2002 Casualty Loss Reserve Seminar Surety Reserving

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2002 Casualty Loss Reserve SeminarSurety
Reserving

• Mike Rozema, ACAS, MAAA
• KPMG LLP

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Overview

• Reserving Considerations
• One Loss Reserve Estimation Approach
• Premium Deficiency Reserves
• Considerations
• Use of Bond Default Rates to estimate future
  losses

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Reserve Estimate Approach

• Gather data
• Understand large claim potential
• Assign probabilities and scenarios to claims with
  high bond limits
• Estimate gross reserves for all other losses
• Estimate ceded reserves
• Simulation

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Step 1 Gather Data

• Bond limits profile
• Large claim information
• Type of business mix
• Reinsurance program

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Step 2 - Understand the potentially large claims

• Review all open claims with significant exposure
• One principal, many bonds
• Review claims files
• Read the contracts
• Do not ignore losses with low case reserves

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Step 3 - Assign probabilities and scenarios to
potentially large losses

• Interview Claims Personnel
• What would you settle these claims for?
• What is our maximum exposure?
• What is the claims handling strategy?
• What is the subrogation potential?
• What is the expected payment pattern?
• Low, Medium, High, and Other Scenarios
• Assign Probabilities and Severities

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Step 4 Estimate reserves for all other losses

• Use traditional actuarial techniques
• Development methods
• Bornhuetter-Ferguson
• Frequency/Severity
• Development patterns affected by bond type
• Expense
• Subrogation
• Statute (Workers Comp Self-insured Bonds)

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Actuarial SOP No. 36

• Explanatory paragraph required when actuary
  believes that there are risks and uncertainties
  that could result in material adverse deviation.
• Identify the amount judged to be material
• Describe the major factors and particular
  conditions underlying the risks and uncertainties
• Expected value estimate is better than the median
  or mode when expected value estimates can be
  significantly greater than other measures.

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An Example
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Step 5 Reinsurance

• Surety Treaty Provisions
• Surety reinsurance is unique, usually separate
  from other lines of business
• Facultative Reinsurance
• Estimate ceded losses for each large loss and for
  all other claims for each scenario.

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Step 6 Simulation

• Simulate Gross Losses
• Use Large Loss Scenario Probabilities
• Use triangle techniques to estimate aggregate
  reserve distribution for all other claims
• Consider correlation between large loss scenarios
  and other reserves
• Estimated Ceded Losses for each Simulation Result

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Simulation Results

• Net and Gross Aggregate Loss Distributions are
  helpful
• Range of reasonable estimates
• Identifying and quantifying risk of material
  adverse deviation
• Effectively communicating risk to management
• Quantifying reasonable risk loads by bond type

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Premium Deficiency Reserves

• SSAP No. 53 Property Casualty Contracts -
  Premiums
• When anticipated losses, loss adjustment
  expenses, commissions, and other acquisition
  costs exceed the recorded UPR, a premium
  deficiency reserve is required.
• Insurance policies shall be grouped in a manner
  consistent with how policies are marketed,
  serviced, and measured.

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Premium Deficiency Reserves

• Considerations
• Surety is generally marketed on its own and
  therefore should be segmented for PDR estimate
• Non-cancelable contracts
• Multiple year contracts understand how premium
  is earned
• Restrictive reinsurance market
• Regulatory constraints to premium increases
• Recession increases frequency

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Premium Deficiency Reserves Loss and ALAE
estimates

• Group principals homogeneously
• Bond Type (e.g. Commercial, Contract)
• Bond Limit
• Financial Strength
• Use rating agency corporate bond default rates to
  estimate claim frequency
• Use historical data to estimate claim severity as
  a percentage of bond limit

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PDR Loss Estimate - Example
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Summary

• Understand Bond Mix, Limits Profile and
  Reinsurance Provisions
• Large Exposures need detailed analysis
• Scenario/simulation approach is useful
• Market/economic conditions may result in premium
  deficiencies