1992 CASUALTY LOSS RESERVE SEMINAR

6B: LOOKING BEYOND THE NUMBERS

Moderator

William H. Crandall Tillinghast

Panel

James F. Cerone Milliman & Robertson, Inc.

Howard V. Dempster CIGNA Property & Casualty Companies

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WILLIAM CRANDALL: This is session 6C - Looking Beyond the Numbers. If you came looking for romance, adventure and excitement, you came to the right place. We don't allow any triangles here. No diagonals. No Bornhuetter- Fergusons or Fisher/Langes. Think of this session as sort of easing you back into the real world again. My name is Bill Crandall. I'm a consultant in the Hartford office of Tillinghast.

I'd like to introduce my fellow panelists. To the immediate left is Jim Cerone, Senior Consultant in the Chicago office of Milliman & Robertson. Before entering the consulting business, in 1982, Jim was head of claims for Commercial Union in Boston. Next to him is Howard Dempster, Senior Vice President & Chief Financial Officer of CIGNA Property & Casualty located in Philadelphia. Howard is a Fellow of the CAS and a prior chief actuary at INA and CIGNA. I also should introduce to you our recorder for this session, Kay Rahardjo, a consultant for Tillinghast in it's Dallas office. I should say first that the statements and opinions contained in our presentation are not necessarily those of ourselves or our employers, but are offered to stimulate thinking and discussion in this elite forum. There are handouts in the back of the room, in fact several of them, one called Loss Reserve Questionnaire. This is one that's been a standard in this session for a couple of years. It was designed by Bob Miccolis and I should also acknowledge that some of the material that we are going to use today also originates with Bob Miccolis and the people who have worked with him in the past on this panel. Our thanks to them for the use of this material

In this session, we're going to look beyond the numbers. Claim reserving is a quantitative process. I certainly won't argue with that. But, numbers almost never tell the whole story. If you're going to use past information in order to project to the future, then you ought to know where the numbers come from. What were the conditions and environment which generated those numbers? Possibly, it would be helpful to think of the quantitative part of claim reserving as being the picture and the qualitative process and events as being a frame around that picture.

We're going to do this presentation in three segments. Jim will lead off with an in-depth discussion of what the loss reserver needs to know about the claim function and how he goes about doing this in the course of his work at M & R. Jim's discussion will be followed by two dramatic presentations by the CLRS Players. We'll pause after each one of these three segments for discussion. We'd like you to come away from this session with a heightened appreciation of perhaps three points. First is that, to do a good job of reserving you have to have a good understanding of how the various functional parts of insurance companies interrelate, how they work with each other and how they affect loss reserves. In other words, you've got to have a good mental model of the insurance company. Second, for each job you do, you've got to look at all the functional areas of the company. You have to ask a lot of questions in order to stock up that mental model with the particulars of this company. Finally, and most importantly, you've got to pay attention to changes in company operations. That's really what you're looking for. Why isn't the past going to be a good predictor of the future? In his career, Jim Cerone estimates he's seen the claim departments of more than 100 insurance companies, most of these as a consultant of M & R, where he is looking for exactly the kind of things that we're talking about today. So, Jim, tell us how you do it.

(Slide 1 )

JAMES CERONE: Thank you, Bill. Between the time I left Commercial Union and joined Milliman & Robertson in 1986, I also worked where Bill works at, Tillinghast. (Laughter) I just wanted to set the record straight. I think the background for this is Tillinghast and M & R both started their first non-actuarial practices by choosing claim practices because of the variations that underlie the numbers we're talking about. So, I wanted to give you the claim perspective of what might be going on behind those numbers. To do that, it's important to understand that the numbers you're looking at, the case reserves and the payments, are being generated by claim people.

(Slide 2)

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My view is that claim people have three major activities. One of them is that they negotiate and they conclude claims. That's bilateral, they have to go through the give and take of negotiations with claimants, policyholders and attomeys. It, sometimes, can be painful, but, in the eyes of a claim person, it's a very difficult thing to do this activity of interacting with third parties to negotiate and conclude claims. It's bilateral and very difficult.

Another major activity of claim people is that they investigate claims. This is also bilateral. They have to go out and interview witnesses, obtain official records and document the facts as to what happens. Although it's not as difficult as negotiating because you're not talking about finalizing issues involving dollars, but simply gathering facts, it's a difficult thing for claim people to do. You have to go out, deal with other people, get them to cooperate and give you the facts. Now, they also have to reserve and evaluate claims. The interesting thing from the claim person's view, at least in my opinion, is that this is a unilateral act and it's very easy for claim people. As compared to having to pick up the phone and deal with a famous plaintiff's attomey or try to get a witness to give you a statement, they can sit in the relative calm of their desk area and pick a number that they think the case is worth, put it down and that's your reserve. So, within the activities of the claim people, one of the numbers important to you, a number you're looking at in coming up with the actuarial reserve, is being generated by claim people to whom setting that case reserve is a relatively simple and easy act.

So, with that background, if you're going to look behind numbers, where should you look?

(Slide 3)

We've identified three major areas. One - you should look for direct claim department changes. First, you should find out if, in the claim department, they've changed their case reserve practices. I think that most successful companies, that employ an actuarial department and a claim department, have developed a close

working relationship between both departments and they regularly meet, sometimes assign an actuary to work in the claim department and actually keep track, in a log book, of what changes may have been made in the claim department and they try to forecast what in the heck is going to happen to the numbers down the road and when might they see it. They just monitor it like that. But, if in your claim department, you're not aware of it, they could be switching from a best estimate based on current information basis to someone saying, "Well, we're going to put a minimum reserve up and we're not going to reserve any bodily injury claim below $5,000." So, that might have an effect on your numbers. It's direct, it's in the claim department and maybe it's obvious.

Another thing you should watch for in the claim department is that, in the effort to control the amount of money paid to defense attomeys, they may change their expense payment practices with defense attorneys. Historically, most claim departments pay the lawyers when they send their bills in and that's on an interim basis. It's usually a monthly or quarterly basis. Some companies have told lawyers that they'll discontinue that and, here and after, they'll only pay their bill at the end of the case. So, you may see - without knowing this - you may see a sudden and dramatic drop in the amount of money being paid to lawyers and think that they found the magic bullet to lower legal expenses. But, I think you'll find that expenses are out there and you should know about it.

Another issue that could be direct is, do they reserve or handle or count differently, extraordinary claims such as products for asbestos and environmental claims involving pollution? Many companies will provide best estimates for each exposure that they have such that, in an automobile accident, if there are three bodily injury claimants, they will count three bodily injury exposures and establish three reserves for that. Those same companies often, when you get to massive litigation where a class action suit comes in on asbestos, will count the litigation as one claim and put up one reserve considering the 5,000 claimants that may be

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named in a class. So, there may be differences within an organization, where they change their historical patterns, that you should be aware of.

(Slide 4)

There can be indirect internal changes. You should watch out for a turnover in claims staff because reserving is very sensitive to the individual estimating biases of the claim person who's setting the reserve. If you find that you're approaching major turnover in claim departments, for whatever reason, recognize that new people are going to be setting the reserves and they're going to bring different estimating biases to those reserves. This isn't even talking about whether their level of experience and competency is going to change also, but you're going to introduce new estimating biases in the reserve process. Our standard is that, as between reserve setters in valuing open claims, they can normally vary plus or minus 10% in putting the reserve number up. That's about as close as, I think, you can expect different claim people to reserve the same case.

