basic track iii

1CLRS Basic Track III

Basic Track III2002 CLRS

September 2002Arlington, Virginia


THIS SESSION WILL DISCUSS

I. Expected Loss Ratio Technique II. Defense and Cost Containment (DCC) (Allocated Loss Adjustment Expenses)

III. Adjusting and Other Expenses (AO) (Unallocated Loss Adjustment Expenses)

IV. Schedule P - Part 1 Summary


EXPECTED LOSS RATIO TECHNIQUE

EXPECTED LOSS RATIO (ELR)

The anticipated ratio of projected ultimate losses to earned premiums.

Sources:» Pricing assumptions» Historical data such as Schedule P» Industry data



EXAMPLE OF ELR USING PRICING ASSUMPTIONSCommissions 20%

Taxes 5%

General Expenses 15%

Profit (2%) Total 38%

Amount to pay for loss & loss expense ---- 62% of premium


EXPECTED LOSS RATIO TECHNIQUEExample of ELR from Schedule P

EZ INSURANCE COMPANY AUTO LIABILITY

Schedule P - Part 1B

Private Passenger Auto Liability/Medical

Years in Loss and Loss Expense PercentageWhich (Incurred/Premiums Earned)

PremiumsWere

Earnedand Losses Direct

Were and Incurred Assumed Ceded Net

1. Prior XXXX XXXX XXXX 2. 1992 73.1% 73.8% 72.4%3. 1993 66.6% 65.9% 67.3%4. 1994 70.3% 68.9% 71.7%5. 1995 69.0% 70.6% 67.4%6. 1996 74.1% 75.0% 73.2%7. 1997 80.2% 83.3% 77.1%8. 1998 60.5% 59.1% 61.9%9. 1999 62.6% 61.3% 63.9%

10. 2000 66.7% 68.0% 65.4%11. 2001 67.0% 68.3% 65.7%

12. Totals XXXX XXXX XXXX

3 year average 65.0% 5 year average 66.8%



Estimating Reserves Based on ELR

Earned Premium x ELR = Expected Ultimate Losses

Ultimate Losses - Paid Losses = Total Reserve

Total Reserve - Case Reserve = IBNR Reserve



Estimating Reserves Based on ELR - ExampleEarned Premium = $100,000Expected Loss Ratio = 0.65Paid Losses = $10,000Case Reserves = $13,000

Total = ($100,000 x 0.65) - $10,000

Reserve = $65,000 - $10,000

= $55,000

IBNR = $55,000 - $13,000

Reserve = $42,000


Estimating Reserves Based on ELR

Use when you have no history such as:– New product lines– Radical changes in product lines– Immature accident years for long tailed lines

Can generate “negative” reserves if Ultimate Losses < Paid Losses




Reserves Based on ELR and Reported Incurred(Bornhuetter-Ferguson Approach)

(Earned Premium x ELR) x (IBNR Factor) = (IBNR Reserves)Where IBNR Factor = (1.000 - 1.000/LDF*)

Reported Incurred + IBNR Reserve = Ultimate Losses

Case Reserve + IBNR Reserve = Total Reserve

*LDF is the cumulative Loss Development Factor to ultimate based on incurred losses.

The IBNR Factor is the percent of expected losses unreported.



Reserves Based on ELR and Reported Incurred


CUMULATIVE INCURRED LOSSES (In Thousands)

Accident ---------------- ---------------- DEVELOPMENT STAGE IN MONTHS -----------------------------------------------Year 12 24 36 48 60 72 84

1995 8,382 9,781 10,110 10,219 10,268 10,280 10,2921996 9,337 10,847 11,092 11,192 11,235 11,2501997 10,540 12,205 12,551 12,690 12,7251998 11,875 13,832 14,238 14,4131999 13,343 15,542 16,0662000 14,469 16,7762001 16,561

Accident ---------------- ---------------- INCURRED LOSS DEVELOPMENT FACTORS ----------------------------Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult

1995 1.167 1.034 1.011 1.005 1.001 1.0011996 1.162 1.023 1.009 1.004 1.0011997 1.158 1.028 1.011 1.0031998 1.165 1.029 1.0121999 1.165 1.0342000 1.1592001

