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Reserving for Long-Duration Policies
Presented byRoger M. Hayne, FCAS, MAAA
CLRS, San Diego, CASeptember 10-11, 2007
04/19/23 2
What We Are Used To
Usual P&C Products– Term of 1 year of less– Loss emergence usually uniform over term
(though some seasonality can exist)– Often “long” lag from claim occurrence to
settlement• Weeks to months for auto physical damage
• Many years for workers comp., med. mal., etc.
As a result– Loss & LAE reserve a principle focus– Unearned premium not usually an issue
Paradigm Shift
Service Contracts, GAP and related products– Terms can be multiple years– Losses cannot be expected to emerge
uniformly over the life of the contract– Usually (though not always) a reasonably
short lag from loss incident to payment As a result– Loss & LAE reserve not often an issue– Unearned premium reserve is the key to both
the balance sheet and income statement
04/19/23 3
Briefly Some Products Considered
Service Contracts on– Vehicles – Appliances – Electronics – Etc.
Home Warranties F&I Related Products– GAP – Tire & Wheel– Etching – Etc.
Manufacturer warranties
04/19/23 4
Loss & LAE Reserves
Can treat as other lines Usual triangles work well
04/19/23 5
Acc. Qtr. 3 Mos. 6 Mos. 9 Mos. 12 Mos.
2006-3Q Pd 9/06 Pd 12/06 Pd 3/07 Pd 6/07
2006-4Q Pd 12/06 Pd 3/07 Pd 6/07
2007-1Q Pd 3/07 Pd 6/07
2007-2Q Pd 6/07
Often case reserves not set so incurred not available
Count data often useful
Loss & LAE Reserve Methods
Short tail, but chain ladder can be volatile for most recent quarter(s)
Good idea to also use an incremental severity method (see Berquist/Sherman)– Chain ladder can be used to estimate claims– Be sure underlying severity trends appear
reasonable As usual, look for changes that could affect the
accuracy of the forecasts such as changes in settlement practices, may need to use Berquiest/Sherman again
04/19/23 6
Unearned Premium
Accounting treatment varies GAAP– Generally time premium recognition to match loss
and expense flows– Usually recognizes “up-front” expenses– May require separate premium deficiency reserve
(PDR) Statutory– Differs for less than 13 month duration and longer– 3-way test for long-duration
04/19/23 7
First Find the Beans Before Counting Recommended first step: Figure out your true
position Use that information to figure appropriate Stat
and GAAP unearned premium booking Step 1: Get estimates of ultimate losses for
contracts on the books Step 2: Use the result from step 1 to assess
loss and expense emergence during contract lives
Step 3: Use results from steps 1 and 2 along with accounting rules to “count the beans”
04/19/23 8
Getting Organized
“Know thyself.” Understand the critical characteristics of the contacts you are about to analyze
Make sure that the data organization and methods will recognize those characteristics
Simple Example: Appliance Warranty at POS– Covers failure during fixed time after contract
purchase– Secondary to manufacturer warranty– Only available at point of sale (POS)
Suggests policy period organization by term
04/19/23 9
Appliance Example
Note can only purchase at time of sale, no selection issues
One organization – policy quarter triangles
04/19/23 10
Pol. Qtr. 3 Mos. 6 Mos. 9 Mos. 12 Mos.
2006-3Q Pd 9/06 Pd 12/06 Pd 3/07 Pd 6/07
2006-4Q Pd 12/06 Pd 3/07 Pd 6/07
2007-1Q Pd 3/07 Pd 6/07
2007-2Q Pd 6/07
Straight forward but– Not directly usable for emergence– Length of tail not known with certainty
Appliance Example
Consider different organization, by policy quarter and occurrence quarter
04/19/23 11
Pol. Qtr. 3 Mos. 6 Mos. 9 Mos. 12 Mos.
2006-3Q OQ 06-3 OQ 06-4 OQ 07-1 OQ 07-2
2006-4Q OQ 06-4 OQ 07-1 OQ 07-2
2007-1Q OQ 07-1 OQ 07-2
2007-2Q OQ 07-2
Directly captures emergence with known tail
Different cells are at different maturities
Appliance Example
First use reserve analysis to estimate ultimate losses for each policy quarter, occurrence quarter cell
One way – use development implied by final selections and paid (incurred) to date to get factors by occurrence quarter age
Apply factors to each cell:– UQ 07-2 = OQ 07-2 x 3-to-ult. factor – UQ 07-1 = OQ 07-1 x 6-to-ult. factor– Etc.
