The Reserving Actuary’s Role in Risk Assessment: Value Added by the Reserving Actuary in...

The Reserving Actuary’s Role in Risk Assessment:Value Added by the Reserving Actuary in Identifying

and Helping Mitigate Financial Risk Both on the Balance Sheet and in Underwriting and

Financial Considerations

The Reserving Actuary’s Role in Risk Assessment:Value Added by the Reserving Actuary in Identifying

and Helping Mitigate Financial Risk Both on the Balance Sheet and in Underwriting and

Financial Considerations

Presented at the Casualty Loss Reserve Seminar

By:

Presented at the Casualty Loss Reserve Seminar

By:

Ronald T. Kuehn, FCAS, MAAA, CPCU, ARM, FCA

Consulting Actuary

September 12, 2005

Ronald T. Kuehn, FCAS, MAAA, CPCU, ARM, FCA

Consulting Actuary

September 12, 2005

11

The Reserving Actuary’s Role in Risk Assessment:

Value Added by the Reserving Actuary



Items Covered

•DDR Reserve

•Asset Liability Matching/Cash Flow Testing/Discounting

•Reinsurance Issues

•Risk Transfer

•Cost of Reinsurance

•Collectibility

Items Covered

•DDR Reserve

•Asset Liability Matching/Cash Flow Testing/Discounting

•Reinsurance Issues

•Risk Transfer

•Cost of Reinsurance

•Collectibility

22





DDR Reserve

•Free tail for death disability and retirement

•Started in early 1980’s when insurers stopped offering occurrence policies

•Originally held as loss or unearned premium reserve

•Currently must be disclosed in opinion and displayed in Exhibit B

DDR Reserve

•Free tail for death disability and retirement

•Started in early 1980’s when insurers stopped offering occurrence policies

•Originally held as loss or unearned premium reserve

•Currently must be disclosed in opinion and displayed in Exhibit B

33





DDR Reserve

Items Required to Compute DDR Reserve (per insured)

•Age

•Policy Inception Date

•Premium

•Also need withdrawal rates by age, assumed retirement age, and decrement (death and disability) tables

DDR Reserve

Items Required to Compute DDR Reserve (per insured)

•Age

•Policy Inception Date

•Premium

•Also need withdrawal rates by age, assumed retirement age, and decrement (death and disability) tables

44





DDR Reserve

NAIC Accounting Practices and Procedures Manual

“Reserve is required to assure that amounts collected by insurers to pay for these benefits are not earned prematurely and that an insurer with an aging book of business will not show adverse operating results simply because an increasing portion of insureds is earning the benefits for which it has paid”

DDR Reserve

NAIC Accounting Practices and Procedures Manual

“Reserve is required to assure that amounts collected by insurers to pay for these benefits are not earned prematurely and that an insurer with an aging book of business will not show adverse operating results simply because an increasing portion of insureds is earning the benefits for which it has paid”

55





DDR Reserve- Steps in Modeling Accrued LiabilityDDR Reserve- Steps in Modeling Accrued Liability

•1. Develop current cost of tail benefit, adjusted for population

•2. Project cost by multiplying by annual growth in premiums

•3. Compute present value of step 2 at entry age based on mortality, interest and withdrawal

•4. Compute present value of step 2 at attained age based on mortality, interest and withdrawal

•5. Compute annuity factor from attained age to retirement, based on premium growth, mortality and withdrawal

•1. Develop current cost of tail benefit, adjusted for population

•2. Project cost by multiplying by annual growth in premiums

•3. Compute present value of step 2 at entry age based on mortality, interest and withdrawal

•4. Compute present value of step 2 at attained age based on mortality, interest and withdrawal

•5. Compute annuity factor from attained age to retirement, based on premium growth, mortality and withdrawal

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DDR Reserve- Steps in Modeling Accrued Liability (cont.)DDR Reserve- Steps in Modeling Accrued Liability (cont.)

•6. Compute annuity factor from entry age to retirement, based on premium growth, mortality and withdrawal

•7. EANC equals step (3) divided by step (5)

•8. Normal cost at attained age equals step (7) times growth in premium between entry and attained ages

•9. Accrued liability equals step (4) minus [ step (8) times step (6) ]

•10. Term cost equals probability of death or disability times step (1)

•6. Compute annuity factor from entry age to retirement, based on premium growth, mortality and withdrawal

•7. EANC equals step (3) divided by step (5)

•8. Normal cost at attained age equals step (7) times growth in premium between entry and attained ages

•9. Accrued liability equals step (4) minus [ step (8) times step (6) ]

•10. Term cost equals probability of death or disability times step (1)