You should look at the issue of staff sizes. As companies look to control their direct staff expenses, some companies have cut down on the number of claim people. That often increases workloads and, if you remember back to the first slide, if the claim person suddenly has more files to handle than he did before, he can't escape the telephone ringing when the lawyer calls in or the policyholder reports a claim. His supervisor probably won't let him escape the need to go out and investigate cases, but that easy job he had of sitting down and putting a reserve up is likely to be the one that slides first. So, increased workloads, resulting from cutbacks in staff, could cause a problem.

Conversely, if you substantially reduce workloads, you may see a surge in reserves as people have more time to spend evaluating their cases. Look out for and be aware of a decree by the vice president of claims, or the president, that they want to get these cases closed. "We want to reduce our inventory of open claims." "We want to clean the dead wood out of those claim files." Well, they usually set quotas and they usually do

flush a lot of cases out of the cabinets, but, as you know, the tendency is to hit your quota by settling the easier ones first and this may accelerate the release of reserve cushions sooner than they would have if it wasn't for the settlement push.

Also, watch out if you hire a new vice president of claims who will come in and say he's going to adopt a new payment philosophy and he's going to get tough. You may find that, in his get-tough payment philosophy, it means that he's going to pay less money than his predecessor did so that the people, to encourage the new boss and show him that they're on the program, may start optimistically reserving their cases and lower them in anticipation of their ability to succeed in paying less money. Maybe they can, maybe they can't.

Finally, I think you've got to be sensitive to the CFO or the CEO or, in some cases, when they even let the actuary speak to claim people, saying that case reserves are redundant. I guarantee you that, once they say it, your case reserves will no longer be redundant. The easy thing to do is to go back and just lower those reserves. If you want them up, tell them you want more case reserves - they'll put them up for you. So, it's best to leave them alone, but these are the changes you should look for.

(Slide 5)

Another area to be sensitive to is the external changes that will influence case reserve levels. Watch out for tort reform. You don't hear much about tort reform now. I guess we heard a lot about that a few years ago. It's like the pop music chart. When tort reform, or whatever is going to come next, comes forward, there may be an anticipation of the benefits of these law changes. People, maybe too soon, realize those expected benefits by lowering the reserves and they may not pan out in the future. That could cause an effect.

I think verdicts are a constant, external pressure that influence your case reserves. Most papers I see and most places I go to, the claim people

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are continually bombarded with high verdicts that are always getting higher. I don't know where the highest verdict area is in the country. I say that if you go take somebody from Wayne County in Detroit and somebody from Dade County in Florida and you take somebody from Manhattan and somebody from Los Angeles and you put them in a room - after a month, they couldn't decide among themselves who had the tougher jurisdiction. I think they're all tough, but the constant bombardment, that things are getting worse and, if you get an extraordinary shock verdict in your area, all can have a ripple effect.

It can also happen, if you have a home office in a rural area and they're supervising cases that are maybe in Los Angeles, or New York City. The people in the rural area sometimes get overwhelmed by the people in L.A. saying no, you can't possibly understand how bad it is out here - let's get the reserves up. Similar to the verdicts, the perception is that the judges and the judicial environment is always liberal - is always against the defendant and will just continue to become increasingly so. That's another extemal change that you should be sensitive to because it's putting pressure on. These are places where to look. Some anecdotal situations that might suggest why you should look, why you should pay any attention at all.

(Slide 6)

The first one is called the CEO's dilemma and, in this particular case, the actuary came in to the CEO and said look, boss, I've got to increase the bulk reserve because I believe that we need more money up and losses are deteriorating. So, the CEO wheeled around and he brought in the chief claim officer and he said - the actuary says that your case reserves are becoming less adequate. The vice president of claims says that's impossible, we haven't had turnover in our staff, we're sensitive to what's happening out there and I believe my case reserves are as adequate today as they were before. So, the CEO decided upon a way he would cut through and find out whether the actuary or the claims chief was pulling his leg - he conducted his own test and he, for a month, would take a look at the

payments made on all casualty claims - not workers' comp - all injury claims that were closed. And, he compared those to the reserve that was on the books on the day they made the final payment. Since he consistently saw that there were savings off of that last reserve on the day they made the payment, he concluded that the actuary was wrong. That didn't prove to be the case when we were finally able to convince him that there was another way to look at it.

(Slide 7)

In this case here, the actuary was looking at a run off book of workers' compensation claims and, after about four years in run off, he was satisfied that the majority of the cases were simply long-term disability claims but the reserves weren't performing the way he expected them to perform. He had no idea of what was going on. When you went behind those numbers that he was looking at and reviewed the claim files, a test was made to provide a second opinion of how much additional money they would pay in the future. Those numbers were very close, but we found that the booked case reserves were discounted by the claim people. That's a very dangerous thing when you let claim people discount your case reserves. What had happened was this. There was - we thought - a fair value placed on the undiscounted value of the case reserves to pay off the cases over the long term. Unfortunately, the claim people went to discount tables and they figured out the number of years of life expectancy, picked their discount rate, and used the factor to discount it. In fact, they were discounting their correct, undiscounted numbers as though they did not have to make a stream of payments, but would have 30 years before they'd make any payments. It was a problem and it resulted in a $70 million upward adjustment. You've got to look behind those numbers.

(Slide 8)

This involved a merger and acquisition. The purchaser of this company said that they would buy this property and casualty insurance company. The purchaser was not a property and

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casualty insurer, in fact, it was a group of lawyers so this may have served them right. (Laughter) They decided they would save some money on due diligence because they knew that consultants and consulting actuaries charge even more than they do as lawyers. They said that they would rely upon the actuarial opinion of the seller, since the actuary just gave a statement of opinion that the reserves were good on the company, they bought the company. A year went by and, to meet the regulatory requirements to come up with an actuarial opinion of reserves, they decided to call the actuary that was doing this before. They called him and somebody else from that consulting actuary came in, looked at the numbers and said, well, you're $10 million short. The owner said, how can that be? He said somebody else from your outfit just said the reserves were good 12 months ago and nothing really extraordinary has happened, so how can we be $10 million short? The second actuary said, I don't know, I'm baffled, but perhaps there was something going on in the claim department by the seller that was withheld from my associate. In fact, there was. The company was being cleaned up for sale. Litigation evolved after that. I don't know if the story there is that you do due diligence when you're buying something. You should hire somebody to represent you and to look at it. But, more importantly, if you're doing an opinion on reserves and the company is up for sale, I'd consider that an extraordinary condition - extraordinary status of the company - and you should probably look beyond the numbers to see if something had gone wrong or something had changed in the claim department.