Result, ultimate emergence to date estimate
04/19/23 12
Appliance Example
Should have separate analyses by term length and appliance type if thought important
04/19/23 13
Pol. Qtr. 3 Mos. 6 Mos. 9 Mos. 12 Mos.
2006-3Q UQ 06-3 UQ 06-4 UQ 07-1 UQ 07-2
2006-4Q UQ 06-4 UQ 07-1 UQ 07-2
2007-1Q UQ 07-1 UQ 07-2
2007-2Q UQ 07-2
(PQ 06-3, OQ 07-2) x 3-to-Ult.(PQ 06-3, OQ 07-2) x 3-to-Ult.(PQ 06-4, OQ 06-4) x 9-to-Ult(PQ 06-4, OQ 06-4) x 9-to-Ult
(PQ 07-1, OQ 07-2) x 3-to-Ult.(PQ 07-1, OQ 07-2) x 3-to-Ult.
Appliance Example - Analysis
Separates emergence from development. Development focuses more on internal effects on claims settlement and processes– Might be consistent across a range of different
contract terms and maybe even contract types– Thus higher level summarization, e.g.
appliance all terms, may be useful and likely to be more stable than by term
Should look at claim counts – provides valuable information and allows separate severity analysis
04/19/23 14
Appliance Example – Analysis
Now the data is organized some methods come to mind:– Chain ladder applied to
• “Traditional” policy quarter data
• Policy quarter by occurrence quarter data
– Incremental average methods averages per• Forecast claim
• Forecast contract
– Bornhuetter-Ferguson– Other
Then select ultimate estimate
04/19/23 15
Appliance Example – Considerations Exposures and premium written may develop,
even for “point of sale” contracts due to cancellations
Since cancellations affect exposure basis, probably better to use estimated ultimate contracts (net of cancellations) in an average pure premium forecast method
For ratemaking interest is more on ultimate loss per initial contract written with a recognition of average return premium
Can do LAE separately if desired
04/19/23 16
Appliance Example – UEPR
GAAP (simplified) – UEPR is portion of written premium relating to future losses and expenses to emerge– Divide the cumulative adjusted losses & LAE by
policy quarter and occurrence quarter triangle by forecast ultimate loss & LAE to get a triangle of emergence factors
– Select representative emergence by quarter– Reflect other expenses and apply resulting factor to
written premium. Compare expected future loss, expense &
refunds to UEPR for PDR
04/19/23 17
Appliance Example – GAAP UEPR
Sample cumulative loss & LAE emergence
04/19/23 18
Pol. Qtr. 3 Mos. 6 Mos. 9 Mos. 12 Mos.
2006-3Q 3% 9% 17% 25%
2006-4Q 4% 10% 14%
2007-1Q 2% 8%
2007-2Q 3%
Select 3% 9% 16% 25%
Assume expenses are 35% or premium, 25% at policy issue and 10% during life, UEPR for 2007-1Q:
WP2007-1Q x 0.75 x (1 - 0.09)
Appliance Example – GAAP PDR
Premium deficiency reserve to cover losses and expenses expected in the future in excess of the UEPR
Easy to obtain from this analysis– Future losses & LAE directly from analysis– Future overhead can be modeled separately or
applied as a load on losses & LAE– Return premium from cancellations probably
should be considered too – can be taken as premiums to date minus estimated ultimate premiums
04/19/23 19
Appliance Example – Statutory UEPR A bit of schizophrenia– Less than 13 months duration (no special
rules):• “Earn pro-rata”
• No allowance for acquisition expenses
• Separate PDR
– 13 months or more, by formula (minimum): The UEPR should be large enough to provide for all future losses and expenses, even if all policies are cancelled at the valuation date, but should release profits no faster than losses and expenses are expected to emerge over the life of the contract
04/19/23 20
Appliance Example – Statutory UEPR Statutory formula, 3 calculations at the UEPR
valuation date that can be based on analysis above– Calc. 1 – amount refunded if all policies are
cancelled at valuation date. Most service contracts cancel pro-rata, but check!!
– Calc. 2 – percent unemerged, parallels the GAAP UEPR calculation above
– Calc. 3 – present value of future losses and expenses, similar to GAAP PDR above, but allows discount to incurral date.
