IBNR

FN 101 – THE LEXICON OF RISK FINANCING BASICS EXPLAINED

Tuesday, April 1710:15 am – 11:30 am

Moderator – Shelly HubickiManager – Risk Finance/Risk Management & Insurance, The Boeing Company

[email protected] (312)544-2177

Speaker – Scott SilitskyVP Contracts & Risk Manager, ThyssenKrupp Elevator Company


Coordinator/Speaker - Barbara Benson GrinnellVice President, Willis


mailto:[email protected]

mailto:[email protected]

Agenda

• Introduction• Basic loss development• Loss analysis• Cash flow comparisons of market quotes• Conclusion

Basic Loss Development

• Purpose: To use the growth patterns of historical losses to predict ultimate losses on policy years that are still open and developing

Sources of Loss Development Factors

• Industry-provided– Insurance carriers– Rating bureaus– Independent consultants– Actuaries

• Organization-specific

Casualty Coverage’s

• Workers’ compensation• Automobile liability• General liability• Products liability

Loss Development Triangles

• Types of triangles– Incurred loss development– Paid loss development– Frequency loss development

• Per occurrence retention– Limited– Unlimited

Incurred But Not Reported Claims

• Incurred But Not Reported (IBNR) claims caused by– Delay between occurrence and reporting of the claim– Actual amount for which a claim will settle is unknown– Indeterminate amount of time between a claims first

report and when all activity on that claim ceases

Sample Company – Loss Run SummaryValuation Date: 12/31/2005 Valuation Date: 12/31/2009Policy Period Incurred Paid # Claims Policy Period Incurred Paid # Claims1/1-12/31/05 352,429 150,254 120 1/1-12/31/05 715,846 625,000 152

1/1-12/31/06 554,123 498,741 149 Valuation Date: 12/31/2006 1/1-12/31/07 1,344,098 1,300,000 160 Policy Period Incurred Paid # Claims 1/1-12/31/08 980,544 758,474 165 1/1-12/31/05 459,510 274,587 150 1/1-12/31/09 816,337 321,587 135 1/1-12/31/06 276,952 145,210 101

Valuation Date: 12/31/2010Valuation Date: 12/31/2007 Policy Period Incurred Paid # ClaimsPolicy Period Incurred Paid # Claims 1/1-12/31/05 718,434 701,058 152 1/1-12/31/05 591,215 525,112 152 1/1-12/31/06 564,587 525,000 149 1/1-12/31/06 393,833 312,541 140 1/1-12/31/07 1,488,670 1,356,987 161 1/1-12/31/07 592,449 256,874 130 1/1-12/31/08 1,322,208 1,254,123 167

1/1-12/31/09 1,104,286 645,874 160 Valuation Date: 12/31/2008 1/1-12/31/10 402,087 195,120 105 Policy Period Incurred Paid # Claims1/1-12/31/05 659,874 565,899 152 Valuation Date: 12/31/20111/1-12/31/06 500,123 478,001 148 Policy Period Incurred Paid # Claims1/1-12/31/07 1,053,915 501,245 155 1/1-12/31/05 718,434 718,434 152 1/1-12/31/08 644,873 295,741 140 1/1-12/31/06 570,145 545,879 149

1/1-12/31/07 1,588,127 1,485,214 161 1/1-12/31/08 1,549,531 1,301,258 170 1/1-12/31/09 1,087,525 1,001,234 175 1/1-12/31/10 578,368 418,547 145 1/1-12/31/11 402,966 150,145 99

Sample Co. – Incurred Loss Triangulation - WC

PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966

Elapsed Months from InceptionIncurred Loss Triangle


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.304 1.287 1.116 1.085 1.004 1.000 1/1-12/31/06 1.000 1.422 1.270 1.108 1.019 1.010 1/1-12/31/07 1.000 1.779 1.275 1.108 1.067 1/1-12/31/08 1.000 1.521 1.348 1.172 1/1-12/31/09 1.000 1.353 0.985 1/1-12/31/10 1.000 1.438 1/1-12/31/11 1.000