(Slide 9)

This next story happened under the authority of a regulator who was pondering as to whether the company was solvent or insolvent. The company wrote excess and surplus lines business and we were in there providing second opinions on the case reserves and the actuaries were writing second opinions on aggregate reserves. During the course of the study, we were walking around the claim department - getting files and so forth - and there's this bank of file cabinets. The file

cabinets had labeled on them, asbestos. The company had just said we don't have any environmental claims, but the label on the file cabinet rang a bell. We opened the drawer and we counted 5,000 asbestos claims they had not recorded on their books. They really didn't have an explanation - I think they said, well, because it was so uncertain. (Laughter) They didn't think they had to put a reserve up for it. (Laughter) But, the regulator didn't buy it and the company was put in the tank. At last count - those 5,000 had gotten up to something like 10,000 asbestos claims. That says that when you look - look not only behind the numbers - but in the file drawers too.

(Slide 10)

This final one also arises out of regulatory work. A company that's now in liquidation had taken their year end reserves and reduced them by 10%. The regulators said, that's a pretty substantial discount off your reserves and we'd like to get a second opinion on it. So, we went in and we thought that the easiest way to proceed was to ask the company why they just wrote down their reserves by 10%. They said they did it because tort reform had just been passed and they were sure that they would save 10% off their losses in the future, so they were going to take it out of their reserves at year-end. We asked for the work papers that showed precisely how they calculated 10%. We could then provide an opinion as to the reasonableness of the method and perhaps conclude the assignment. At that, the CFO said there were no work papers. We asked, how he got the 10%. His position was that, well, you know tort reform is going to have a benefit, so you know that the benefit is going to be bigger than zero, so we picked 10%. At that point, we had to look behind those numbers and we couldn't allow it. You just couldn't allow a prospective 10% take off of the reserves. There are lots of things going on behind the numbers. Most of them relate to the claim department and so the message is, you should always look behind the numbers! Thank you.

MR. CRANDALL: Are there any questions or comments on Jim's presentation? Yes, sir.

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QUESTION: Out of curiosity, in the case with the law firm purchased this insurance company, did the actuary get named in the suit?

MR. CERONE: Yes.

QUESTION: I wonder about - or worry about - how long it takes to do this. Come into a client on a limited budget. I just don't have time to look at everything they have (inaudible) reserving. Are there certain areas that are most important to look at. You're not looking at the whole claims department?

MR. CERONE: At M & R, the actuary determines whether or not he needs a claim review. He'll look at the information and, if something doesn't make sense to him, he'll ask us to come in and sit in on the interview. But, in all cases, the actuary will sit down and interview the chief claim officer and go through a checklist that covers much of what we're talking about - with the claim officer - and their statements and opinions and assertions as to whether changes have been made or not. That, probably, takes 4 hours of an interview. The actual getting in and testing for changes and so forth is a sometimes thing. Maybe 20% of the time, you've got to bring somebody in to actually look at the files and interpret it. But you always go through the process of the Sherman Berquist paper. Or Berquist Sherman paper - Jim Berquist worked for M & R. For years I thought Jim's first name was Sherman. (Laughter) That paper covers in good detail the things that the actuary should be asking, not only of the claim department, but the underwriting department and the other departments. That would be a good guideline to follow.

QUESTION: And if you don't turn up anything suspicious there the numbers don't look (inaudible) then maybe you say it's O.K.

MR. CERONE: Yes.

QUESTION: I have a question. (Inaudible)

MR. CERONE: No, there were extemal auditors. The commissioner now has an affirmative action

against the directors and officers and the auditors. It's a public company.

MR. CRANDALL: The first of our two skits is a consulting set up. You have to use the power of your imagination to transform this into the office of the chief financial officer of the Upstart Insurance Company. I am that chief financial officer. Howard's the consultant and he's coming in for his first fact-finding visit for a new client and then he's going to do his analysis. In this skit, as well as the one that follows, we're going to stop the action, from time to time, and comment on things as we go along. Jim Cerone will have the role of the outside commentator and you will know that you're going to get a comment from Jim - when that happens (lights go down). (Laughter) So, on to the Upstart Insurance Company.

CFO: Well, nice to meet you, Howard. How was your trip down?

CONSULTANT: No problems at all today, Bill. That's pretty good for this time of year, particularly having to change planes at O'Hare.

CFO: You must have a lot of traveling in your work.

CONSULTANT: You wouldn't believe. At Ernst, Deloitte, Anderson, where I work, (laughter) this time of year is a real mad house. But I hope you won't mind that I find it easier to keep track - keep myself on track - if I work from an agenda. Here's a questionnaire to make sure we touch all the bases and it also saves your time.

CFO: Yeah, I like that idea. Do all of you actuaries use something like that?

CONSULTANT: Well, I'm not sure, but I think it helps to make us the outstanding one of the big three auditing firms. I haven't had much of a chance to get familiar with Upstart Insurance Company yet. What can you tell me about it's history and organization?

CFO: Well, let's see, Howard. Upstart was founded about 1925 primarily as a comp

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underwriter. In the 40's and 50's, we got into some forms of general liability and, then, into the 60's and early 70's, as packaging became more popular, we got into multi-peril, rd say most of that's related to habitational types of business.

CONSULTANT: You mentioned multi-peril and habitational. Exactly what lines of business do you write and how are they distributed? For example, how are they distributed by line by state?

CFO: I'd say that about half the business is package - then about 15% is comp and 15% is auto. Again, related to the habitational types of business. Now, that's on the commercial side. We've started breaking into the personal lines a bit. It's not a major book, but we hope to diversify that. I'd say about 80% of the business is in New York, primarily New York City. The rest of it is in the New England states. Maybe the mid-Atlantic states as well.

CONSULTANT: And the multi-peril business that you're writing, could you be more specific about the type of business that you're writing?

CFO: Sure. multi-peril is our biggest book. I'd say that 70% of that is condos, co-ops, luxury apartment houses, maybe 15% restaurants. Maybe another 10% light manufacturing and then a little miscellaneous stuff.

CONSULTANT: Just what is this miscellaneous stuff?

CFO: Oh, well, the miscellaneous is probably mercantile - maybe a little bit of products. Would you like an extract on that?

CONSULTANT: For the miscellaneous class?

CFO: Right.

CONSULTANT: No. I don't think that will be necessary, Bill, but I would like to have more information on your major categories of business. The dwel l ings, the restaurants, the manufacturing. If you could give me a history of, let's say, the last five years of premiums to start

with in each of these major categories, by state; that would be very useful.

CFO: O.K. I can get that for you.

MR. CERONE: Note that Howard didn't get off track on the minuscule data on that miscellaneous business. He stuck to his guns to try to get the major classes and the major focus of the business of the company. (Laughter)

CFO: Howard, what are you going to do with this information once we dig it up?

CONSULTANT: Well, I'm going to use the incurred loss development method to estimate what your reserves should be.

CFO: The incurred method? What makes you think that will work for us? I mean, you don't know that much about us do you?

MR. CERONE: (Laughter) Watch out here. Howard is getting himself into real hot water. He's mentioned a particular method in an intewiew. Maybe he can get out of this though. (Laughter)

CONSULTANT: Bill, you're absolutely right. It's premature of me to tell you ahead of time what method I'm going to be using. I'll probably use the incurred loss development method. It's a very basic method and rm sure it's something that I'll use when I do my preliminary analysis. But, really, the major reason I'm here today is to gather information from you to determine what methods, and what adjustments to those methods, might be appropriate as I review your data. So, you can be assured, Bill, that I'm not just going to stick to some cookbook approach. I'll be basing my methods on your data.

