September 2002 Arlington, Virginia

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Intermediate Track III

September 2002Arlington, Virginia

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Introduction

The Ideal Situation

Loss reserve data should contain a long, stable history of homogeneous claim experience, where

no significant operations changes materially affect either the mix of business or the handling of claims, and there should be a sufficient number of claims to

produce credible loss patterns.

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IntroductionThe Reality

Virtually all elements of “The Ideal” are periodically violated:1. The Mix Changes2. Claim Handling Changes3. Case Reserves are Strengthened/Weakened4. Other Factors

Changes in Deductibles, Limits, SIRs Changes in Reinsurance Tort Reform, other law changes New Sources of Loss Changes in the Economy

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Introduction

This Session Will Discuss

The potential impact of mix changes

Changes in claim closing patterns

Changes in case reserve adequacy

What Else?

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CHANGEIN

MIX

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Change in Mix

Cumulative Paid Losses (Combined)

Accident Months of DevelopmentYear 12 24 36+ Ultimate

1998 $2,000 $4,000 $5,100 $5,1001999 2,000 4,000 5,100 5,1002000 2,000 4,000 5,1002001 2,000 5,100

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Change in Mix

Cumulative Paid Losses (Category A)

Accident Months of DevelopmentYear 12 24 36+ Ultimate1998 $1,500 $1,800 $2,100 $2,1001999 1,500 1,800 2,100 2,1002000 1,500 1,800 2,1002001 500 700

Develops quicklyMost of losses within 12 months

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Change in Mix

Cumulative Paid Losses (Category B)

Accident Months of DevelopmentYear 12 24 36+ Ultimate1998 $500 $2,200 $3,000 $3,0001999 500 2,200 3,000 3,0002000 500 2,200 3,000 3,0002001 1,500 9,000

Develops slower than Category AMost of losses between 12-24 months

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Change in Mix

Paid Loss Ultimate Comparison

Accident Year 2001 ultimate loss if change in mix is ignored: $5,100

Accident Year 2001 ultimate if data is separately analyzed: $9,700

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Change in Mix

Key Principle

Always search for subdivisions of data related to possible causes of variable loss development

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Change in Mix

Suggested Subdivisions of Data Include

Primary:1. Geographic2. New Products vs. Old3. Subline or Coverage4. Deductibles or Policy Limits5. Type of Loss Payment (e.g., Medical vs. Indemnity)

Reinsurance:1. Attachment Point2. Production Source3. Line or Subline

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Change in Mix

How Do You Decide?

Ask:1. Underwriters2. Claims Department3. Agents4. Actuaries

The Key:Learn as much as possible about the book of business you are evaluating. What it has been historically What it is becoming

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Change in Mix

What Should be Done if Mix Change Includes New Business for Which You Have Insufficient Data?

Seek Alternative Sources of DataPerhaps general liability book formerly was comprised solely of “OL&T” exposures, but in recent years began adding “M&C” risks. Possible Solution: Relate ISO development patterns for M&C to OL&T and modify development factors for your analysis.

Discuss Potential Impacts with Claims, Underwriting, Other Actuaries Length of Tail Frequency Severity Loss Ratios

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CLAIMCLOSING

PATTERNS

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Claim Closing PatternsWhat is driving the divergence?

Unadjusted Paid Loss Development Method

Accident Months of DevelopmentYear 12 24 36+ Ultimate1999 $1,000 $4,000 $6,000 $6,0002000 1,000 3,500 5,2502001 750 4,219

Incurred Loss Development Method

Accident Months of DevelopmentYear 12 24 36+ Ultimate1999 $2,000 $5,000 $6,000 $6,0002000 1,967 4,917 5,9002001 1,867 5,600

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Claim Closing Patterns

1) Review Closing Rates to Determine Whether There Has Been a Change

2) Seek Independent Confirmation That a Change Has Occurred

3) Restate Historical Closed Claims Using Current Closing Rates

4) Restate Historical Paid Losses Using Restated Closed Claims

5) Apply Standard Loss Development Method To Restated Paid Losses

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Data Needed Paid Loss Development Triangle (slide 15) Reported Claims Development Triangle Projected Ultimate Claims Closed Claims Development Triangle