ALL YEARS AVERAGE 1.163 1.030 1.011 1.004 1.001 1.001

SELECTED LDFs 1.163 1.030 1.011 1.004 1.001 1.001 1.000

CUMULATIVE LDFs 1.219 1.048 1.017 1.006 1.002 1.001 1.000

1.000 IBNR FACTOR = (1.000 - ------) = % OF EXPECTED LOSSES WHICH ARE UNREPORTED

LDF

IBNR FACTOR 0.180 0.046 0.017 0.006 0.002 0.001 0.000


Reserves Based on ELR and Reported Incurred

EZ INSURANCE COMPANY AUTO LIABILITY(In Thousands)

Expected CumulativeAccident Earned Loss Expected IBNR Incurred Ultimate

Year Premium Ratio Losses Factor IBNR Losses Losses(1) (2) (3) (4) (5) (6) (7) (8)

(2) x (3) slide 10 (4) x (5) slide 10 (6) + (7)

1995 17,153 0.60 10,292 0.000 0 10,292 10,2921996 18,168 0.60 10,901 0.001 11 11,250 11,2611997 21,995 0.60 13,197 0.002 26 12,725 12,7511998 24,173 0.60 14,504 0.006 87 14,413 14,5001999 25,534 0.60 15,320 0.017 260 16,066 16,3262000 31,341 0.60 18,805 0.046 865 16,776 17,6412001 38,469 0.60 23,081 0.180 4,155 16,561 20,716

Total 176,833 106,100 5,404 98,083 103,487



Comparison of Reserve Methodologies

Expected Losses

Expected $6,000 $10,000Rptd IBNR

Example : Reported Incurred Losses are Twice as High as Expected

ELR $12,000 $4,000Rptd IBNR

Bornuetter- $12,000 $10,000Ferguson Rptd IBNR

Incurred $12,000 $20,000Development Rptd IBNR

Example : Reported Incurred Losses are Half of Expected

ELR $3,000 $13,000Rptd IBNR

Bornuetter- $3,000 $10,000Ferguson Rptd IBNR

Incurrred $3,000 $5,000Development Rptd IBNR



BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON-INSURANCE EXAMPLE

Given the following, how many home runs will Barry Bonds hit this year? He has hit 20 home runs through 40 games There are 160 games in a season

Three pieces of information are need to perform a Bornhuetter-Ferguson (B-F) projection: Expected Ultimate Value Cumulative Loss Development Factor Amount Incurred To Date


The three pieces of information for our example : Before the season started, how many home runs would we have expected Barry Bonds to hit?

Expected Ultimate Value = 40

To project season total from current statistics, multiply the current statistics by 4 since the season is 1/4 completed.

Cumulative Loss Development Factor = 4.000

He has already hit 20 home runs.Amount Incurred To Date = 20



B-F Projection: Ultimate Value = (Expected Value*IBNR Factor)+(Inc. to Date)

IBNR Factor = 1.000 - (1.000/LDF) = 1.000 - (1.000/4.000) = .75(In Other Words, 75% of the season is left to be played)

Ultimate Value = (40 * .75) + 20 = 50

The B-F Method projects that Barry Bonds will hit 50 home runs this year.Games 0-40 Games 41-80 Games 81-120 Games 121-160

20 Home Runs 10 Home Runs 10 Home Runs 10 Home Runs



Comparison of B-F with Two Other Methods

Incurred Loss Development MethodUltimate Value = Incurred To Date * Cumulative LDF

= 20 * 4.000 = 80 Home Runs

Games 0-40 Games 41-80 Games 81-120 Games 121-16020 Home Runs 20 Home Runs 20 Home Runs 20 Home Runs

Expected Loss Ratio MethodUltimate Value = Expected Value = 40 Home Runs

Games 0-40 Games 41-80 Games 81-120 Games 121-16010 Home Runs 10 Home Runs 10 Home Runs 10 Home Runs




Reserves Based on ELR and Reported Incurred(BORNHUETTER-FERGUSON)