CFO: O.K. That's fine.

CONSULTANT: Now, what can you tell me about the underwriting of your business -the guidelines and procedures and so forth.

CFO: Well, business is all produced through independent agents. We've got some large

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accounts, but nothing national. Large agents might produce, maybe, up to 8% of the business, but there are only a couple of those. We follow ISO. We also follow the NCCI in comp. I guess the guidelines are pretty well documented.

CONSULTANT: Well, then, I guess I can get a copy of those guidelines.

CFO: Sure.

CONSULTANT: Have there been any changes to the underwriting guidelines in, let's say, the last five years?

CFO: Well, I wouldn't say so.

CONSULTANT: So, the printed guidelines you're going to get me a copy of will have a date of 1986 or prior on it and there haven't been any changes in the last five years?

CFO: Well, it seems to me that there have been several updates since then, but I doubt they've really changed much from the prior.

CONSULTANT: Well, could I get a copy of the guidelines that were in effect prior to, say, 1986 and then copies of the changes since then?

CFO: I'll see what we can dig up.

CONSULTANT: Good, Bill, because I think it's important for me to try to determine just what changes have been made over the past five years. You mentioned that you use ISO rates for your SMP business. How do you evaluate those rates in terms of deciding whether they are appropriate for your business?

CFO: Well, we look over the ultimate accident year pure premium and compare it to the rates that we've had at that time and then make a judgment about rates going forward. Of course, we have to look at our expenses too.

CONSULTANT: Can you give me a history of the rate changes?

CFO: Yes, we can do that.

CONSULTANT: How about rating plans? Do you use schedule experience rating plans, for example?

CFO: Oh, sure. You don't write much business these days unless you can be flexible on your pricing. They tend to move up and down with changes in competitive conditions, but they've been about 5% over time.

CONSULTANT: Do you have a report, Bill, that would give me that information?

CFO: Well, it would be pretty hard to develop that statistically for the SMP book. It just doesn't really lend itself to that very well.

CONSULTANT: But, you did say that the credit had been consistent at about 5% over time. How do you know that if you don't have documentation for it?

CFO: Well, that's based, of course, on what the underwriters say, based on their own internal audits and reviews.

CONSULTANT: Well, I realize your underwriting managers aren't in today, but can you check with the underwriting department and get some documentation for those numbers?

CFO: O.K. I'll see what we can find, but why are you so interested in these schedule credits, Howard?

CONSULTANT: Well, on the plane ride down here today, I had a chance for a quick look at your annual statement. Looking at the loss ratios in Schedule P for your multi-peril business, I noticed that, for the last couple of years, you're anticipating a significantly reduced loss ratio. It was really such a dramatic decrease that I wanted to make sure that I gathered enough information to be able to evaluate that. So, I'm very much interested in anything that might affect those loss ratios.

MR. CERONE: Note here that Howard's doing pretty well. He did his homework on preparing for the Schedule P question. He noted that SMP

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was a big part of the company's book. He went through the annual statement and saw something happening to the loss ratios and he was trying to get that information out of Bill. But, he didn't stick strictly to his set of questions. He looked ahead and he looked at the published information in the annual statement to see how he could use it in his investigations.

CONSULTANT: Bill, I haven't really had a chance to look much at the other lines of business yet so I don't know what detailed pricing information I'll require. But, it might turn out that I'd like pricing information on your other lines of business. Is that available?

CFO: Well, surprisingly enough, it's easy for GL and we can give you a rate history for the other lines.

CONSULTANT: O.K. Good. That's fine. Have there been any other major changes, Bill, that might have effected your SMP book of business?

CFO: Well, when the market tightened, say in '85 or '86 - really around '86, we started to use that as an opportunity to really re-underwrite that book and concentrate on what the underwriters called preferred risk. I know I've looked at statistics and I'd say about a half to a third of the units have dropped off since then, so I guess it must be true. In fact, we got out of a pretty large program of mercantile business - things like major department stores.

CONSULTANT: Well, these department stores - you quit writing them and you cancelled them in '86. You got off all of them completely?

CFO: Definitely. Absolutely.

CONSULTANT: That's interesting. Was it a major segment of your business prior to that?

CFO: Let's see. I guess they maybe would be about 5% now. They might have been 20-25% before that.

CONSULTANT: Wow. That's really a big portion. I'm glad to know, Bill, that you've had a

change there. That's very important information for me.

MR. CERONE: Surprise, surprise. No changes in underwriting guidelines in the last five years, but one-third of the accounts disappeared and 25% of the business went down to 5%. Howard didn't get an answer to his first question, but he persisted as part of asking the specific question about SMP and found out that there was a major change in underwriting. If he had only gotten those earlier underwriting guidelines, he wouldn't have picked up the change and he wouldn't have known that the prior history included the mercantile business.

CONSULTANT: Bill, we touched briefly on the fact that you use ISO rates and that you do some analysis of the ISO rates to determine how they should apply to your business. Tell me more about that.

CFO: Well, let's see. As I said, we do use ISO loss costs and we do some schedule crediting. Those are on, I guess you'd say, the preferred risks. For standard business, we wdte that through our subsidiary, Quickstart Insurance.

CONSULTANT: I'm sorry. You said you have a sub, Quickstart?

CFO: That's right.

CONSULTANT: Gee, I didn't realize that.

MR. CERONE: Another surprise. Howard asked Bill to describe the company. It had been in business since 1925 just writing a few lines of business. Now, we get down to cases and find out there's another company. If Howard had looked through the annual statement all the way to the back, he would have seen the organization chart and seen that there was Quickstart and Upstart, part of the same organization. (Laughter)

CONSULTANT: Bill, are you aware of any other significant changes that I should be aware of.

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CFO: Well, you mentioned reviewing Schedule P. You might want to know about the reinsurance commutations we did.

CONSULTANT: Well, what can you tell me about that?

CFO: Several years ago it looked like one of the reinsurers on our general casualty treaty was circling the drain. They came forward to us in an effort to save themselves and proposed a commutation. We looked at it, analyzed it and then we did it. Basically, we booked that into the Schedule P, just crediting the outstanding losses and crediting the paid losses.

CONSULTANT: I'm not quite sure I understand that, Bill. Crediting outstanding losses and crediting paid losses. Can you clarify that for me?

CFO: Sure. When we had the reinsurance set up, we had a reinsurance recoverable in outstanding, which is a debit, so we credited that to offset it and, then, when they paid us, we had a credit for reinsurance recoverable paids. We booked that. Very simple.

CONSULTANT: I guess I still don't understand, Bill. Can you explain that a little more simply? Yes, and very slowly.

CFO: Basically, we took down the ceded that was up so we credited the losses. You know ceded is usually a debit and then credited as an increase to the outstanding.

CONSULTANT: Yes, but you have got to realize that actuaries aren't accountants so I just need you to go over this very slowly.

CFO: I just became aware of that.

CONSULTANT: A lot of people don't realize the difference, Bill.

