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!