Slide 1
Basic Track III
2001 CLRS
September 2001
New Orleans, Louisiana
Slide 2
THIS SESSION WILL DISCUSS
I. Expected Loss Ratio Technique
II. Allocated Loss Adjustment Expenses (ALAE) (Defense and Cost Containment)
III. Unallocated Loss Adjustment Expenses (ULAE) (Adjusting and Other Expenses)
IV. Schedule P - Part 1 Summary
Slide 3
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
Slide 4
EXPECTED LOSS RATIO TECHNIQUE
EXAMPLE OF ELR USING PRICING ASSUMPTIONS
Commissions 20%
Taxes 5%
General Expenses 15%
Profit (2%)
Total 38%
Amount to pay for loss & loss expense ---- 62% of premium
Slide 5
EXPECTED LOSS RATIO TECHNIQUE
Example 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 Percentage
Which (Incurred/Premiums Earned)
Premiums
Were
Earned
and Losses Direct
Were and
Incurred Assumed Ceded Net
1. Prior XXXX XXXX XXXX
2. 1991 73.1% 73.8% 72.4%
3. 1992 66.6% 65.9% 67.3%
4. 1993 70.3% 68.9% 71.7%
5. 1994 69.0% 70.6% 67.4%
6. 1995 74.1% 75.0% 73.2%
7. 1996 80.2% 83.3% 77.1%
8. 1997 60.5% 59.1% 61.9%
9. 1998 62.6% 61.3% 63.9%
10. 1999 66.7% 68.0% 65.4%
11. 2000 67.0% 68.3% 65.7%
12. Totals XXXX XXXX XXXX
3 year average 65.0%
5 year average 66.8%
Slide 6
EXPECTED LOSS RATIO TECHNIQUE
Estimating Reserves Based on ELR
Earned Premium x ELR = Expected Ultimate Losses
Ultimate Losses - Paid Losses = Total Reserve
Total Reserve - Case Reserve = IBNR Reserve
Slide 7
EXPECTED LOSS RATIO TECHNIQUE
Estimating Reserves Based on ELR - Example
Earned 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
Slide 8
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
EXPECTED LOSS RATIO TECHNIQUE
Slide 9
EXPECTED LOSS RATIO TECHNIQUE
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.
Slide 10
EXPECTED LOSS RATIO TECHNIQUE
Reserves Based on ELR and Reported Incurred
EZ INSURANCE COMPANY AUTO LIABILITY
CUMULATIVE INCURRED LOSSES (In Thousands)
Accident ---------------- ---------------- DEVELOPMENT STAGE IN MONTHS---------------- ---------------- Year 12 24 36 48 60 72 84
1994 $8,382 $9,781 $10,110 $10,219 $10,268 $10,280 $10,2921995 9,337 10,847 11,092 11,192 11,235 11,2501996 10,540 12,205 12,551 12,690 12,7251997 11,875 13,832 14,238 14,4131998 13,343 15,542 16,0661999 14,469 16,7762000 16,561
Accident ---------INCURRED LOSS DEVELOPMENT FACTORS ---------------------------------- ---------------- Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult
1994 1.167 1.034 1.011 1.005 1.001 1.0011995 1.162 1.023 1.009 1.004 1.0011996 1.158 1.028 1.011 1.0031997 1.165 1.029 1.0121998 1.165 1.0341999 1.1592000
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
Slide 11
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)
1994 $17,153 0.60 $10,292 0.000 $0 $10,292 $10,2921995 18,168 0.60 10,901 0.001 11 11,250 11,2611996 21,995 0.60 13,197 0.002 26 12,725 12,7511997 24,173 0.60 14,504 0.006 87 14,413 14,5001998 25,534 0.60 15,320 0.017 260 16,066 16,3261999 31,341 0.60 18,805 0.046 865 16,776 17,6412000 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
EXPECTED LOSS RATIO TECHNIQUE
Slide 12
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
EXPECTED LOSS RATIO TECHNIQUE
Slide 13
BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE
Given the following, how many home runs will Ken Griffey, Jr. 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
Slide 14
The three pieces of information for our example : Before the season started, how many home runs would we have expected Ken Griffey, Jr.