CFO: Well, the debits are on the left and the credits are on the right. (Laughter)

CONSULTANT: No. I was referring to the difference between accountants and actuaries, but we won't get into that one now.

CFO: Aldght. What do you want to know, Howard?

CONSULTANT: Well, could you just go over it one more time to make sure I understand it or maybe I could try repeating it back to you. Let me see. You commuted the reserves. Since you took the loss reserves back, you increased the loss reserves.

CFO: That's right.

CONSULTANT: So that means that you, then, credited the ceded reserves.

CFO: You're getting there, Howard.

CONSULTANT: O.K. Then, of course, you were paid for taking these reserves back - hopefully - and that payment - you reflected that by reducing your paid losses.

CFO: You got it.

CONSULTANT: And that's what you mean when you say you credited your paid losses. O.K. So, you credited your paid losses, you credited your ceded reserves.

CFO: Exactly.

CONSULTANT: I think I understand that, Bill. And that's the way it appears in your annual statement for 1991 ?

CFO: That's exactly right.

CONSULTANT: Good. I'm glad to know that.

MR. CERONE: Boy, that was tough. Did anybody understand Bill the first time? Debits and credits? Howard was looking for his accounting book. He figured that wouldn't work. Obviously, this had a big impact and he had to figure out what happened. Howard could have taken some notes and said to himself I'll come

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back to this later, but he persisted in trying to get Bill to come up with some sort of simple description of what happened and, actually, how Schedule P might be effected. But, now, he's got a little further to go because he's got to know what development data he's going to get. Whether it is going to be before the commutations or after the commutations.

CONSULTANT: Now, Bill, the claim department operations often have a major impact on the data that I'm looking at when I do a loss reserve review. What can you tell me about Upstart's claim operation?

CFO: Well, I doubt that that's had very much of an impact. It's been pretty consistent - long tenure management. The former Claim VP retired, after probably 50 years, somewhere maybe in '85 or '86. Then, there's a new guy that came in. He's got a pretty good background from a major carrier. I remember that he just felt that the adjusters weren't all that aggressive about setting up reserves so I think, you know, now that I think about it, he really did implement a program to do some case reserve strengthening. You know, get them up faster.

CONSULTANT: And do you think that they did strengthen the case reserves in the process?

CFO: Yes, I do.

CONSULTANT: I don't think they did though. (Laughter)

CFO: Why do you say that?

CONSULTANT: Well, one thing I looked at this moming, on the way down, was the ratio of your paid losses to your incurred losses. If what you said really happened, then I should see those ratios decreasing as case reserves increased. But, I don't see that happening. So, I don't see how it could be the case.

CFO: Well, Howard, in my files somewhere, I've got a couple of memos that say we did. (Laughter)

CONSULTANT: AII I can tell you, Bill, is what I saw. But, you know, thinking about it, I guess maybe I could be missing something. There is a possibility that would have happened - if I'm looking at the ratios of paid to incurred losses - there's really two pieces I'm looking at, the numerator and the denominator. You're saying that the incurred losses, that is the denominator, increased. . .

CFO: That's right.

CONSULTANT: . . . because of the case reserve strengthening. I'm saying that I didn't see any change in the ratios of paid to incurred so maybe something happened with the paid losses. Is there anything that might have happened to cause the paid losses to speed up?

CFO: No, I can't think of anything.

CONSULTANT: What about department case loads, for example. changed over time?

the claim Have they

CFO: Well, I know this guy came in and he had sort of a formula approach for allocating cases based on their degree of complexity. Whether the claim was in suit or not in suit. And, I know he diwied up the claims separately. I don't think that would have much of an effect though.

CONSULTANT: Have there been any mandates for the claim department personnel? That they should speed up claims processing, for example, or pay the easier claims. Did anything like that happen?

CFO: Well, you know, this new guy kind of prefers to pay claims at a lower value today rather than some future higher value tomorrow. I don't know that that would have much of an effect - would it?

CONSULTANT: Well, maybe. It may have a significant impact on the loss payments. CFO: O.K., perhaps it would.

CONSULTANT: Well, I'm still puzzled then, Bill. If you want me to give full credit to the fact that

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case reserves have been strengthened, and I don't see that in the paid to incurred ratios, then I need to do some more investigation, rm wondering if I could talk to your claims adjusters. Maybe they have some insight in terms of how the claim payments might have been sped up.

CFO: Boy, would that be a waste of time. (Laughter)

CONSULTANT: Well, I think that's really important though, Bill. I'd really like to talk to them.

CFO: At $400 an hour, I'm sure you would. (Laughter) All they're going to say is I'm getting $4 an hour and they're just going to sit there and complain and whine and, you know. Besides the Claims VP is out for a couple of weeks.

CONSULTANT: You say the claims adjusters will be whining? What would they have to whine about?

CFO: Anything. Anychange. These are some of the most stubbom people in the world. They never want to give up a buck, for one thing. That's great. They don't want to deal with change so, I mean, the last time we had a change, it was this IAS system in the New York courts.

CONSULTANT: The IAS system? I'm not familiar with that, Bill. What was that all about?

CFO: Well, it was called the individual assignment system and, basically, the New York court system was real bogged down and became a bottleneck. Any suit claims that we had, and any other company for that matter, went into a central court calendar. All the cases were funneled through that calendar. Once a case got ready to come up for trial, then they'd assign it to a judge who might have another case, he might be on vacation. So, you know, it was very, very slow. So what they did - as the cases continued to grow in New York they said, let's get rid of the calendar. Let's divvy up all of the cases to individual judges. Now, you've got all those judges managing their own case loads. When

they got the assignments, they freaked out at the volume of cases. So, they said let's move these cases. So, they were really pushing both the plaintiffs and the carrier to settle out of court. Now, I think about it, that probably did speed up our settlement.

CONSULTANT: Well, that sounds like it Bill. Going back to earlier in my notes here I see that 80% of your business was in New York. So that could be the missing piece of information. It certainly would have an impact in causing the paid losses to increase. Could you give me some documentation for that so I'll have a better understanding of just exactly what took place and what the timing was?

CFO: Well, I know it was published. Let's see what we can dig up.

CONSULTANT: Thanks.

MR. CERONE: Note here Howard had to dig and dig back and forth to get his information. Reserves were strengthened - at least that's what the memo said - but something had happened in the claim counts and Howard couldn't see that in advance. He finally got Bill to see the light and come up with his own explanation of what might have happened.

CONSULTANT: Well, Bill, I think that pretty well wraps things up for now. Your secretary is getting the copy of your most recent actuarial reserve analysis for me. I'll take that information back to my office and start my preliminary evaluation. After I finish that, I'll probably need to come back and sit down with you a bit longer to go over any new questions that arise.

CFO: Yeah, and hopefully before your rates go up.

CONSULTANT: Well, yeah, O.K., Bill. Anytime. (Laughter) Good to talk to you.

CFO: Good talking to you, Howard.