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DDR Reserve-Entry Age Normal Funding

•EANC- Level percent of future malpractice premiums (from physician’s original date of insurance) equal to present value of projected retirement benefits

•Accrued Liability-Present value of future projected retirement benefits less present value of future normal costs

•Term Cost- Cost of providing benefit to the insureds who die or become disabled during the current year

DDR Reserve-Entry Age Normal Funding

•EANC- Level percent of future malpractice premiums (from physician’s original date of insurance) equal to present value of projected retirement benefits

•Accrued Liability-Present value of future projected retirement benefits less present value of future normal costs

•Term Cost- Cost of providing benefit to the insureds who die or become disabled during the current year

88





DDR Accrued Liability ComparisonDDR Accrued Liability Comparison

Age Term AccruedDistribution EANC Cost Liability

Random 53,162 13,127 223,626

Younger 24,589 6,116 98,847

Older 187,438 51,829 766,119

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Asset Liability Matching /Cash Flow Testing

•Actuaries currently do not generally have to perform cash flow testing and asset liability matching calculations

•In the future, actuaries may be much more involved in cash flow testing and asset liability matching


•Actuaries currently do not generally have to perform cash flow testing and asset liability matching calculations

•In the future, actuaries may be much more involved in cash flow testing and asset liability matching

1010






New Bermuda Requirements for Opinion Letter and Discounting

•Company can hold discounted reserves

•Loss Reserve Specialist (actuary) cannot assume a discount rate but decline responsibility for the rate

•LRS cannot advise that assets have not been reviewed, since assets affect the choice of discount rate

•Amount must be set aside for variations in ultimate losses, payment dates and interest rates

•LRS must include statement that assumptions are appropriate

(Note: The Bermuda Registrar of Companies has not yet implemented these requirements)


New Bermuda Requirements for Opinion Letter and Discounting

•Company can hold discounted reserves

•Loss Reserve Specialist (actuary) cannot assume a discount rate but decline responsibility for the rate

•LRS cannot advise that assets have not been reviewed, since assets affect the choice of discount rate

•Amount must be set aside for variations in ultimate losses, payment dates and interest rates

•LRS must include statement that assumptions are appropriate

(Note: The Bermuda Registrar of Companies has not yet implemented these requirements)

1111






Data Needed for Asset- Liability Cash Flow Modeling

•Payment Pattern

•Estimate of Ultimate Loss (and ALAE)

•Allocation of Invested Assets Used to Meet Liabilities

•Assumed Interest Rate and Borrowing Rate


Data Needed for Asset- Liability Cash Flow Modeling

•Payment Pattern

•Estimate of Ultimate Loss (and ALAE)

•Allocation of Invested Assets Used to Meet Liabilities

•Assumed Interest Rate and Borrowing Rate

1212





Asset Liability Matching /Cash Flow TestingAsset Liability Matching /Cash Flow Testing

1313

A-1 ACTUARY INSURANCE CO MPANY

Asset Liability Sufficiency 12/31/2004

(1) (2) (3) (4) (5)

Beginning Interest Available Mid Year Interest on

Year Balance Income Assets Balance Borrowing

2004

2005 0 0 5,515,000 5,515,000 0

2006 3,166,845 78,205 0 3,245,051 0

2007 2,651,867 65,488 0 2,717,355 0

2008 1,931,087 47,688 0 1,978,775 0

2009 1,119,641 27,650 0 1,147,290 0

2010 359,739 8,884 0 368,623 0

2011 0 0 0 0 16,351

2012 0 0 800,000 800,000 44,111

2013 0 0 0 0 5,072

2014 0 0 400,000 400,000 11,318

2015 203,195 5,018 0 208,213 0






1414



(6) (7) (8) (9) (10)

Total Balance After Cumulative

Year Payments Due Outflow Borrowing Borrowing

2004 0 0

2005 2,424,475 2,424,475 3,090,525 0 0

2006 657,094 657,094 2,587,957 0 0

2007 832,807 832,807 1,884,548 0 0

2008 886,118 886,118 1,092,657 0 0

2009 796,221 796,221 351,069 0 0

2010 602,202 602,202 (233,580) 233,580 233,580

2011 380,225 396,576 (396,576) 396,576 630,156

2012 198,185 242,296 557,704 0 630,156

2013 84,163 89,234 (89,234) 89,234 161,686

2014 28,698 40,016 359,984 0 161,686

2015 7,734 7,734 200,478 0 0






1515



(11) (12) (13) (14) (15) (16)