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
BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE
Slide 15
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 Ken Griffey, Jr. 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
BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE
Slide 16
Comparison of B-F with Two Other Methods
Incurred Loss Development Method
Ultimate Value = Incurred To Date * Cumulative LDF
= 20 * 4.000 = 80 Home Runs
Games 0-40 Games 41-80 Games 81-120 Games 121-160
20 Home Runs 20 Home Runs 20 Home Runs 20 Home Runs
Expected Loss Ratio Method
Ultimate Value = Expected Value = 40 Home Runs
Games 0-40 Games 41-80 Games 81-120 Games 121-160
10 Home Runs 10 Home Runs 10 Home Runs 10 Home Runs
BORNHUETTER-FERGUSON APPROACH APPLIED TO A NON INSURANCE EXAMPLE
Slide 17
EXPECTED LOSS RATIO TECHNIQUE
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
Slide 18
EXPECTED LOSS RATIO TECHNIQUE
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
Slide 19
ALAE RESERVING METHODS
ALLOCATED LOSS ADJUSTMENT EXPENSE (ALAE)
Previous Definition :
Expenses that are specifically assigned to an individual claim
Currently Called:
DEFENSE AND COST CONTAINMENT EXPENSE
Slide 20
DEFENSE AND COST CONTAINMENT EXPENSE
Current Definition (effective 1/1/98) :
Limits ALAE to internal or external expenses relating to the following
· Defense
· Litigation
· Medical Cost Containment
Therefore, the ability to assign a particular type of expense to a single claim is no longer the determining factor as to whether the expense is ALAE or ULAE
“Loss Adjustment Expenses” other than allocated expenses are assigned to the group Unallocated Loss Adjustment Expense
ALAE RESERVING METHODS
Slide 21
1. PAID ALAE DEVELOPMENT
2. CUMULATIVE PAID ALAE TO
CUMULATIVE PAID LOSSES
ALAE RESERVING METHODS
Slide 22
ALAE RESERVING METHODSCumulative Paid ALAE
($ in thousands)
EZ INSURANCE COMPANY AUTO LIABILITY
Accident ------------DEVELOPMENT STAGE IN MONTHS---------------------------------- ---------------Year 12 24 36 48 60 72 84
1994 $71 $166 $286 $416 $527 $611 6771995 83 189 313 458 584 6721996 93 213 361 523 6571997 103 226 394 5811998 108 245 4371999 128 2802000 132
Accident --------------- --------------- PAID ALAE DEVELOPMENT FACTORS---------------------------Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult
1994 2.338 1.723 1.455 1.267 1.159 1.1081995 2.277 1.656 1.463 1.275 1.1511996 2.290 1.695 1.449 1.2561997 2.194 1.743 1.4751998 2.269 1.7841999 2.1882000
Average 2.259 1.720 1.461 1.266 1.155 1.108
4 point average 2.235 1.720 1.461
Avg. excl. high/low 2.258 1.720 1.459
Time wght. average 2.239 1.734 1.463 1.264 1.154
Vol. wght. average 2.251 1.724 1.461 1.266 1.155 1.108
SELECTED LDFs 2.251 1.724 1.461 1.266 1.155 1.108 1.108
CUMULATIVE LDFs 10.175 4.520 2.622 1.795 1.418 1.228 1.108
Slide 23
ALAE RESERVING METHODS
ALAE Reserves Based on Paid ALAE Development
EZ INSURANCE COMPANY AUTO LIABILITY($ in Thousands)
Accident ALAE Paid Selected Estimated UnpaidYear to Date Factor Ultimate ALAE(1) (2) (3) (4) (5)
slide 22 slide 22 (2) x (3) (4) - (2)
1994 $677 1.108 $750 $731995 672 1.228 825 1531996 657 1.418 932 2751997 581 1.795 1,043 4621998 437 2.622 1,146 7091999 280 4.520 1,266 9862000 132 10.175 1,343 1,211
Total $3,436 $7,304 $3,868
Slide 24
ALAE RESERVING METHODS
ALAE Reserves Based on Paid ALAE Development
ADVANTAGES DISADVANTAGES
Similar to paid losses; easy & straightforward Ignores relationship to losses
