carrier loss data standardized• Widespread use of RMIS• Insurance market pushing larger

loss retentions• Insurers will provide loss data in

multiple formats (when asked)• Some carriers allow access to

their online systems

Data Implications

Variable costs represent an increasing % of TCOR

5

Contractors are under increasing pressure to validate cost of insurance to owners. Insurance Cost allocation for government work highly regulated (FAR, CAS) Increased importance on accurate measurement and forecasting of variable loss costs

RISK MANAGEMENT & SAFETY

2%

INSURANCE BROKERAGE FEES5%

INSURANCE PREMIUMS 28%

LOSSES & LOSS ADJUSTMENT

EXPENSE65%

Willis ConstructionSample of 49 clients

$0

$5,000

$100,000

$200,000

$250,000

$300,000

$350,000

$500,000

$750,000

$1,000,000 0

2

4

6

8

10

12

14 13

12

3

14

1 1

12

1 1

Workers Comp Deductible Levels

$0

$10,000

$25,000

$50,000

$75,000

$100,000

$150,000

$200,000

$250,000

$270,000

$350,000

$500,000

$750,000

$1,000,000 0

2

4

6

8

10

12

6

23

6

1

4

1 1

11

1 1

7

23

General Liability Deductible Levels

Data Sources & Applications

• Renewal Negotiation• Collateral Analysis• Accounting / Liability

Accruals• Project Costing• Acquisition Pricing• Benchmarking

InternalInsurance Program Data (retentions,

limits, rates)

Premiums

Loss Data

Exposure Data (Payroll, CV, Vehicle counts)

RM Overhead

Safety & Loss Control

ExternalInsurance Carrier loss rates,

aggregate rates

Industry LDFs (AM Best, NCCI)

Experience Mods

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Projected Ultimate Loss

An estimate of total claims cost· Within the deductible layer· For a single policy period· Once all claims are settled, paid and closed.

For first party coverage (Property or Builders Risk), losses are directly measured based on property valuation whether actual cash value or replacement cost. (Short tail)

For casualty lines (AL, GL and WC), due to the lengthy period of time between the occurrence of a claim and final settlement, estimation of ultimate loss is required.

8

Components of Loss

Paid

Paid

PaidOutstanding Case

Reserves

Incurred but not reported (IBNR) Outstanding Case

Reserves

Incurred but not reported (IBNR)

3 months 6 months Claim Closed

Loss Development

Measuring IBNR

XYZ Construction ( Valued as of 3/27/2012 )Workers Compensation Incurred Losses Development Triangle (Limited to $250,000 PO)

1 2 3 4 5 6 7 8 9 10Experience Period 12 months 24 months 36 months 48 months 60 months 72 months 84 months 96 months 108 months 120 months

1 6/1/2000 To 5/31/2001 688,113 1,313,416 1,380,707 1,341,767 1,350,924 1,348,103 1,353,342 1,353,508 1,357,685 1,371,248

2 6/1/2001 To 5/31/2002 1,272,629 2,118,666 2,410,284 2,559,856 2,802,430 2,884,460 2,888,163 3,017,388 3,023,259 3,022,408

3 6/1/2002 To 5/31/2003 4,048,964 4,581,738 4,996,855 5,247,677 5,090,751 5,091,001 5,089,254 5,085,664 5,085,659

4 6/1/2003 To 5/31/2004 778,680 1,440,285 1,760,011 1,839,979 1,986,062 1,987,490 1,987,490 1,987,399

5 6/1/2004 To 5/31/2005 1,692,891 2,231,172 2,246,244 2,364,051 2,543,919 2,541,738 2,532,844

6 6/1/2005 To 5/31/2006 1,861,210 2,892,533 3,532,579 3,636,037 3,654,268 3,560,541

7 6/1/2006 To 5/31/2007 1,197,109 1,744,078 1,821,767 1,964,366 1,898,302

8 6/1/2007 To 5/31/2008 1,477,914 1,926,047 2,200,930 2,204,225

9 6/1/2008 To 5/31/2009 1,341,166 1,947,308 2,230,905

10 6/1/2009 To 5/31/2010 844,060 1,396,356

11 6/1/2010 To 5/31/2011 730,908

Workers' Compensation Incurred Losses Report-to-report Development Factors (Limited to $250,000 PO)12 Mos To 24 Mos To 36 Mos To 48 Mos To 60 Mos To 72 Mos To 84 Mos To 96 Mos To 108 Mos To 120 Mos To