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Step 1: Review Closing Rates to Determine Whether There Has Been

a Change

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Reported Claims

Accident Months of DevelopmentYear 12 24 36 Ultimate1999 500 900 1,000 1,0002000 480 880 9802001 450 900

Closed Claims

Accident Months of Development Year 12 24 36+1999 250 810 1,0002000 240 7042001 180

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Closed / Reported

Accident Months of DevelopmentYear 12 24 361999 50.0% 90.0% 100.0%2000 50.0% 80.0%2001 40.0%

Closed / Ultimate


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Step 2: Seek Independent Confirmation that a Change Has Occurred

Ask the Claims Department About Changes in: Opening and Closing Practices The Claims Handling Environment Levels of Staffing, Reorganizations Definition of a Claim (e.g., Multiple Claimants)

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Step 3: Restate Historical Closed Claims Using Current Closing Rates

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Adjusted Closing Percent


Adjusted Closed Claims

Accident Months of DevelopmentYear 12 24 36+1999 200 718 1,0002000 196 7042001 180

Ultimate Claims (slide 19) * Adjusted Closing % 200 = 1,000 * 20.0% 718 = 1,000 * 71.8% 196 = 980 * 20.0%

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Step 4: Restate Historical Paid Losses Using Restated Closed Claims

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Linear Interpolation of Adjusted Paid Losses

Accident Year 1999 @ 12 Months Age 0 Age 12 Accident Year 1999 @ 24 Months Age 12 Age 24

Actual Closed Claims (slide 19) 0 250 Actual Closed Claims (slide 19) 250 810

Actual Paid Loss (slide 15) 0 1,000 Actual Paid Loss (slide 15) 1,000 4,000

Therefore, 200 Claims would expect to have $800 paid loss Therefore, 718 Claims would expect to have $3,507 paid loss

AY 1999 200 - 0 x (1,000 - 0) + 0 = 800 AY 1999 718 - 250 x (4,000 - 1,000) + 1,000 = 3,507

@ 12 Months 250 - 0 @ 24 Months 810 - 250

Accident Year 2000 @ 12 Months Age 0 Age 12

Actual Closed Claims (slide 19) 0 240

Actual Paid Loss (slide 15) 0 1,000

Therefore, 196 Claims would expect to have $817 paid loss

AY 2000 196 - 0 x (1,000 - 0) + 0 = 817

@ 12 Months 240 - 0

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Step 5: Apply Standard Loss Development Method to Restated

Paid Losses

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Claim Closing PatternsAdjusted Paid Loss Development Method

Accident Months of DevelopmentYear 12 24 36+1999 $800 $3,507 $6,0002000 817 3,5002001 750

Accident Months of DevelopmentYear 12-24 24-36 36-Ult1999 4.38 1.712000 4.28

Selected 4.33 1.71 1.00CDF 7.41 1.71 1.00

Ultimate 5,561 5,988 6,000

from slide 25

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Impact of Adjustment

Revised OriginalAccident Forecast Forecast

Year Slide 27 Slide 15 Difference1999 $6,000 $6,000 $02000 5,988 5,250 7382001 5,561 4,219 1,342Total $17,549 $15,469 $2,080

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CASERESERVE

ADEQUACY

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Case Reserve AdequacyWhat is driving the divergence?

Incurred Losses ($000)

Accident Months of Development ProjectedYear 12 24 36+ Ultimate1999 10,000 40,000 50,000 50,0002000 10,000 45,000 56,2502001 10,417 55,340

Paid Losses ($000)

Accident Months of Development ProjectedYear 12 24 36+ Ultimate1999 2,000 24,000 50,000 50,0002000 2,500 30,000 62,5002001 3,125 78,125

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Case Reserve AdequacyWhat if claim closing patterns are not changing?

