CASUALTY LOSSRESERVE SEMINAR

HOW A.M. BEST EVALUATES RESERVE ADEQUACY

Matthew C. MosherManaging ActuarySeptember 28, 1998

1998 Meeting

DISCUSSION OUTLINE

Purpose

Sources of Information

Methods Used

Determining Ultimates

Discount Calculation

PURPOSE OF RESERVE ADEQUACY

Capitalization - Key to Solvency

Allocation of Capital

Determine True Profitability

INFORMATION SOURCES

Statutory Annual Statement

Actuarial Work Papers

Supplemental Rating Questionnaire

INTERNAL RESERVE MODELOVERVIEW

Three Paid Loss Development Based Methods

Three Incurred Loss Development Based Methods

LDF’s by Line

Dollar Weighted Age-to-Ultimate LDF’s

Fixed Loss Ratio Override

Credibility Weighted By-Line

INTERNAL RESERVE MODELLAYOUT

By Line, By Accident YearAdequacy Projection of Each MethodCredibility Weighted AdequacyCarried ReservesLoss & ALAE Ratios

By Line EquityNet Carried Loss & LAE ReservesStatutory DiscountEstimated DeficiencyCalculated DiscountLoss Reserve Equity

INTERNAL RESERVE MODELMETHODS

Company-BasedPaid LD - Based on Previous AY ProjectionsPaid LD - Based on Previous AY Sch P, Part 2Incurred LD - Based on Previous AY ProjectionsIncurred LD - Based on Previous AY Sch P, Part 2

Industry-BasedPaid Loss DevelopmentIncurred Loss Development

METHOD 2 - COMPANYPAID LOSS DEVELOPMENT

Prior Years and AY 1988 Part 2 Incurred equals ultimate

AY 1989AY89 Ult. = AY89 Pd@108 x AY88 Pt2

AY88 Pd@108

AY 1997AY97 Ult. = AY97 Pd@12 x AY94, AY95, AY96 Pt2

AY94, AY95, AY96 Pd@12

METHOD 4 - COMPANYINCURRED LOSS DEVELOPMENT

Prior Years and AY 1988 Part 2 Incurred equals ultimate

AY 1989AY89 Ult. = AY89 Pd+Cs@108 x AY88 Pt2

AY88 Pd+Cs@108

AY 1997AY97 Ult. = AY97 Pd+Cs@12 x AY94, AY95, AY96 Pt2

AY94, AY95, AY96 Pd+Cs@12

METHOD 1 - COMPANYPAID LOSS DEVELOPMENT

Prior Years

Req. Res. = Carr. Res. x 1 + 3Yr Dev in PY’s 2

PY Carr Res @12/94

AY 1988AY88 Ult. = AY88 Pt3 +

Carr. Res. x 1 + 3Yr Dev in PY’s & AY88 PY & AY88 Carr Res @12/94

METHOD 1 - COMPANYPAID LOSS DEVELOPMENT

AY 1989AY89 Ult. = AY89 Pd@108 x AY88 Proj Ult

AY88 Pd@108

AY 1990AY90 Ult. = AY90 Pd@96 x AY88, AY89 Proj Ult

AY88, AY89 Pd@96

AY 1997AY97 Ult. = AY97 Pd@12 x AY94, AY95, AY96 Proj Ult

AY94, AY95, AY96 Pd@12

METHOD 3 -COMPANYINCURRED LOSS DEVELOPMENT

Prior Years

Req. Res. = Carr. Res. x 1 + 3Yr Dev in PY’s 2

PY Carr Res @12/94

AY 1988AY88 Ult. = AY88 Pt3 +

Carr. Res. x 1 + 3Yr Dev in PY’s & AY88 PY & AY88 Carr Res @12/94

METHOD 3 - COMPANYINCURRED LOSS DEVELOPMENT

AY 1989AY89 Ult. = AY89 Pd+Cs@108 x AY88 Proj Ult

AY88 Pd+Cs@108

AY 1990AY90 Ult. = AY90 Pd+Cs@96 x AY88, AY89 Proj Ult

AY88, AY89 Pd+Cs@96

AY 1997AY97 Ult. = AY97 Pd+Cs@12 x AY94, AY95, AY96 Proj Ult

AY94, AY95, AY96 Pd+Cs@12

METHOD 5 - INDUSTRYINCURRED LOSS DEVELOPMENT

Prior Years Required Reserves= PY Carr. Res. x Industry Tail Factor

AY 1988 Ultimate= AY88 Pt3 + AY88 Carr. Res. x Ind. Tail Factor

AY 1989 Ultimate= AY89 Pt3 x Industry 108-to-Ult. Paid LDF

AY 1997 Ultimate= AY97 Pt3 x Industry 12-to-Ult. Paid LDF

METHOD 6 - INDUSTRYINCURRED LOSS DEVELOPMENT

Prior Years Required Reserves= PY Carr. Res. x Industry Tail Factor

AY 1988 Ultimate= AY88 Pt3 + AY88 Carr. Res. x Ind. Tail Factor

AY 1989 Ultimate= AY89 Pt2 - Pt4 x Industry 108-to-Ult. Incurred LDF

AY 1997 Ultimate= AY97 Pt2 - Pt4 x Industry 12-to-Ult. Incurred LDF

FIXED LOSS RATIO OVERRIDE

Used If LDF > 4.0

AY 1997 Loss Ratio= AY97 Ind. LR x AY95 Co. Ult. LR + AY96 Co. Ult.

LR AY95 Ind. Ult. LR + AY96 Ind. Ult.

LR

AY 1997 Ultimate= AY97 Loss Ratio x 1997 Net Earned Premium

WEIGHTING OF METHODS

Early Years vs. Latest Years

Paid vs. Incurred Methods

Company Credibility Based on Variation in Loss

Development Pattern

CREDIBILITY

Sum the Coefficient of Variance over First Six Development Periods

Compare to Industry Levels

Minimum of 40% Credibility

DISCOUNTING

Calculated By Line of Business

Uses Company Payment Patterns, if Stable

Uses IRS Payment Pattern Calculation

Three Calendar Year Average

Uses a 5% Discount Rate

QUALITATIVE/ QUANTITATIVE REVIEW

QualitativeSchedule P Development PatternAvg. Premium Per Policy vs. AY Loss Ratio

Trends

QuantitativeModel ProjectionPaid to Incurred RatiosReserves to Earned Premium

DISCUSSIONS WITH MANAGEMENT

Actuarial Work Papers

Understand Distortions in Data

Reconcile Differences, if Possible

RATING IMPLICATIONS

Confidence in Reserve Practices

Feeds into Capital Adequacy

Impacts Appraisal of Profitability