END OF FIRST SKIT

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MR. CRANDALL: O.K. let's look at some of the highpoints of that. There were some good things and there were some bad things out of that interview. On the good side, Howard was persistent, almost to a fault, but he had to get his information somehow. Now, if Howard had just asked for the data to start his analysis, he wouldn't have realized that something was wrong. That something couldn't easily be explained. He may have used the old SMP data and come up with inappropriate tail factors because it had the mercantile business in there. Howard also asked for documentation. The important thing here is that he didn't just ask for it, but he had to follow- up and make sure he gets it and make sure he gets it in the right amount of detail. Howard realized that the methods he was going to use, both in his question asking and in the actual analysis, have to be flexible. They have to reflect the changes in the operation of the company. Howard also asked for clarification of the terms he didn't understand - the accounting treatment of the commutation, the IAS system and the other things that he didn't have a background in.

So, what did he do right? Let me ask you. How many of you feel that Howard was well prepared for this interview as a consultant coming into a first client interview? (Laughter) O.K. Well, I think I agree with the majority here. One thing that's probably a good idea for a consultant meeting a new client is to ask for advanced information. If you have a data request, go to the client then. When he gets that, he has a chance to look at it and then he can put it along side this questionnaire, which is kind of the mental model that we were talking about - a checklist of things to look for - and, using those two sources, he can put together a good set of questions which are customized to this particular client.

I mentioned the commutation program. Obviously, Upstart bought reinsurance. If Howard had looked through the annual statement and looked through Schedule F, he would have seen they bought reinsurance, but he didn't ask any questions about ceded reinsurance. Loss adjustment expense - we didn't hear anything about whether they were included in the case reserves or in some form of bulk reserve. The

process by which claims are reported and recorded. We don't know anything about that. That's usually pretty important. Data processing and accounting weren't looked into in any depth. There were not even any initial questions. Even though Howard asked for the latest actuarial analysis, he didn't get into how IBNRs were established or how they are set up on an accounting basis. How about your reaction?

MR. CERONE: You want to take Howard down a couple more pegs?

QUESTION: I guess I'm worried about him planting anew the idea that maybe the payments were speeded up. I think it's impossible for anyone to convince you that what you see was the right answer is to your benefit. You say, yeah, that's probably what happened.

MR. CRANDALL: Well, do you think consultants should be allowed leading questions like that? That's just what it was.

AUDIENCE RESPONSE: If we want to lead you astray, that's O.K., but I worry about leading you into saying the right answer that makes things look better.

MR. CRANDALL: Or perhaps he didn't really believe that. Maybe just after information, just trying to get me to say something more. Because he got more out of me by my volunteering stuff than he got out of asking direct questions. I think lots of times, in the course of an interview, if you just let the subject ramble a bit, you get interesting stuff coming up.

Anything more on Howard and Bill?

QUESTION: Having not known the existence of that second company was a pretty big oversight.

MR. CRANDALL: All you have to do is go through the book and go toward the back and there's the organizational chart. He obviously wasn't too well prepared in that regard. So far as we know, the NAIC blank was all that he had to look at.

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O.K. Well, we'll move on to skit two. We were a little bit hard on Howard in skit 1. The playwright is anonymous, but I think you'll see that Howard does pretty well in this one and Bill not so well. This takes place in an intemal company setting. We're now within a company, not with consultants. Bill, the CEO, as played by myself, is a 37 year veteran of this company. Now, you're going to have to use your imagination to imagine me having been 37 years in the business. I worked my way up through the field marketing function. Bill has forgotten more about this business than most people ever learned. In fact, he has forgotten almost everything. (Laughter) Closing the books for 1991 was complicated by a skirmish with the company's outside auditing firm and it's actuaries. The result was a very near miss on a qualified opinion. The audit committee of the board of directors, shaken by these events, leaned pretty heavily on Bill to hire a staff actuary. They were also mindful of the fact that they were scheduled for an insurance department examination at the end of the next year and they wanted to make sure that their house was as clean as possible. As a result, Howard was finally hired and became the company's first actuary. He came on board very late in the year and he really had worked hard to develop, by mid-January, his preliminary loss reserve estimates. As Howard has had no contact with Bill at all, other than a brief employment interview, he really isn't sure what to expect of his first interview. So, let's listen in.

SECOND SKIT

HOWARD: Hello, Bill, am I too early?

BILL: Nope. Come right in and have a seat. You know, you look familiar to me somehow. (Laughter)

HOWARD: Well, you might remember that we met in late November when I was hired.

BILL: Oh, I remember that alright. I mean before. You ever been in the consulting market?

HOWARD: No. I've always worked in company actuarial departments.

BILL: Oh, well, all actuaries look alike to me. (Laughter) Well, what have you got for me, Harold.

HOWARD: That's Howard. I have a preliminary estimate of year end loss reserves for you to look at.

BILL: Well, so tell me the good news. I almost strangled that actuary from Peat, Price and Lybrand last year. (Laughter) For one of the big three, they really screwed up on our loss reserves.

HOWARD: Well, I'm afraid I have a little bad news for you.

BILL: Well, let's get on with it then. What's the bad news?

HOWARD: The bad news is that we do need to strengthen our loss reserves somewhat more than the increase that P P & L estimated last year. The good news is that we made up a little bit of the deficiency during the past year.

BILL: How did you ever come up with a reserve deficiency? We've never had a reserve problem since I started with this company 37 years ago and I can't believe that we have one now.

MR. CERONE: Oh, oh. (Laughter) It looks like Howard is in a little trouble here. The CEO is giving him a hard time. How is he going to convince Bill that his reserves are low?

HOWARD: Bill, I think I can sell you that my numbers are reasonable. To begin, let me say that rve covered a lot of ground over the last two months. I spent my time, up until Christmas, familiarizing myself with the rest of your staff and their perceptions of the business. Then, after the holidays, I was able to run data through year end to see if I could see what I expected to based upon my conversations.

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BILL: Who did you learn the most from, Sam my marketing man?

HOWARD: No. Actually, I learned the most, in terms of interpretation of data, from Sally, the head of systems, and Marty, your head of claims. The reason is, because of the new claims processing system that was installed in the beginning of last year, I was able to do some sampling and found that paid claims and case reserve transactions are now recorded in the data system up to two weeks earlier than under the old system. Consequently, I was not alarmed at what I saw on the last diagonal in terms of development. Glenn, your chief underwriter, was also very helpful and provided me with some valuable data and information.

BILL: You can stop right there. Once you start talking about diagonals and development, you lose me. Just give me the bottom line of your review and tell me why I should believe it.

HOWARD: O.K. I believe that the reserve balances at December 31 st should be $7 million higher than the mechanical process, that P P & L used, would have produced. It's an unfortunate hit to eamings, but reverses the false profits you have reported for many years. (Laughter) The reserve balances for the last five accident years need to be strengthened.

BILL: Howard, are you sure you've never been in the consulting business? (Laughter) You know, you don't sound like a guy I'm paying good money to to be part of the team. Why should I believe that we need to mess up our great results for 1992 with another $7 million of reserves?

HOWARD: Well, actually, Bill, the number could be $6 million or $8 million, but I can guarantee you it's not $4. However, it could be as much as $10. The point is that we're too far down the line on a number of accident years for there to be much further variability. You, unfortunately, didn't have adequate evaluations made over the course of those years and over-reported profits of the previous four years, which we now have to make up. The good news, Bill, is that, even with this hit, the company's performance, over the last five

years, under your leadership, is still well above that of the industry and your main competitors.