May work well for older AYs Heavily influenced by amountof highly volatile initial payments
Slide 25
Cumulative Paid ALAE to Cumulative Paid Losses($ In Thousands)
EZ INSURANCE COMPANY AUTO LIABILITY
Accident ---------------- ---------------- CUMULATIVE PAID ALAE ------------------------------- ----------------Year 12 24 36 48 60 72 84
1994 $ 71 $ 166 $ 286 $ 416 $ 527 $ 611 $ 6771995 83 189 313 458 584 6721996 93 213 361 523 6571997 103 226 394 5811998 108 245 4371999 128 2802000 132
Accident ---------------- ---------------- CUMULATIVE PAID LOSSES-------- ---------------- ----------------Year 12 24 36 48 60 72 84
1994 3,361 5,991 7,341 8,259 8,916 9,408 9,7591995 3,780 6,671 8,156 9,205 9,990 10,5081996 4,212 7,541 9,351 10,639 11,5361997 4,901 8,864 10,987 12,4581998 5,708 10,268 12,6991999 6,093 11,1722000 6,962
ALAE RESERVING METHODS
Slide 26
Cumulative Paid ALAE to Cumulative Paid Losses
EZ INSURANCE COMPANY AUTO LIABILITY
Accident ------CUMULATIVE PAID ALAE TO CUMULATIVE PAID LOSSES-------
Year 12 24 36 48 60 72 84
1994 0.021 0.028 0.039 0.050 0.059 0.065 0.0691995 0.022 0.028 0.038 0.050 0.058 0.0641996 0.022 0.028 0.039 0.049 0.0571997 0.021 0.025 0.036 0.0471998 0.019 0.024 0.0341999 0.021 0.0252000 0.019
ALAE RESERVING METHODS
Slide 27
ALAE RESERVING METHODS
Cumulative Paid ALAE to Cumulative Paid Losses
EZ INSURANCE COMPANY AUTO LIABILITY
Accident ---------------- ---------------- PAID TO PAID DEVELOPMENT FACTORS--------------------Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult
1994 1.312 1.406 1.293 1.173 1.099 1.0681995 1.290 1.355 1.297 1.175 1.0941996 1.279 1.367 1.273 1.1591997 1.213 1.406 1.3011998 1.261 1.4421999 1.1932000
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
Slide 28
ALAE RESERVING METHODS
ALAE Reserves Based on Cumulative Paid ALAE to Cumulative Paid Loss Development
EZ INSURANCE COMPANY AUTO LIABILITY($ In Thousands)
Developed Paid IndicatedAccident Ratio Devel. Paid/Paid Ultimate Ultimate ALAE ALAE
Year to Date Factor Ratio Losses ALAE 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)
1994 0.069 1.068 0.074 $10,292 $762 $677 $851995 0.064 1.141 0.073 11,261 822 672 1501996 0.057 1.251 0.071 12,751 905 657 2481997 0.047 1.462 0.069 14,500 1,001 581 4201998 0.034 1.887 0.064 16,326 1,045 437 6081999 0.025 2.629 0.066 17,641 1,164 280 8842000 0.019 3.252 0.062 20,716 1,284 132 1,152
Total $103,487 $6,983 $3,436 $3,547
Slide 29
ADVANTAGES
Recognizes relationship of ALAE to losses.
Straightforward methodology, predictable.
Provides tool for monitoring relationship of ALAE to losses.
DISADVANTAGES
Over or under estimation of losses reflected in ALAE estimates.
More complex than paid ALAE development.
Heavily influenced by volatile initial ratios of ALAE to loss.
Significant ALAE can be spent to close claims without payment.
Changes in legal defense strategies may distort.
ALAE RESERVING METHODS
Slide 30
UNALLOCATED LOSS ADJUSTMENT EXPENSE (ULAE)
Previous Definition :
Expenses incurred in connection with settling claims which are not readily assigned to specific claims
Currently Called:
ADJUSTING & OTHER EXPENSE
ULAE RESERVING METHODS
Slide 31
ADJUSTING & OTHER EXPENSE
Current Definition (effective 1/1/98) :
Those expenses, other than allocated expenses, assigned to the expense group “Loss Adjustment Expense”. Unallocated expenses include but are 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
ULAE RESERVING METHODS
Slide 32
ULAE 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.