Incremental Growth TriangleElapsed Months from Inception

24 month incurred losses12 month incurred losses

578,368402,087

=

= = 1.438


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.304 1.287 1.116 1.085 1.004 1.000 1/1-12/31/06 1.000 1.422 1.270 1.108 1.019 1.010 1/1-12/31/07 1.000 1.779 1.275 1.108 1.067 1/1-12/31/08 1.000 1.521 1.348 1.172 1/1-12/31/09 1.000 1.353 0.985 1/1-12/31/10 1.000 1.438 1/1-12/31/11 1.000


EMFI 12 24 36 48 60 72 84Incremental Avg. 1.000 1.469 1.233 1.126 1.057 1.007 1.000

Average all policy years


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.304 1.287 1.116 1.085 1.004 1.000 1/1-12/31/06 1.000 1.422 1.270 1.108 1.019 1.010 1/1-12/31/07 1.000 1.779 1.275 1.108 1.067 1/1-12/31/08 1.000 1.521 1.348 1.172 1/1-12/31/09 1.000 1.353 0.985 1/1-12/31/10 1.000 1.438 1/1-12/31/11 1.000

EMFI 12 24 36 48 60 72 84Incremental Avg. 1.000 1.469 1.233 1.126 1.057 1.007 1.000 Adjusted Inc. Avg. 1.000 1.408 1.295 1.126 1.057 1.007 1.000


Remove any “irregular” averages


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.304 1.287 1.116 1.085 1.004 1.000 1/1-12/31/06 1.000 1.422 1.270 1.108 1.019 1.010 1/1-12/31/07 1.000 1.779 1.275 1.108 1.067 1/1-12/31/08 1.000 1.521 1.348 1.172 1/1-12/31/09 1.000 1.353 0.985 1/1-12/31/10 1.000 1.438 1/1-12/31/11 1.000

EMFI 12 24 36 48 60 72 84Incremental Avg. 1.000 1.469 1.233 1.126 1.057 1.007 1.000 Adjusted Inc. Avg. 1.000 1.408 1.295 1.126 1.057 1.007 1.000 Cumulative Average 1.000 1.408 1.823 2.052 2.169 2.184 2.184


36 month cumulative average X 48 month incremental average

1.823 X 1.126 = 2.052

Multiply each consecutive incremental average by the previous cumulative average


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.304 1.287 1.116 1.085 1.004 1.000 1/1-12/31/06 1.000 1.422 1.270 1.108 1.019 1.010 1/1-12/31/07 1.000 1.779 1.275 1.108 1.067 1/1-12/31/08 1.000 1.521 1.348 1.172 1/1-12/31/09 1.000 1.353 0.985 1/1-12/31/10 1.000 1.438 1/1-12/31/11 1.000



EMFI 12 24 36 48 60 72 84Development Factor 2.184 1.551 1.198 1.064 1.007 1.000 1.000

= 1.551

=

= 84 month cumulative avg.

24 month cumulative avg.

2.184

1.408=


PolicyYear 12 24 36 48 60 72 841/1-12/31/05 352,429 459,510 591,215 659,874 715,846 718,434 718,434 1/1-12/31/06 276,952 393,833 500,123 554,123 564,587 570,145 1/1-12/31/07 592,449 1,053,915 1,344,098 1,488,670 1,588,127 1/1-12/31/08 644,873 980,544 1,322,208 1,549,531 1/1-12/31/09 816,337 1,104,286 1,087,525 1/1-12/31/10 402,087 578,368 1/1-12/31/11 402,966

PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.304 1.287 1.116 1.085 1.004 1.000 1/1-12/31/06 1.000 1.422 1.270 1.108 1.019 1.010 1/1-12/31/07 1.000 1.779 1.275 1.108 1.067 1/1-12/31/08 1.000 1.521 1.348 1.172 1/1-12/31/09 1.000 1.353 0.985 1/1-12/31/10 1.000 1.438 1/1-12/31/11 1.000



Discovery Schedule Cumulative 45.8% 64.5% 83.5% 94.0% 99.3% 100.0% 100.0% Incremental 45.8% 18.7% 19.0% 10.5% 5.3% 0.7% 0.0%