BILL: O.K., but, even if you convince me, I've still got the board to deal with. It does reassure me, Howard, that you agree with the rest of the insurance industry that, when it comes to multi- peril business, we really know what we're doing. But, you still have to convince me that what you're saying is reasonable.

HOWARD: Well, I think I'm prepared to do that. First, let me assure you that I have carefully researched the data base I used to ensure it's integrity. I have applied a number of techniques to the data that are accepted, within actuarial circles, as being good predictors. I have made appropriate adjustments or considerations for the unusual number of catastrophes the last two years, the unusual number of large losses in the data after you increased your liability retentions, the system change I mentioned before and the changes made to your case reserving practices in the middle of last year.

BILL: Now, wait a minute, Howard. I've managed to get by 37 years in this business without getting all tangled up with all that technical actuarial garbage and I'm not going to start now. Why should I believe your numbers? Just give me one good reason that makes sense. Why $7 million?

MR. CERONE: Things are definitely not getting better for Howard. Bill has just taken 70 years worth of progress in actuarial science and tossed it into the garbage can. Is Bill just stonewalling? Is Howard seriously reconsidering his decision to join this company? Let's see what happens.

HOWARD: O.K., Bill, let's talk about this $7 million because I understand your problem. I have the same concern myself. So, I've done some reality checks on my recommendations. Let's talk about some of them. The first thing I looked at was the resulting loss ratio, by accident year, after I added the $7 million. I then indexed each year to 1986. This is pretty well completely developed by now. Here's a graph of what that looks like. (Attachment 1)

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You can see that the pattem is about what we'd expect - with 1986 and 1987 being the lowest loss ratio years representing the best years of the cycle. 1984 was very bad and, since 1987, we've been sliding backwards again.

BILL: Well, I agree on the general state for the industry, but we never let our pricing slip. We price consistently over time. We're not crazy like our competitors. We only care about profit, not production.

HOWARD: That's a very noble philosophy, Bill, (Laughter) and the fact that you believe that your business is being run that way may be the reason we have this problem. Remember I said that Glenn, your chief underwriter, gave me some valuable data. What he had was a history of your underwriting mod over the last five years.

BILL: You mean like 98% of manual?

HOWARD: Yeah, that's the idea, but the actual number runs closer to about 85%.

BILL: Oh, I don't believe that. If that's true, someone's cheating on the rules.

HOWARD: Now, first of all, believe it and, secondly, it doesn't mean that someone's cheating, rve taken this data and combined it with changes to manual rates over time, thrown in a trend factor and developed an index which tells me what I would expect to happen to loss ratios over time as a result of pricing and inflation. I then indexed the results of 1986 to be comparable to the loss ratio exhibit and I get a picture that looks like this. (Attachment 2)

BILL: Well, that shape looks similar to the loss ratio one.

HOWARD: That's right. And, since I indexed both the loss ratio and price monitor data to 1986, I can look at them together and here's what that looks like. (Attachment 3)

BILL: Well, that's interesting. The lines are remarkably similar and, when they differ,

sometimes the loss ratio index ratio is higher and other times the price monitor is higher.

HOWARD: They're more similar than you think, Bill. Your observation is an expected outcome. That is, in the down cycle, loss ratios will typically deteriorate more quickly than pricing would predict. That's because there are hidden price decreases that our price monitors don't pick up.

BILL: Like what?

HOWARD: Well, for example, loosened terms and conditions, such as eliminating the pollution exclusion or throwing in earthquake coverage for free.

BILL: Well, why would we do a thing like that?

HOWARD: To stay competitive in the marketplace while not looking bad on the price monitors. Our insureds are more likely to submit nuisance claims in this environment - in the soft market -as they know they will still be able to get coverage at the same price or lower. As an example, look at the 1984 and 1985 years. These years were the worst down cycle in the industry's history. The graph says that the loss ratios were markedly higher than price monitors would have suggested.

MR. CERONE: Well, it looks like Howard has finally gotten Bill's attention. He has found an area where the boss feels more at home. Howard is using trends in the company's profit and loss statements and price controls to back up the conclusions he has reached about the balance sheet.

BILL: Well, now the lines reverse again beginning in 1987 and that was the end of the hard market.

HOWARD: Yes. And, as terms and conditions were tightened, insureds were less apt to submit small claims for fear of being cancelled. The loss ratio improved by more than the price monitors would predict. Then, they reverse again in '89 as the down cycle goes into full swing.

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BILL: Very interesting. This all makes sense to me. It's helpful to get behind the numbers and put things in perspective. What else do you have?

HOWARD: Well, when I was talking to Sam, your marketing manager, he was telling me how proud he was of his organization because of the growth in new business. He showed me some data that demonstrated that new business typically ran about 25% of a years writings. This year it's up to 35% and he's going for 40% next year.

BILL: What's wrong with that? Even if we booked all of that, the $7 million you're taking out of reserve - we would still have plenty of surplus to support that kind of volume.

HOWARD: Well, not so fast now, Bill. I remember an article I had to read when studying for one of my actuarial exams. What it showed, for homeowners I think, is that new business produces higher loss ratios than renewal business.

BILL: Well, Howard, I can understand why new business might have a higher expense ratio, but not loss ratio. Besides, we sell commercial multi- pedl, not homeowners.

HOWARD: Well, I didn't know either so I went back over time, and looked at our experience between new and renewal by policy year. Both sets of data were reasonably stable so I projected each of the years to ultimate. Here's what it looks like. (Attachment 4)

BILL: I presume that the lines are together in the early years because that was the hard market.

HOWARD: Exactly.

BILL: It looks like they're about 10 points apart now?

HOWARD: Yes, and that is the reason for not being so enthusiastic about the new business Sam is putting on. The difference between 25% and 35% new business, with a 10 point difference

in new and renewal loss ratios, is 1 point on the entire book.

BILL: Well, did you factor that into your reserve recommendations?

HOWARD: Yes, I did.

BILL: This is helpful. What else did you do?

HOWARD: Well, actually, quite a number of things that I've come to look at as reasonable tests. I won't bore you with them, as most of them are more technical. There is one other piece of information that I have which compares us to our principle competitors.

BILL: How do you know about them?

HOWARD: I had copies of their annual statements for the last year and, from that, I was able to compare our loss ratio by accident year to theirs. I also included a comparison of reserves to premiums by accident year. Now, for us, the loss ratios include my recommendations of the $7 million. If this analysis had been done in previous years, our most recent accident year loss ratios would have looked consistently lower than our competition, which would have been the direct result of lower than required reserves. A red flag would have been raised to at least do some more investigation as our book is so similar to our competitors.

BILL: Now, Howard, I think you may work out alright. Frankly, I've never been too comfortable with all this balance sheet stuff. I've always thought about it as just big sandbox for the accountants to play in. (Laughter) So, it's been helpful to look at some real numbers with you. Look, I want you to go over this stuff again with me and the audit committee next Thursday. Then, we'll decide what to recommend to the board, O.K.?

HOWARD: Sure thing. See you on Thursday.

END OF SECOND SKIT

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MR. CRANDALL: In real life this kind of reasonableness check can sometimes give a very useful perspective on your loss reserve levels. Who has some thoughts on this last skit?