24 Mos 36 Mos 48 Mos 60 Mos 72 Mos 84 Mos 96 Mos 108 Mos 120 Mos 132 MosExperience Period

1 6/1/2000 To 5/31/2001 1.909 1.051 0.972 1.007 0.998 1.004 1.000 1.003 1.010 1.3622 6/1/2001 To 5/31/2002 1.665 1.138 1.062 1.095 1.029 1.001 1.045 1.002 1.000 3 6/1/2002 To 5/31/2003 1.132 1.091 1.050 0.970 1.000 1.000 0.999 1.000 4 6/1/2003 To 5/31/2004 1.850 1.222 1.045 1.079 1.001 1.000 1.000 5 6/1/2004 To 5/31/2005 1.318 1.007 1.052 1.076 0.999 0.997 6 6/1/2005 To 5/31/2006 1.554 1.221 1.029 1.005 0.974 7 6/1/2006 To 5/31/2007 1.457 1.045 1.078 0.966 8 6/1/2007 To 5/31/2008 1.303 1.143 1.001 9 6/1/2008 To 5/31/2009 1.452 1.146

10 6/1/2009 To 5/31/2010 1.654 11 6/1/2010 To 5/31/2011

Average Report to Report Factors 1.529 1.118 1.036 1.028 1.000 1.000 1.011 1.002 1.005 Report to Ultimate Factors 2.527 1.652 1.478 1.426 1.387 1.386 1.386 1.371 1.368 1.362

Request your loss data as of a set date each year (expiration or year end)

Section 1Loss Forecasting

Loss Forecast

A Projection of ultimate losses:

• Within the deductible layer

• For the upcoming or renewal policy period

• Based on historical loss and exposure history

• Adjusted for inflation

• Forecast = loss rate x projected exposures

Applications:• Risk Transfer Premium Negotiation• Renewal Year Collateral• Project Cost Allocation

Total LossExposures

= LossRate

Case Study #1 :Loss Forecasting

General Contractor just signed contract for $30,000,000 projectGeneral Liability program has a $250,000 per occurrence

deductibleThe liability rate charged to the job needs to cover both fixed cost

premiums and expected losses within the deductible

Goal: Forecast an expected loss rate for the deductible

Summarize and limit loss data

Historical losses should be limited at theforecast deductible level

Individual large losses should be

identified and limited

Apply Loss Development & Select Ultimate Loss

Some actuaries reduce LDF to 1.0 when all claims are paid

Carriers generally select ultimate loss based on incurred; for older years paid factors may be more appropriate

Losses and exposures are adjusted for inflation

Verify trend factors are applicable.

Consider separate analysis of workers compensation for states with significant benefit level adjustments.

Select loss rate and apply to forecast exposures

Verify projected exposures

Carrier expected loss rates can be derived from collateral requirements

Deductible aggregate rates identify maximum exposure

Project AllocationXYZ Construction, Inc.Project Cost Allocation

Commercial Construction Value (CV) 500,000,000$

Fixed Costs

Insurance Premiums Carrier Deductible/SIR Premium % of CVAutomobile Liability Chartis $100,000 BI / $1,000 PD 140,000$ 0.03%Professional & Pollution Liability Catlin $100,000 163,000$ 0.03%Professional & Pollution Excess Liability Great American various 100,000$ 0.02%Property Chartis various 113,000$ 0.02%Contractor's Equipment Chartis various 50,000$ 0.01%D&O / EPL / Fiduciary Zurich various 44,000$ 0.01%Crime Zurich $50,000 25,000$ 0.01%General Liability Chartis $250,000 197,000$ 0.04% Umbrella Chartis - 145,000$ 0.03% 2nd Layer Excess Allied World - 40,000$ 0.01% 3rd Layer Excess Chartis - 50,000$ 0.01% 4th Layer Excess Great American - 30,000$ 0.01% 5th Layer Excess XL 25,000$ 0.01%