Largest by PY for last 3, PY aggregate prior
04/19/23 21
Know Thyself
It is always a good idea to know what you expect to see and why. This often helps identify issues in the data or features that might not be appropriately captured in your models
I would expect appliance loss emergence to be slow early on, and non-existent in early occurrence quarters (depending on OEM warranty)
I would expect build-up with continuing increase till the end
Deviations should be investigated
04/19/23 22
Some Complications in Real Life
Different products have different expected patterns, different OEM warranties, different inherent tendencies to break down
Motor vehicle contracts tend to be toward the more expensive end of the spectrum, have a rather long history (since the 1970’s or so) and tend to have twists and complications. Two major ones:– Extended eligibility– Point of Sale contracts
Take them in reverse chronological order
04/19/23 23
Vehicle Service Contracts
General features of vehicle service contracts:– Have limitation both with respect to time coverage
exists and mileage covered– Secondary to OEM warranty– May provide for items not under OEM
Traditional new car contracts:– Time measured from original vehicle in-service
date– Mileage based on odometer mileage– May be sold on cars that are actually used, with no
change in coverage provision
04/19/23 24
Vehicle Service Contracts
Used Car Contracts– Time measured from contract purchase date– Mileage aggregate from time of contract
purchase POS New Car Contracts– Time measured from contract purchase date– Mileage based on odometer mileage– May be sold on cars that are actually used
Suggests analysis of both used and POS new contracts on policy quarter basis
04/19/23 25
POS New Car Contracts
Typically a car must be under OEM warranty to qualify for a “new” car contract
OEM warranty depresses losses in early stages of new car contract
For “POS” new car contracts mileage at contract purchase effects both:– Length of remaining OEM warranty so delay to full
service contract coverage and– Effective length of coverage provided
For these reasons it is a good idea to subdivide POS analyses by start miles
04/19/23 26
POS New Car Contracts – Considerations A relatively recent contract provision (last 5 or
so years, depending on carrier or administrator) Often reference is to “twin” traditional new car
contract Actually POS contracts – Provide more coverage than corresponding
traditional new car contract– Additional coverage is in “tail”
Care should be taken in using traditional contracts to price or reserve POS contracts
04/19/23 27
Traditional New Car Contracts
In-service quarter organization instead of policy quarter due to start characteristics
Maintains known end date Should subdivide by in-service to policy lag– Affects start of possible losses– There has been considerable adverse selection for
such “extended eligibility” Possible for policy (and premium) development to
be upwards before reductions from cancellations Need to allocate results to policy quarter
04/19/23 28
Vehicle Contract Characteristics
Improvements in vehicle quality affect loss costs and development
For vehicles– Mileage limitations eliminate vehicles as time
progresses– Repair costs tend to increase with mileage
Broadly, losses for new car contracts tend to be “back loaded” due to OEM warranty
Broadly, losses for used car contracts tend to be “front loaded” due to lack of OEM warranty
04/19/23 29
GAP
Guaranteed Auto Protection (GAP) provides for the difference between the loan or lease balance and actual cash value of car in case vehicle is a total loss
Term equal to loan/lease term Exposure– Heavily front-ended– Loan to value affects
• Loss cost
• Loss emergence
– LTV of 150% or more not uncommon now
04/19/23 30
Trust Accounts
Some insurance on vehicle service contract programs on a “trust” basis– Loss portion of contract cost put into “trust”– Trust earns interest– Trust pays losses and certain expenses– Insurance coverage in case trust is exhausted
Insurance coverage can cover trust:– For contracts issued in a period of time– Entire trust
Premium usually charge per contract
04/19/23 31
Trust Account Insurance
Should look at underlying trust account(s) Policy (underwriting) period coverage– Less complicated– Loss, LAE, UEPR similar to other multiple year
coverages– Premiums correspond to exposure
Aggregate coverage (i.e. red alert)– If policy is annual arguably no loss until entire
fund is exhausted• Loss & LAE reserve $0 unless a reasonable chance for
fund to be exhausted by year end
• UEPR???? Not clear!!!
– Premiums do not match exposure!!!04/19/23 32
Conclusion
Loss reserves amenable to most reserving methods applied to accident (repair) period (month, quarter, year) data
Exposure period by occurrence period organization a powerful tool allowing separation between policy characteristics (emergence) and internal processing (loss development)
Focus first at assessing ultimate experience, then think about counting the beans
04/19/23 33