ASSUMPTIONS

Premium accurate measure of exposure

Expected loss ratio predictable

Constant reporting, reserving and settling

SAMPLE PROBLEMS

Pricing inconsistency

Instability in accident year loss ratios

Introduction of automated claim system

Backlog in processing



Reserves Based on ELR and Reported Incurred (BORNHUETTER-FERGUSON)

ADVANTAGES

Compromises between loss development and expected loss ratio methods

Avoids overreaction to unexpected incurred losses to date

Suitable for new or volatile line of business

Can be used with no internal loss history

Easy to use

DISADVANTAGES

Assumes that case development is unrelated to reported losses

Relies on accuracy of expected loss ratio and reporting pattern

Less responsive to losses incurred to date

Relies on accuracy of earned premium


LAE RESERVING METHODS

Loss adjustment expenses are reported as either Defense & Cost Containment expenses or Adjusting & Other expenses

Prior to 1/1/98, the ability to assign a claim expense to a particular claim was the determining factor in how the expense was reported in the Annual Statement.

For most companies the definition change has had little impact. DCC is nearly equal to allocated expense.AO is nearly equal to unallocated expense.


DEFENSE AND COST CONTAINMENT EXPENSE

Internal or external expenses relating to the following:· Defense· Litigation· Medical Cost Containment

ADJUSTING AND OTHER EXPENSE

Expenses including but not limited to the following : · Fees of adjustors and settling agents

· Attorney fees incurred in the determination of coverage, including litigation between insurer and policyholder

· Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators

LAE RESERVING METHODS


1. PAID DCC DEVELOPMENT

2. CUMULATIVE PAID DCC TO CUMULATIVE PAID LOSSES

DCC RESERVING METHODS


DCC RESERVING METHODSCumulative Paid DCC

($ in thousands)


Accident --------------- --------------- DEVELOPMENT STAGE IN MONTHS ---------------------------Year 12 24 36 48 60 72 84

1995 71 166 286 416 527 611 6771996 83 189 313 458 584 6721997 93 213 361 523 6571998 103 226 394 5811999 108 245 4372000 128 2802001 132

Accident --------------- --------------- PAID DCC DEVELOPMENT FACTORS ---------------------------Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult

1995 2.338 1.723 1.455 1.267 1.159 1.1081996 2.277 1.656 1.463 1.275 1.1511997 2.290 1.695 1.449 1.2561998 2.194 1.743 1.4751999 2.269 1.7842000 2.1882001

Average 2.259 1.720 1.461 1.266 1.155 1.108

4 point average 2.235 1.720 1.461

Avg. excl. high/low 2.258 1.720 1.459

Time wght. average 2.239 1.734 1.463 1.264 1.154

Vol. wght. average 2.251 1.724 1.461 1.266 1.155 1.108

SELECTED LDFs 2.251 1.724 1.461 1.266 1.155 1.108 1.108

CUMULATIVE LDFs 10.175 4.520 2.622 1.795 1.418 1.228 1.108



DCC Reserves Based on Paid DCC Development

EZ INSURANCE COMPANY AUTO LIABILITY($ in Thousands)

Accident DCC Paid Selected Estimated UnpaidYear to Date Factor Ultimate DCC(1) (2) (3) (4) (5)

slide 22 slide 22 (2) x (3) (4) - (2)

1995 677 1.108 750 731996 672 1.228 825 1531997 657 1.418 932 2751998 581 1.795 1,043 4621999 437 2.622 1,146 7092000 280 4.520 1,266 9862001 132 10.175 1,343 1,211

Total 3,436 7,304 3,868



DCC Reserves Based on Paid DCC Development

ADVANTAGES DISADVANTAGES

Similar to paid losses; easy & straightforward Ignores relationship to losses

May work well for older accident years Heavily influenced by amountof highly volatile initial payments


Cumulative Paid DCC to Cumulative Paid Losses($ In Thousands)


Accident ---------------- ---------------- CUMULATIVE PAID DCC ------------------------------- ----------------Year 12 24 36 48 60 72 84