1,122,000$ 0.22%

Administration Cost % of CVSafety / Broker Admin Fee / RM Overhead & Admin 300,000$ 0.06%

Variable Costs

Estimated Loss Costs Deductible/SIR Expected Loss Maximum Loss Expected % CV Max % CVAutomobile Liability $100,000 BI / $1,000 PD 150,000$ 450,000$ 0.03% 0.09%Professional & Pollution Liability 100,000 -$ 300,000$ 0.00% 0.06%D&O / EPL / Fiduciary 50,000 -$ 150,000$ 0.00% 0.03%Crime 50,000 150,000$ 0.00% 0.03%General Liability 250,000 835,000$ 2,505,000$ 0.17% 0.50%

985,000$ 3,555,000$ 0.20% 0.71%

Total 2,407,000$ 4,977,000$ 0.48% 1.00%

Exposure Information

The deductible rates (expected and aggregate) may help provide an applicable range for project cost allocation

Common Data Issues Overstating Loss Data

• Incorrectly Limiting Loss Data - Not grouping multiple claims of a single occurrence

• Outstanding case reserves on claims that have settled and should be closed

• Including self insured states losses in an insured states forecast

• Not adjusting incurred and paid losses for recovery

• Developing losses in policy years where all claims are closed. (Debatable)

If loss data is high, loss rate will be artificially high

Case Study Impact of Overstating Losses

Case study loss rate was $1.67

If the two large losses in policy years 2008 and 2011 were the result of common occurrences, the losses in those policy years should decrease by $250,000.

After correcting the losses, the rate decreases to $1.31 This results in a decrease in the forecast from $835,000 to $655,000

Period Inception

Period Expiration

Adjusted Losses AdjustedPure Loss Rate per $1,000 CV

10/1/2008 9/30/2009 345,987$ 398,908,800$ 0.8710/1/2009 9/30/2010 602,675$ 409,077,500$ 1.4710/1/2010 9/30/2011 420,854$ 408,432,000$ 1.0310/1/2011 9/30/2012 833,701$ 501,473,000$ 1.6610/1/2012 9/30/2013 858,758$ 558,885,000$ 1.54

Average 1.31

Common Data Issues

Overstating Exposure Data• Including CV/payroll that is enrolled in a CCIP or OCIP

• Including self insured states payroll in the insured’s state analysis

• Including exposures related to sold or discontinued operations

If exposure data is high, loss rate will be artificially low

Case Study Impact of Overstating Exposure

Case study loss rate was $1.67

If 25% of construction value was enrolled in CCIP/OCIP ,exposures should be decreased by 25%

After correcting the exposures, the rate increases to $2.23 This results in a increase in the forecast from $835,000 to $1,115,000

Period Inception

Period Expiration

Adjusted Losses AdjustedPure Loss Rate per $1,000 CV

10/1/2008 9/30/2009 595,987$ 299,181,600$ 1.9910/1/2009 9/30/2010 602,675$ 306,808,125$ 1.9610/1/2010 9/30/2011 420,854$ 306,324,000$ 1.3710/1/2011 9/30/2012 1,421,253$ 376,104,750$ 3.7810/1/2012 9/30/2013 858,758$ 419,163,750$ 2.05

Average 2.23

Loss Forecasting Tips The loss forecast is only as good as the source data.

· Request loss data from your carrier in an excel format· Know your large losses; make sure claims data is accurate.· Utilize claim reviews; claim closure projects

Make sure discontinued operations are excluded from historical loss and exposure data for forecasting purposes

Verify that allocated loss adjustment expense is treated consistent with renewal terms.

Ask your carrier for loss triangles limited at your deductible level

· Utilize company specific loss development factors if there is sufficient underlying data to be statistically valid.

Consider an LDF of 1.0 on policy years where all claims are closed.