Slide 33
ULAE RESERVING METHODS
The “50/50” Rule
•3 year average of the ratio of calendar year paid ULAE 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.
Slide 34
ULAE RESERVING METHODS
Consideration in Selecting Ratio of Calendar Year Paid ULAE to Paid Losses
Average over 3 years may not produce appropriate factor:
• ULAE 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
Slide 35
Example of "50/50" Rule
EZ Insurance Co. - Auto Liability($ In Thousands)
Calendar Paid Paid RatioYear ULAE Losses (2) / (3)
(1) (2) (3) (4)
1998 $1,038 $14,107 0.074
1999 1,244 15,906 0.078
2000 1,459 17,709 0.082
Total $3,741 $47,722 0.078
ULAE RESERVING METHODS
Slide 36
Example of "50/50" Rule
Ratio of ULAE Paid to Paid Losses 0.078
50% of Ratio 0.039
Known Case Loss Reserves $22,989
IBNR Reserve $5,296
ULAE Reserve
= (0.039 x $22,989) + (0.078 x $5,296)
= $897 + $413
= $1,310
ULAE RESERVING METHODS
Slide 37
Assumptions in Applying “50/50” Rule
Age of claim does not affect the ratio of paid ULAE to Losses ULAE and Losses are paid at the same rate These assumptions should be reviewed for each situation where the “50/50” rule is used
ULAE RESERVING METHODS
Slide 38
Recent Developments in ULAE Reporting
Effective with the 1997 Annual Statement, the “50/50” rule no longer underlies annual statement Schedule P reporting of paid unallocated expenses.
Rather, unallocated loss expense payments and reserves should be allocated to the years in which the losses were incurred based on the number of claims reported, closed and outstanding in those years.
An insurer is permitted to use the “50/50” rule or some other reasonable procedure when suitable claim information is not available.
ULAE RESERVING METHODS
Slide 39
SCHEDULE P - PART 1 SUMMARY
ANNUAL STATEMENT FOR THE YEAR 2000 OF THE TYPICAL P&C INSURANCE COMPANY
SCHEDULE P - PART 1 - SUMMARY
($000 omitted)
Premiums Earned Loss and Loss Expense Payments
Years in 1 2 3 Defense and Cost Adjusting and Other 12
Which Loss Payments Containment Payments Payments 10 11 Number of
Premiums Were 4 5 6 7 8 9 Salvage Total Claims
Earned 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) Assumed
1. Prior XXXX XXXX XXXX XXXX
2. 1991
3. 1992
4. 1993
5. 1994
6. 1995
7. 1996
8. 1997
9. 1998
10. 1999
11. 2000
12. Totals XXXX XXXX XXXX XXXX
Losses Unpaid Defense and Cost Containment Unpaid Adjusting and Other 23 24 25
Case Basis Bulk + IBNR Case Basis Bulk + IBNR Unpaid Number of
13 14 15 16 17 18 19 20 21 22 Total Claims
Direct Direct Direct Direct Direct Salvage and Net Losses Outstanding
and and and and and Subrogation and Expenses Direct and
Assumed Ceded Assumed Ceded Assumed Ceded Assumed Ceded Assumed Ceded Anticipated Unpaid Assumed
1. Prior
2. 1991
3. 1992
4. 1993
5. 1994
6. 1995
7. 1996
8. 1997
9. 1998
10. 1999
11. 2000
12. Totals
Slide 40
DATA AVAILABLE FROM SCHEDULE P
Losses» Direct+Assumed, Ceded
» Cumulative Paid Losses, Net of Salvage and Subrogation (columns 4-5)
» Case Reserves Held (columns 13-14)
» Bulk + IBNR Reserves Held (columns 15-16)
» Incurred Losses = Paid + Case Reserves + IBNR Reserves
Claim Counts» Reported (column 12)
» Outstanding (column 25)
» Closed = Reported - Outstanding
Loss Adjustment Expenses» Defense and Cost Containment (ALAE) and Adjusting and Other (ULAE)
» Direct+Assumed, Ceded
» Paid, Case Reserves, Bulk + IBNR Reserves
Earned Premium (columns 1-3)
Slide 41
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 may have various meanings!