1 / development factor

= 1 / 2.184 = 45.8%

Sample Co. – Paid Loss Triangulation - WCPolicyYear 12 24 36 48 60 72 841/1-12/31/05 150,254 274,587 525,112 565,899 625,000 701,058 718,434 1/1-12/31/06 145,210 312,541 478,001 498,741 525,000 545,879 1/1-12/31/07 256,874 501,245 1,300,000 1,356,987 1,485,214 1/1-12/31/08 295,741 758,474 1,254,123 1,301,258 1/1-12/31/09 321,587 645,874 1,001,234 1/1-12/31/10 195,120 418,547 1/1-12/31/11 150,145

PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.827 1.912 1.078 1.104 1.122 1.025 1/1-12/31/06 1.000 2.152 1.529 1.043 1.053 1.040 1/1-12/31/07 1.000 1.951 2.594 1.044 1.094 1/1-12/31/08 1.000 2.565 1.653 1.038 1/1-12/31/09 1.000 2.008 1.550 1/1-12/31/10 1.000 2.145 1/1-12/31/11 1.000



Payout Schedule Cumulative 22.6% 47.7% 79.3% 83.3% 90.3% 97.6% 100.0% Incremental 22.6% 25.1% 31.6% 4.0% 7.0% 7.3% 2.4%

Paid Loss TriangleElapsed Months from Inception


Sample Co. – Frequency Triangulation - WCPolicyYear 12 24 36 48 60 72 841/1-12/31/05 120 150 152 152 152 152 152 1/1-12/31/06 101 140 148 149 149 149 1/1-12/31/07 130 155 160 161 161 1/1-12/31/08 140 165 167 170 1/1-12/31/09 135 160 175 1/1-12/31/10 105 145 1/1-12/31/11 99

PolicyYear 12 24 36 48 60 72 841/1-12/31/05 1.000 1.250 1.013 1.000 1.000 1.000 1.000 1/1-12/31/06 1.000 1.386 1.057 1.007 1.000 1.000 1/1-12/31/07 1.000 1.192 1.032 1.006 1.000 1/1-12/31/08 1.000 1.179 1.012 1.018 1/1-12/31/09 1.000 1.185 1.094 1/1-12/31/10 1.000 1.381 1/1-12/31/11 1.000



Discovery Schedule Cumulative 75.5% 95.3% 99.2% 100.0% 100.0% 100.0% 100.0% Incremental 75.5% 19.8% 4.0% 0.8% 0.0% 0.0% 0.0%

Number of Claims TriangleElapsed Months from Inception


Discovery and Payout Patterns

• General/products liability– Slowest patterns– Longest tail because of investigation, litigation, and time lag between

report and occurrence date

• Workers’ compensation– Payout increases steadily over time– Benefits are statutorily defined– Duration of injury and amount of medical treatment unknown

Discovery and Payout Patterns

• Automobile liability– Relatively quick patterns– Relatively no lengthy litigation

Loss Analysis – Forecasting and Ultimate Liability Analysis

• Ultimate liability projections– Adhere to FASB and GASB requirements regarding

contingent liabilities

• Loss forecasting– Part of the budgeting and marketing process

Sample Co. – WC Remaining Liability Projections

(a) (b) (c) (d) (e)(a x b) (c - d)

Policy YearIncurred Losses

@ 12/31/11

Loss Development

Factor Ultimate LossesPaid Losses @

12/31/11Remaining Liabilities

1/1-12/31/05 718,434 1.000 718,434 718,434 - 1/1-12/31/06 570,145 1.000 570,145 545,879 24,266 1/1-12/31/07 1,588,127 1.007 1,598,815 1,485,214 113,601 1/1-12/31/08 1,549,531 1.064 1,648,625 1,301,258 347,367 1/1-12/31/09 1,087,525 1.198 1,302,747 1,001,234 301,513 1/1-12/31/10 578,368 1.551 897,261 418,547 478,714 1/1-12/31/11 402,966 2.184 879,900 150,145 729,755

Total 6,495,096 7,615,927 5,620,711 1,995,216

Sample Co. – WC Loss Forecast

(a) (b) (c) (d) (e) (f) (g)(a x b) (c x d) (e / f)