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Section 2Reserve Analysis

Reserve AnalysisEstimating the total remaining liability:

· For past & current policy years· As of a specific date

Process:· Estimate ultimate loss

‒ Generally, the actuary will use several methods and select one· Subtract total paid to date

Applications:· Financial Reporting· Collateral determination of expired policy years· Valuing Acquisitions

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Case Study #2 :Reserve Analysis

General Contractor has an expiring Contractor Controlled Insurance Program with no new enrollment

Program included a $250,000 deductible for workers compensationThe GC needs to book an outstanding liability for residual risk on

its balance sheetThe GC wants to negotiate with the carrier for a release of

collateral

Goal: Interpret actuarial analysis and provide accounting with the appropriate reserve estimate

Interpreting an actuarial analysis

Validate loss data before providing to actuary

Know your large losses and clash claims

In a primary casualty program, make sure historical loss limits are correct

Errors in loss data will be magnified when loss development is applied

Your actuary will use multiple methods to estimate ultimate loss

Read the footnotes

Understand the selection of projected ultimate

Communicate with your actuary

Request a confidence level analysis or range to increase flexibility Inquire about discounting losses to reflect anticipated payment patterns

Reserve Analysis Tips Review the data before submitting to the actuary

· Know your large claims‒ Challenge individual claim reserves if they are high based on your knowledge of the loss.

(i.e. potential subrogation)‒ Challenge losses you know have been paid that have outstanding reserves that should be

closed.· Watch for duplicate claims or claims that should be excluded

‒ Subguard claims should not be included on a GL loss run· Notify the actuary of any multiple claim occurrences and/or clash claims· Look for recovery dollars. Total incurred should be appropriately adjusted.

Communicate historical deductible levels / loss limits Request a confidence level analysis or a range. Consider discounting Ask if your loss history is sufficient to produce loss Triangles / development factors

based on your claims experience versus industry.

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Section 3Collateral

Insurance Collateral Assets of the insured pledged to the insurance carrier to cover deductible losses

In large deductible policies, the insurer “pays on behalf” of the insured and seeks reimbursement for deductible losses creating credit risk

With insufficient collateral, insurers are subject to accounting penalties (Schedule F) which result in a reduction in admitted assets

For the insured, insurance collateral may restricts assets, draw on credit capacity and can create liquidity issues

The payment agreement outlines the collateral terms

Carriers may accept alternative forms of collateral

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Request Carrier Calculation

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ReserveAnalysis

Loss Forecast

XYZ CompanySecurity Required

Effective Date: 10/01/13Evaluated as of: 05/31/13

Incurred Paid UltimateLoss Limited Limited Limited Security

Year LOB Limit Loss Loss Loss Required

2008 WC 500,000 3,294,938 2,368,758 3,491,663 1,122,9052008 GL 750,000 102,658 88,767 132,778 44,0112008 Auto 25,000 128,606 128,606 129,550 9442008 Total 3,526,139 2,565,039 3,753,991 1,167,860

2009 WC 500,000 696,333 379,343 759,011 379,6682009 GL 750,000 791,894 787,921 1,361,938 574,0172009 Auto 25,000 112,520 82,076 113,550 31,4742009 Total 1,600,744 1,237,457 2,234,499 985,159

2010 WC 500,000 1,042,299 671,150 1,278,572 607,4222010 GL 750,000 12,423 12,423 20,695 8,2722010 Auto 25,000 72,724 72,724 75,792 3,0682010 Total 1,132,229 747,995 1,375,059 618,762

2011 WC 500,000 735,221 443,672 1,359,222 915,5502011 GL 750,000 10,955 905 326,881 325,9762011 Auto 25,000 68,443 55,656 83,076 27,4202011 Total 693,731 429,756 1,769,179 1,268,946

2012 WC 500,000 382,390 185,444 2,381,461 2,196,0172012 GL 750,000 0 0 982,235 982,2352012 Auto 25,000 40,487 28,044 100,596 72,5522012 Total 372,302 165,838 3,464,293 3,250,805

2013 WC 500,000 2,609,117 2,609,1172013 GL 750,000 511,738 511,7382013 Auto 25,000 105,470 105,4702013 Total 3,226,325 3,226,325

Total excluding Renewal 7,325,145 5,146,085 12,597,021 7,291,532Renewal Year 3,226,325 3,226,325Total All Years 7,325,145 5,146,085 15,823,346 10,517,857