1995 71 166 286 416 527 611 6771996 83 189 313 458 584 6721997 93 213 361 523 6571998 103 226 394 5811999 108 245 4372000 128 2802001 132

Accident ---------------- ---------------- CUMULATIVE PAID LOSSES -------- ---------------- ----------------Year 12 24 36 48 60 72 84

1995 3,361 5,991 7,341 8,259 8,916 9,408 9,7591996 3,780 6,671 8,156 9,205 9,990 10,5081997 4,212 7,541 9,351 10,639 11,5361998 4,901 8,864 10,987 12,4581999 5,708 10,268 12,6992000 6,093 11,1722001 6,962



Cumulative Paid DCC to Cumulative Paid Losses


Accident ---------------- CUMULATIVE PAID DCC TO CUMULATIVE PAID LOSSES -------------------------------Year 12 24 36 48 60 72 84

1995 0.021 0.028 0.039 0.050 0.059 0.065 0.0691996 0.022 0.028 0.038 0.050 0.058 0.0641997 0.022 0.028 0.039 0.049 0.0571998 0.021 0.025 0.036 0.0471999 0.019 0.024 0.0342000 0.021 0.0252001 0.019



DCC RESERVING METHODSCumulative Paid DCC to Cumulative Paid Losses


Accident ---------------- ---------------- PAID TO PAID DEVELOPMENT FACTORS ------------------------------Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult

1995 1.312 1.406 1.293 1.173 1.099 1.0681996 1.290 1.355 1.297 1.175 1.0941997 1.279 1.367 1.273 1.1591998 1.213 1.406 1.3011999 1.261 1.4422000 1.1932001

Average 1.258 1.395 1.291 1.169 1.097 1.068

4 point avg. 1.237 1.393 1.291

Avg. excl. high/low 1.261 1.393 1.295

Time wght. Average 1.240 1.403 1.291 1.167 1.096

Vol. wght. Average 1.258 1.393 1.291 1.169 1.096 1.068

SELECTED LDFs 1.237 1.393 1.291 1.169 1.096 1.068 1.068

CUMULATIVE LDFs 3.252 2.629 1.887 1.462 1.251 1.141 1.068



DCC Reserves Based on Cumulative Paid DCC to Cumulative Paid Loss Development

EZ INSURANCE COMPANY AUTO LIABILITY($ In Thousands)

Developed Paid IndicatedAccident Ratio Devel. Paid/Paid Ultimate Ultimate DCC DCC

Year to Date Factor Ratio Losses DCC to Date Reserves(1) (2) (3) (4) (5) (6) (7) (8)

slide 26 slide 27 (2) x (3) slide 11 (4) x (5) slide 25 (6) - (7)

1995 0.069 1.068 0.074 10,292 762 677 851996 0.064 1.141 0.073 11,261 822 672 1501997 0.057 1.251 0.071 12,751 905 657 2481998 0.047 1.462 0.069 14,500 1,001 581 4201999 0.034 1.887 0.064 16,326 1,045 437 6082000 0.025 2.629 0.066 17,641 1,164 280 8842001 0.019 3.252 0.062 20,716 1,284 132 1,152

Total 103,487 6,983 3,436 3,547


ADVANTAGES

Recognizes relationship of DCC to losses.

Straightforward methodology, predictable.

Provides tool for monitoring relationship of DCC to losses.

DISADVANTAGES

Over or under estimation of losses reflected in DCC estimates.

More complex than paid DCC development.

Heavily influenced by volatile initial ratios of DCC to loss.

Significant DCC can be spent to close claims without payment.

Changes in legal defense strategies may distort.



ADJUSTING AND OTHER EXPENSE

Expenses including but not limited to the following : · Fees of adjustors and settling agents

· Attorney fees incurred in the determination of coverage, including litigation between insurer and policyholder

· Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators

AO RESERVING METHODS



THE “50/50” Rule

Assumes 50% of ULAE is paid when the claim is opened, and 50% is paid when the claim is closed.



The “50/50” Rule

• 3 year average of the ratio of calendar year paid AO to paid losses.

• 50% of the ratio applied to known case loss reserves.

• 100% of the ratio applied to IBNR reserves.