Policy Year

Incurred Losses @ 12/31/11 LDF

Ultimate Losses

Inflation Factor @ 7%

Inflated Ultimate Losses

Number of Employees

Inflated Ult. Loss Per

Employee

1/1-12/31/05 718,434 1.000 718,434 1.606 1,153,648 700 1,648 1/1-12/31/06 570,145 1.000 570,145 1.501 855,634 800 1,070 1/1-12/31/07 1,588,127 1.007 1,598,815 1.403 2,242,421 900 2,492 1/1-12/31/08 1,549,531 1.064 1,648,625 1.311 2,161,011 950 2,275 1/1-12/31/09 1,087,525 1.198 1,302,747 1.225 1,595,921 975 1,637 1/1-12/31/10 578,368 1.551 897,261 1.1449 1,027,274 1,000 1,027 1/1-12/31/11 402,966 2.184 879,900 1.070 941,493 900 1,046

1/1-12/31/11 1,443,000 1.000 1,443,000 900 1,603

Assumptions:1. Client specific loss development factors2. No losses in excess of the per occurrence limit3, Workers' compensation inflation rate = 7% per year4. Forecast includes all policy years

Sample Co. – WC Loss Forecast

(a) (b) (c) (d) (e) (f) (g)(a x b) (c x d) (e / f)

Policy Year

Incurred Losses @ 12/31/11 LDF

Ultimate Losses

Inflation Factor @ 7%

Inflated Ultimate Losses

Number of Employees

Inflated Ult. Loss Per

Employee

1/1-12/31/05 718,434 1.000 718,434 1.606 1,153,648 700 1,648 1/1-12/31/06 570,145 1.000 570,145 1.501 855,634 800 1,070 1/1-12/31/07 1,588,127 1.007 1,598,815 1.403 2,242,421 900 2,492 1/1-12/31/08 1,549,531 1.064 1,648,625 1.311 2,161,011 950 2,275 1/1-12/31/09 1,087,525 1.198 1,302,747 1.225 1,595,921 975 1,637 1/1-12/31/10 578,368 1.551 897,261 1.1449 1,027,274 1,000 1,027 1/1-12/31/11 402,966 2.184 879,900 1.070 941,493 900 1,046

1/1-12/31/11 1,116,000 1.000 1,116,000 900 1,240

Assumptions:1. Client specific loss development factors2. No losses in excess of the per occurrence limit3, Workers' compensation inflation rate = 7% per year4. Forecast excludes policy years 1/1-12/31/05 through 1/1-12/31/08

Excluded

Risk Financing

• Determining the most cost-effective way to pay or fund for losses

Risk Financing Continuum

Risk Transfer Risk Retention

Guaranteed Cost

Large Deductible

Qualified Self-Insurance

Captive

Large Deductible

• Loss retention plan• Excess insurance covers losses above deductible• Positive cash flow• Ability to influence program costs• Access to insurer services• Collateral requirements• Tax deduction disadvantage

Qualified Self Insurance

• Formalized retention program• Excess insurance purchased for losses exceeding limit• Qualification requirements vary by state• Positive cash flow• Ability to influence program costs• Unbundled services• Administrative requirements

Factors Influencing Design of Risk Financing Programs

• Expected losses• Market conditions• Corporate

philosophy• Risk control

commitment• Financial position

• Geographical locations

• Loss payout patterns• Effective tax rate• Corporate ownership• Cash flow

comparisons

Cash flow Comparisons

• Definition: Using the net present value of alternative market quotes to determine the most cost-effective program

Present Value Analysis

$ today is worth more than $ tomorrow because of investment

income implications.

Investment Income

• Fund losses at a discount, additional money will be added as interest is earned

• Varied by program and payout• One decision tool to select the ideal program

Tax Implications

• Need to consider when the losses and premium can be deducted from taxable income

• Different programs are treated differently• Should involve corporate tax department

Costs Included

• Expected losses• Primary and excess

premiums• Claims handling• Taxes• Assessments• Loss Control

• Broker fees• Collateral• Fronting costs• Residual market

loads• Boards and bureaus• State funds

Case Study

• Compare the net present value of the following programs– Guaranteed cost– Self-insurance