Security Adjustment (675,000)Total Security & Escrow Required 9,842,857

Validate the data

Claim Number Status Loss Date

Carrier Report Date

Line of Business

Jur/Cov/Gar State

Accident Description Code

Accident State

Contract Effective Date Year Total Incurred

Limited Incurred Limited Paid

WC555916398 Open 5/19/2009 5/19/2009 WC NC 100 - AMPUTATION NC 2008 1,366,221 500,000 318,134 WC555921752 Closed 7/6/2009 7/6/2009 WC NC 210 - FRACTURE NC 2008 1,318,868 500,000 500,000 WC949009267 Open 6/24/2009 6/24/2009 WC TX 500 - FATALITY-NOC TX 2008 869,200 500,000 166,926 WC555A07413 Open 2/25/2011 2/28/2011 WC GA 160 - BRUISE/CONTU GA 2010 686,712 500,000 194,322 WC608628100 Open 3/11/2009 3/11/2009 WC CA 309 - STR/SPR/BACK CA 2008 488,445 488,445 222,200 WC608640069 Open 9/11/2009 9/15/2009 WC CA 313 - STR/SPR LEG CA 2008 312,742 312,742 260,620 WC608A09883 Open 6/3/2010 8/22/2011 WC CA 700 - CUMTV TRAUMA CA 2009 290,688 290,688 28,687 WC608656989 Open 6/22/2010 6/22/2010 WC CA 210 - FRACTURE CA 2009 212,535 212,535 157,547 WC80D016360 Closed 12/9/2008 12/10/2008 WC MD 400 - MULTIPLE MD 2008 209,314 209,314 209,314 WC608A28968 Open 3/1/2012 5/31/2012 WC CA 310 - SPR/STRAIN CA 2011 180,842 180,842 123,959 WC390583506 Closed 10/6/2010 11/10/2010 WC PA 310 - SPR/STRAIN PA 2010 147,457 147,457 147,457 WC608A48480 Open 10/25/2010 12/3/2012 WC CA 700 - CUMTV TRAUMA CA 2010 146,622 146,622 116,048 WC608626660 Closed 1/30/2009 2/16/2009 WC CA 310 - SPR/STRAIN CA 2008 134,041 134,041 134,041 WC949004168 Closed 5/5/2009 5/7/2009 WC TX 309 - STR/SPR/BACK TX 2008 129,419 129,419 129,419 WC555A65647 Open 5/22/2012 7/18/2012 WC SC 310 - SPR/STRAIN SC 2011 90,869 90,869 13,391 WC555A58429 Open 4/28/2012 5/11/2012 WC GA 400 - MULTIPLE GA 2011 87,025 87,025 32,457

Row Labels Sum of Total Incurred Sum of Limited Incurred Sum of Total Paid Sum of Limited Paid10/1/2008 5,349,228 3,294,938 3,187,626 2,368,758 10/1/2009 696,333 696,333 379,343 379,343 10/1/2010 1,229,011 1,042,299 671,150 671,150 10/1/2011 735,221 735,221 443,672 443,672 10/1/2012 382,390 382,390 185,444 185,444

Request carrier data at same evaluation date

Tips to Negotiating Collateral Prepare an independent analysis Save prior year carrier calculations, question more conservative

calculations on old policy years Review your payment agreements

· Separate executed payment agreements for each policy period· Look for pre-defined LDFs or collateral adjustment terms

Make the carrier comfortable with your credit profile· Submit financial statements· Disclose recent developments· Develop a relationship with the credit officer / invite your CEO & CFO

Ask about paid loss credits Consider collateral implications prior to marketing your program Understand the various forms of security that your carrier will accept

(LOC’s, trusts, cash/asset backed accounts)

Your response…..

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To your underwriter………

“According to the data , our loss rate has actually decreased as a result of our new safety initiatives”

To your actuary…….

“The apparent adverse loss development is actually a result of a change in TPA that is more conservative therefore IBNR should be adjusted downward”

To your broker…….

“It appears that the LDFs applied by the carrier are inconsistent with the payment agreement and the LOC should be decreased by….”

To your owner…….

“We have elected to purchase guaranteed cost coverage which unfortunately will increase the insurance allocation on your projects”

To your DCAA auditor…..

“Please review the attached actuarial analysis which includes the estimate of projected average loss”