• It may be necessary to separate the “broad” IBNR reserve into development on known case reserves and “pure” IBNR.



Consideration in Selecting Ratio of Calendar Year

Paid AO to Paid Losses

Average over 3 years may not produce appropriate factor:

• AO payments may not completely correlate to the years’ loss payments

May need to judgmentally select factor based on:

• Steadily increasing or decreasing factors

• Changes in expense allocation procedures


Example of "50/50" Rule

EZ Insurance Co. - Auto Liability($ In Thousands)

Calendar Paid Paid RatioYear AO Losses (2) / (3)

(1) (2) (3) (4)

1999 1,038 14,107 0.074

2000 1,244 15,906 0.078

2001 1,459 17,709 0.082

Total 3,741 47,722 0.078



Example of "50/50" Rule

Ratio of Paid AO to Paid Losses 0.078

50% of Ratio 0.039

Known Case Loss Reserves 22,989

IBNR Reserve 5,296

AO Reserve

= (0.039 x 22,989) + (0.078 x 5,296)

= 897 + 413

= 1,310



Assumptions in Applying “50/50” Rule

Age of claim does not affect the ratio of paid AO to Losses AO and Losses are paid at the same rate These assumptions should be reviewed for each situation where the “50/50” rule is used



SCHEDULE P - PART 1 SUMMARY

ANNUAL STATEMENT FOR THE YEAR 2001 OF THE TYPICAL P&C INSURANCE COMPANY

SCHEDULE P - PART 1 - SUMMARY

($000 omitted)

Premiums Earned Loss and Loss Expense PaymentsYears in 1 2 3 Defense and Cost Adjusting and Other 12Which Loss Payments Containment Payments Payments 10 11 Number of

Premiums Were 4 5 6 7 8 9 Salvage Total ClaimsEarned and Direct Direct Direct Direct and Net Paid Reported -Losses Were and Net and and and Subrogation (4 - 5 + 6 - 7 Direct and

Incurred Assumed Ceded (2 - 3) Assumed Ceded Assumed Ceded Assumed Ceded Received + 8 - 9) Assumed1. Prior XXXX XXXX XXXX XXXX2. 19923. 19934. 19945. 19956. 19967. 19978. 19989. 199910. 200011. 200112. Totals XXXX XXXX XXXX XXXX

Losses Unpaid Defense and Cost Containment Unpaid Adjusting and Other 23 24 25Case Basis Bulk + IBNR Case Basis Bulk + IBNR Unpaid Number of13 14 15 16 17 18 19 20 21 22 Total Claims

Direct Direct Direct Direct Direct Salvage and Net Losses Outstandingand and and and and Subrogation and Expenses Direct and

Assumed Ceded Assumed Ceded Assumed Ceded Assumed Ceded Assumed Ceded Anticipated Unpaid Assumed1. Prior2. 19923. 19934. 19945. 19956. 19967. 19978. 19989. 199910. 200011. 200112. Totals


DATA AVAILABLE FROM SCHEDULE P

Earned Premium (columns 1-3)

Losses» Direct+Assumed, Ceded» Cumulative Paid Losses, Net of Salvage and Subrogation (columns 4-5)» Case Reserves (columns 13-14)» Bulk + IBNR Reserves (columns 15-16)» Incurred Losses = Paid + Case Reserves + IBNR Reserves


DATA AVAILABLE FROM SCHEDULE P

Loss Adjustment Expenses» Direct+Assumed, Ceded» Defense and Cost Containment (columns 6-7; 17-20)» Adjusting and Other (columns 8-9; 21-22)» Cumulative Paid LAE, Case Reserves, Bulk + IBNR Reserves

Claim Counts» Reported (column 12)» Outstanding (column 25)» Closed = Reported - Outstanding


SCHEDULE P TERMINOLOGY

Bulk + IBNR reserves include:» Reserves for claims not yet reported (pure IBNR)» Claims in transit» Development on known claims» Reserves for reopened claims

Reserves = Liabilities = Accruals = Unpaid = Case Reserves + IBNR

Incurred losses and Claim counts may have various meanings!

basic track iii

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