Bal. After Bal. After Interest End of Year Cum. Borrowing

Year Borrowing Repayments Repayments Income Balance After Repayments

2004 0 0

2005 3,090,525 0 3,090,525 76,321 3,166,845 0

2006 2,587,957 0 2,587,957 63,910 2,651,867 0

2007 1,884,548 0 1,884,548 46,539 1,931,087 0

2008 1,092,657 0 1,092,657 26,983 1,119,641 0

2009 351,069 0 351,069 8,670 359,739 0

2010 0 0 0 0 0 233,580

2011 0 0 0 0 0 630,156

2012 557,704 557,704 0 0 0 72,452

2013 0 0 0 0 0 161,686

2014 359,984 161,686 198,298 4,897 203,195 0

2015 200,478 0 200,478 4,951 205,429 0






Value of Asset Liability Testing

•Determine if assets and liabilities are properly matched

•Determine if borrowing is needed

•Enable readjustment of invested assets

•Show true cost of payment of liabilities


Value of Asset Liability Testing

•Determine if assets and liabilities are properly matched

•Determine if borrowing is needed

•Enable readjustment of invested assets

•Show true cost of payment of liabilities

1616




Value Added by the Reserving ActuaryReinsurance Issues

Model Construction and Data Needed

to Analyze a Reinsurance Treaty

•Copy of the treaty

•Clear understanding of treaty terms

•Subject premium, ceded premium

•Projected total and ceded losses

•Understanding of cash flows, inner aggregates, etc. under the treaty

Reinsurance Issues

Model Construction and Data Needed

to Analyze a Reinsurance Treaty

•Copy of the treaty

•Clear understanding of treaty terms

•Subject premium, ceded premium

•Projected total and ceded losses

•Understanding of cash flows, inner aggregates, etc. under the treaty

1717





Modeling Expected Cash Flows Under Reinsurance Treaty

Reinsurance Issues

Modeling Expected Cash Flows Under Reinsurance Treaty

•Need to generate number of paid claims by year

•For each claim, generate a “loss” based on historic severities

•Pay out loss according to assumed pattern

•Sum (and limit, if necessary) all losses for each year

•Rank yearly results to compute confidence intervals

•Need to generate number of paid claims by year

•For each claim, generate a “loss” based on historic severities

•Pay out loss according to assumed pattern

•Sum (and limit, if necessary) all losses for each year

•Rank yearly results to compute confidence intervals

1818





Reinsurance Risk Transfer Analysis

•Compute discounted value of cash inflows and outflows

•Treaty must provide for significant probability of significant loss to reinsurer (amounts not specified)

•If contract does not meet required criteria, actuary should discuss with management whether proposal should be accepted

Reinsurance Issues

Reinsurance Risk Transfer Analysis

•Compute discounted value of cash inflows and outflows

•Treaty must provide for significant probability of significant loss to reinsurer (amounts not specified)

•If contract does not meet required criteria, actuary should discuss with management whether proposal should be accepted

1919





Expected PV of Cash Flows Under Reinsurance Treaty ($000)

Reinsurance Issues

Expected PV of Cash Flows Under Reinsurance Treaty ($000)

Year PV Amount1 4,7002 (1,800)3 (1,300)

4-end (1,300)Total Cash Flows 300Premium Ceded 5,000Net Cost of Reins 6.0% 2020





Net Cost of Reinsurance

•Difference between ceded premium and ultimate ceded loss (and LAE, if applicable) on a present value basis, divided by premiums ceded

•Ceded losses may be estimated directly or as difference of gross and net

•Actuary can show management if ceding certain losses is profitable or is accomplished at relatively low cost. If not, management may want to commute the treaty.

Reinsurance Issues

Net Cost of Reinsurance

•Difference between ceded premium and ultimate ceded loss (and LAE, if applicable) on a present value basis, divided by premiums ceded

•Ceded losses may be estimated directly or as difference of gross and net

•Actuary can show management if ceding certain losses is profitable or is accomplished at relatively low cost. If not, management may want to commute the treaty.

2121



Reinsurance Issues



Reinsurance Issues

Treaty

Prob. of

Reins Loss

Loss to Reinsurer

Proj. Net Cost

of Reins.

A 10% 5% 3.0%

B 10% 15% 3.0%

C 10% 20% 4.5%

D 10% 25% 7.0%

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Reinsurance Issues-Recoverability

•Determine Best’s rating of company’s reinsurers

•Discuss collectibility problems with management

•May need to perform additional investigation if any reinsurers are in financial difficulty and may not be able to meet obligations

Reinsurance Issues-Recoverability

•Determine Best’s rating of company’s reinsurers

•Discuss collectibility problems with management

•May need to perform additional investigation if any reinsurers are in financial difficulty and may not be able to meet obligations

2323

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