Reported Claims

Accident Months of Development Year 12 24 36 Ultimate1999 5,000 8,000 10,000 10,0002000 5,000 8,000 10,0002001 5,000 10,000

Closed Claims

Accident Months of Development Year 12 24 36+1999 1,000 6,000 10,0002000 1,000 6,0002001 1,000

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Case Reserve Adequacy

1) Review Paid-To-Incurred Triangles2) Review Trends in Average Paid Claims

Versus Trends in Average Case Reserves3) Review Potential Reasons for Observed

Trends4) Adjust Historical Case Reserves to

Current Adequacy Levels5) Calculate Adjusted Incurred Losses6) Project Ultimate Losses Using Adjusted

Incurred Losses and Standard Loss Development

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Step 1: Review Paid - To - Incurred Triangles

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Accident Months of DevelopmentYear 12 24 361999 20% 60% 100%2000 25% 67%2001 30%

[paid loss / incurred loss from slide 30]

Ratios are increasing. Since settlementrates appear consistent, may be due to adecrease in case reserve adequacy.

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Step 2: Review Trends in Average Paid Claims Versus Trends in Average

Case Reserves

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Accident Average Paid Loss Average Case ReservesYear 12 24 12 241999 2,000 4,000 2,000 8,0002000 2,500 5,000 1,875 7,5002001 3,125 1,823

Trend 25% 25% -4.5% -6.3%

Average Paid Loss = Paid Loss Triangle (Slide 30) / Closed Claim Triangle (Slide 31) * 1,000

Average Case Reserves = (Incurred Loss Triangle - Paid Loss Triangle (Slide 30)) /

(Reported Claim Triangle - Closed Claim Triangle (Slide 31)) * 1,000

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Step 3: Review Potential Reasons for Observed Trends

Is the book shifting to a lower severity mix?

Have policy limits and/or reinsurance retentions kept pace with claims inflation?

Has anything material changed in the handling of claims?

Turnover in claim department staff

Changes in philosophy

If you conclude there has been case reserve weakening (or strengthening), adjust the data. Here’s one approach.

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Step 4: Adjust Historical Case Reserves to Current Adequacy Levels

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Assumption: 25% is the Actual Rate of Claim Inflation

Accident Adjusted Average Case ReservesYear 12 24 361999 1,167 6,000 02000 1,458 7,5002001 1,823

6,000 = 7,500 / 1.25 1,458 = 1,823 / 1.251,167 = 1,823 / (1.25 ̂2)

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Step 5: Calculate Adjusted Incurred Losses

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Paid to # of Adjusted AdjustedDate + Open x Average = Incurred

Losses Claims Case Reserves Losses(slide 30) (slide 31) (slide 39)/1000

AY 1999@ 12 Months 2,000 + 4,000 x 1.167 = 6,667

AY 1999@ 24 Months 24,000 + 2,000 x 6.000 = 36,000

AY 2000@ 12 Months 2,500 + 4,000 x 1.458 = 8,334

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Step 6: Project Ultimate Losses Using Adjusted Incurred Losses and Standard Loss Development

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Case Reserve AdequacyAdjusted Incurred Losses

Accident Months of DevelopmentYear 12 24 36+1999 $6,667 $36,000 $50,0002000 8,334 45,0002001 10,417

Accident Months of DevelopmentYear 12-24 24-36 36-Ult1999 5.40 1.392000 5.40

Selected 5.40 1.39 1.00CDF 7.50 1.39 1.00

Ultimate 78,125 62,500 50,000

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Impact of Adjustment

Original Original RevisedIncurred Paid Incurred

Accident Estimate Estimate EstimateYear Slide 30 Slide 30 Slide 431999 $50,000 $50,000 $50,0002000 56,250 62,500 62,5002001 55,340 78,125 78,125Total $161,590 $190,625 $190,625

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What Else?

Deductibles/Limits/SIRs change Reinsurance Arrangements Change Tort Reform New Sources of Loss Changes in the Economy

September 2002 Arlington, Virginia

Documents

Transcript of September 2002 Arlington, Virginia