Sample Co. – 1/1-12/31/12 WC Guaranteed Cost Cash Flow

(a) (b (c) (d) (e) (f)(b x 34%) (b - c) (d x f)

MonthPremium

Cash Flow Tax EffectAfter-Tax

Cash FlowDiscount

Factor

Discounted After Tax

Cash Flow1 125,000 42,500 82,500 1.0000 82,500 2 125,000 42,500 82,500 0.9967 82,231 3 125,000 42,500 82,500 0.9935 81,962 4 125,000 42,500 82,500 0.9902 81,695 5 125,000 42,500 82,500 0.9870 81,428 6 125,000 42,500 82,500 0.9838 81,163 7 125,000 42,500 82,500 0.9806 80,898 8 125,000 42,500 82,500 0.9774 80,634 9 125,000 42,500 82,500 0.9742 80,371

10 125,000 42,500 82,500 0.9710 80,109 11 125,000 42,500 82,500 0.9678 79,847 12 125,000 42,500 82,500 0.9647 79,587

Total 1,500,000 510,000 990,000 972,424

Assumptions:1. Premium is paid in 12 monthly installments at the first of the month2. Losses are discounted at a 4% discount rate3. The effective tax rate is 34%

Sample Co. – 1/1-12/31/12 WC Self Insurance Cash Flow

Month

Cumulative Payout

Schedule

Incremental Payout

Schedule Paid Losss Letter of

Credit Fee Excess

Premium Claims

Handling Admin.

Expenses Fees & Assess.

Total Cash Flow

After-Tax Cash Flow

Discount Factor

Discounted After-Tax

Cash Flow

1 0.09% 0.09% 1,004 5,000 8,333 50 5,000 2,500 21,888 14,446 1.0000 14,446 2 1.18% 1.09% 12,164 8,333 608 21,106 13,930 0.9967 13,884 3 2.35% 1.17% 13,057 8,333 653 22,043 14,549 0.9935 14,454 4 3.71% 1.36% 15,178 8,333 759 24,270 16,018 0.9902 15,862 5 5.34% 1.63% 18,191 8,333 910 27,434 18,106 0.9870 17,871 6 7.15% 1.81% 20,200 8,333 1,010 29,543 19,498 0.9838 19,182 7 9.15% 2.00% 22,320 8,333 1,116 31,769 20,968 0.9806 20,561 8 11.32% 2.17% 24,217 8,333 1,211 33,761 22,283 0.9774 21,779 9 13.85% 2.53% 28,235 8,333 1,412 37,980 25,067 0.9742 24,420

10 16.57% 2.72% 30,355 8,333 1,518 40,206 26,536 0.9710 25,767 11 19.47% 2.90% 32,364 8,333 1,618 42,316 27,928 0.9678 27,030 12 22.64% 3.17% 35,377 8,333 1,769 45,479 30,016 0.9647 28,956

Subtotal 22.64% 252,662 5,000 100,000 12,633 5,000 2,500 377,796 249,345 244,212

24 47.73% 25.09% 280,004 3,868 14,000 297,873 196,596 0.9460 185,970 36 79.29% 31.56% 352,210 2,614 17,610 372,434 245,806 0.9096 223,578 48 83.31% 4.02% 44,863 1,036 2,243 48,142 31,774 0.8746 27,789 60 90.29% 6.98% 77,897 835 3,895 82,626 54,533 0.8409 45,860 72 97.58% 7.29% 81,356 486 4,068 85,910 56,700 0.8086 45,848 84 100.00% 2.42% 27,007 121 1,350 28,479 18,796 0.7775 14,614

Total 100.00% 1,116,000 13,958 100,000 55,800 5,000 2,500 1,293,258 853,550 787,871

Sensitivity Analysis

• How do optimistic and pessimistic loss projections alter the net present value decision of the various program alternatives?

Sample Company – Net Present Value Cash Flow Comparison

$428,825

$787,871

$1,505,963

972,424 972,424 972,424

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

Optimistic Expected Pessimistic

Loss Scenario

Ne

t C

as

h F

low

Self Insurance

Guaranteed Cost

In Conclusion…

• Key Points– Loss development– Loss analysis– Cash flow comparisons

• Questions

IBNR

Documents

Transcript of IBNR