QUESTION: . . . mind set was very tough for someone who's been in business for a long time. We went to - our company was in a similar situation where the actuary came in and they had not had an actuary doing the financials. (inaudible) need to put up some major reserve adjustments and most of the management had been in for a very long time in business and could not quite grasp the idea that they had not been . . (inaudible) for those other years. It's always been a trouble to get them to (inaudible). It's a good idea to (inaudible) the approach. It's possible to start giving some of the explanations.

MR. CRANDALL: Good observation. Bill obviously wasn't about to change his perspective quickly. I recall a case of similar circumstances where the chief underwriting officer of the company had a little graph in the bottom drawer and every month, when the actuary brought up the reserve runoff document, he'd put a little mark on his graph and draw a line. He'd been doing this for many years. Matter of fact, the document - I remember the number 1792, which was the year the company was formed, this was the principle document of the underwriter. But, we discovered that there was a systematic error in that document and there had been for years. The next month, we went up with the corrected document and very proudly handed it to him. He opens the draw, pulls out the sheet and goes to put the mark on that. It doesn't work out at all. The mark's way off. We explained to him that there was a problem. He had simply been getting wrong information for years. He was a smart guy and he understood it. He wasn't as dumb as Bill was today. But, he said, I want you to do this. I want you to bring me the document on the old basis and the new basis. He continued to put those marks in the incorrect document - just as he had been for years. That was the way he thought about the business and he couldn't stand to have it jerked away from him so quickly. Old timers are sometimes a problem with technical issues.

QUESTION: Who had the discussion Howard mentioned in changing claims reserve factors that are in Bill's . . . (inaudible). He didn't really address that. (Inaudible)

MR. CRANDALL: I will speak to the playwright about that and see what we can do for next year

please come back. I think you're right, we should have developed that area more. Anything more?

I have some final wisdom for you. They're just five sort of common sense tips. I think they tie in more with the first skit that Howard and I did.

The first is to be prepared. We talked about - if it's a new account, new situation - get advanced information. Get your questions as pointed toward that particular situation as you can. Otherwise, you'll risk overlooking a whole line of questioning maybe ceded reinsurance or changes of the company's procedures. Further, if the quality of your analysis is ever brought into question, - speaking of that, how many people believe that actuarial malpractice suits are likely to increase in the future? (Laughter) See, we do have a problem. Maybe having a good file, a comprehensive list of questions in your workpapers, can serve as documented evidence that you began your analysis in accordance with sound actuarial principles. Be professional, be prepared. Good place to start.

Number 2, don't be afraid to ask dumb questions. Ask for definitions, clarifications, explanations. Your role is to obtain information, not to show how knowledgeable you are. Don't let your ego get in the way. If you didn't understand something, just ask. If you're not sure if you understand something, ask. Even if you do understand, it doesn't hurt to ask. In fact, by playing dumb, you may find out things that you otherwise would never learn. So ask dumb questions and learn all you can.

Number 3, avoid IBUI and focus on the important issues. Don't get side tracked on irrelevant issues no matter how intellectually interesting them may be to you. As you gather information, sort the important issues from the immaterial and

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keep probing the important issues. If you don't go through the sifting process, you're apt to end up with a lot of information, but little in-depth understanding of the critical items so keep your focus on the important issues. Keep narrowing the focus of your inquiry in order to reach the best professional opinions you can.

Fourth, be persistent. Don't be overly concemed that your questions might be annoying. Your analysis will be judged by your expertise, not by whose feathers you ruffled. On that far, distant day, when you may be sitting in the courtroom raising your right hand . . . Be persistent in requesting what you believe is important. To do your job right, you need to dig and to probe. If a specific wording in a commutation agreement appears to be important to you, don't be satisfied until you get a copy of it. If data on large losses is important, but not readily available, don't be satisfied until you receive it. Be persistent so that your final opinions will be based on all the important information.

Number 5, plan to go back and ask another round of questions. After you gather your initial

information, you should begin your numerical evaluation, your first cut at the reserves, but keep in mind that that may be just a preliminary analysis. As you do your calculations, new issues may arise. Then, you can focus your investigation more and ask another series of questions, if necessary. You have no obligation to stick to your preliminary findings. Your obligation is to go through the iterations necessary to be satisfied that your estimate is the best that you can develop. So, recognize, at the outset, that a second round of questions may be necessary and be sure you leave the door open with the client if you're a consultant or with the boss if you're an internal actuary.

To summarize, be prepared, don't be afraid to ask dumb questions, focus on the important issues, be persistent and plan to go back with another round of questions if you need to. I think that these five simple tips will make you a better professional actuary. And that concludes this particular show. The next big event on your schedule, I hope, is lunch. (Laughter) Thank you for coming.

1020

Milliman & Robert.son, Inc.

1992 CASUAL TY LOSS RESERVE SEMINAR

LOOKING BEYOND THE NUMBERS

"A Claims Perspective"

Milliman & Robert.son, Inc.

3 MAJOR ACTIVITIES OF CLAIM PEOPLE

• Negoiate and Conclude Claims--Bilateral. Very Difficult.

• Investigate Claims--Bilaterah Difficult. • Reserve and Evaluate Claims--Unilateral.

Easy.

I

2

1021

MiUiman & Robertson, Inc.

~ WHERE TO LOOK

1. Direct Claim Department Changes

• Case Reserve Pract ices - - Min imums, Authorities

• Legal Expense P a y m e n t s - - I n t e r i m / E n d of Case

• Extraordinary Claims m Products / Envi ronmental

Milliman & Robertson, Inc.

WHERE TO LOOK (Cont.)

2. Indirect, Internal Changes

• Claim Staff T u r n o v e r - - Change in Biases

• Staff Size - - Change in Work loads

• Set t lement P u s h e s - - " D e a d w o o d "

• Payment Phi losophy ~ "Get Tough "

• Senior Management P ronouncemen ts "Reserves are Redundant "

1022

Milliman & Robertson, Inc.

WHERE TO LOOK (Cont.)

3. External Changes

• L a w s - - Tort Reform

• Verd ic ts N H i g h e r

• Jud ic ia l E n v i r o n m e n t - - L iberal

Milliman & Robertson, Inc.

WHY LOOK?

The CEO's Dilema

• The Actuary

• Last Reserves/Payments

1023

Milliman & Robertson, Inc.

WHY LOOK?

The $70 Million Discount

• Workers' Compensation Run-Off

• How Many Times?

MUliman & Robertson, Inc.

WHY LOOK?

Before and After the Sale

• $10 Million More?

• I'm Stumped!

1024

Milliman & Robertson, Inc.

WHY LOOK?

5,000 and Counting

• File Cabinets

• A Familiar Ring

MiUiman & Robertson, Inc.

WHY LOOK?

10% Off The Top

• Tort Reform

• Bigger Than Zero

10

1025

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COMMERCIAL MULTI PERIL P R I C E M O N I T O R - A C C I D E N T Y E A R LOSS R A T I O R E L A T I V I T I E S

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_ = _ N E W B U S I N E S S _ ¢ _ R E N E W A L B U S I N E S S

1027

1028