[PPT] - Balance sheet integrity In focus: the underwriting cycle seminar PowerPoint Presentation

SLIDE 1

Balance sheet integrity

In focus: the underwriting cycle seminar

Casualty Actuarial Society October 5-6, 2009 Daniel Lowen, FCAS, MAAA

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Agenda

► Define balance sheet integrity ► Explain Ernst & Young analysis ► Present analysis results and hindsight look for five

Schedule P lines

► Personal auto liability ► Commercial auto liability ► Commercial multi-peril ► Medical malpractice – claims-made ► Other liability – occurrence

► Present hindsight look only for two more lines

► Workers compensation ► All lines combined

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The auditing actuary’s role in assessing a balance sheet

► Basic steps of our work:

► Review Company actuary’s work, performing independent analysis

wherever it appears necessary

► Establish a range of reasonable liability estimates to see if

Company held lies within range

► Check movement since prior year to check if it is consistent with

loss development in interim

► Check position in our range for consistency with prior year

► Ideally, we serve as a helpful peer review ► Possible problems we look for

► Hiding bad news that will have to emerge eventually ► Managing earnings

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Defining balance sheet integrity — the auditing actuary’s perspective

There are three quantities to consider when assessing the integrity of the reserves (considering each accident year in isolation):

1. Booked loss ratio (known)
2. Company actuary’s estimate of ultimate loss ratio (often unknown or partially known)
3. Our estimate of ultimate loss ratio (known)
4. True ultimate loss ratio (not known for several years)

► True balance sheet integrity is the narrowness of the gap between 1 and 2. ► Auditing actuaries measure the narrowness of the gap between 1 and 3. ► With hindsight, the narrowness of the gap between 1 and 4 can give us some insight

into what the degree of balance sheet integrity might have been at the time.

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Ernst & Young analysis — description

Mechanical procedure for deriving our own ultimate loss estimates, established to minimize judgment bias:

► Development factors selected for paid and reported loss & DCC

triangles

► Ultimates from chain-ladder projections compared to premium to

select IELR for Bornhuetter-Ferguson projections

► Ultimates selected from among projections and liability estimated for

each accident year

► Booked A&O expenses accepted without analysis

(continued)

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Ernst & Young analysis — description

We wanted to compare:

► Our estimates of accident year ultimate loss ratios to booked loss

ratios at 12 months

► Our estimates of year-end liabilities (excluding accident years over

10 years old) to booked

This was possible for loss and LAE net of reinsurance only, as Schedule P does not provide triangles gross of reinsurance.

(continued)

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Ernst & Young analysis — description

► We also looked back at booked ultimate loss

ratios for each accident year, going back to AY 1995

► We did this for loss and LAE net of reinsurance,

gross of reinsurance, and ceded to reinsurance

► Ceded loss ratios fluctuate widely due to

interaction of gross and net, so it was hard to discern a pattern in the charts we developed

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Ernst & Young analysis — selected lines

Criteria for five lines selected:

► 10 years of data in Schedule P ► Perceived consistency across industry (i.e., not

reinsurance lines)

► Developing fast enough to ignore development beyond

120 months Selected lines:

► Personal auto liability ► Commercial auto liability ► Commercial multi-peril ► Medical malpractice — claims-made ► Other liability — occurrence

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Personal auto liability (1) — total liability gap

Industry PAL: over/(under)-estimation of year-end liabilities

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Financial statement year Percent of actuarial liability estimate

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Personal auto liability (2) — AY gap

Industry PAL, accident year net ultimate loss ratios at 12 months

70% 75% 80% 85% 90% 95% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium Industry ULR Actuarial ULR

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Personal auto liability (3) — AY gap

Industry PAL: over/(under)-estimation of accident year ULR at 12 months

2%

0% 2% 4% 6% 8% 10% 12% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium

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Personal auto liability (4) — net hindsight

Industry PAL, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

7%
6%
5%
4%
3%
2%
1%

0% 1% 2% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium

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Personal auto liability (5) — gross hindsight

Industry PAL, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

7%
6%
5%
4%
3%
2%
1%

0% 1% 2% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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Personal auto liability (6) — ceded hindsight

Industry PAL, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

10%
5%

0% 5% 10% 15% 20% 25% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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Commercial auto liability (1) — total liability gap

Industry CAL: over/(under)-estimation of year-end liabilities

20%
15%
10%
5%

0% 5% 10% 15% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Financial statement year Percent of actuarial liability estimate

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Commercial auto liability (2) — AY gap

Industry CAL, accident year net ultimate loss ratios at 12 months

60% 65% 70% 75% 80% 85% 90% 95% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium Industry ULR Actuarial ULR

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Commercial auto liability (3) — AY gap

Industry CAL: over/(under)-estimation of accident year ULR at 12 months

12%
10%
8%
6%
4%
2%

0% 2% 4% 6% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium

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Commercial auto liability (4) — net hindsight

Industry CAL, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

5%

0% 5% 10% 15% 20% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium f

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Commercial auto liability (5) — gross hindsight

Industry CAL, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

10%
5%

0% 5% 10% 15% 20% 25% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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Commercial auto liability (6) — ceded hindsight

Industry CAL, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

10%
5%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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Commercial multi-peril (1) — total liability gap

Industry CMP: over/(under)-estimation of year-end liabilities

20%
15%
10%
5%

0% 5% 10% 15% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Financial statement year Percent of actuarial liability estimate

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Commercial multi-peril (2) — AY gap

Industry CMP, accident year net ultimate loss ratios at 12 months

55% 60% 65% 70% 75% 80% 85% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium Industry ULR Actuarial ULR

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Commercial multi-peril (3) — AY gap

Industry CMP: over/(under)-estimation of accident year ULR at 12 months

8%
6%
4%
2%

0% 2% 4% 6% 8% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium

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Commercial multi-peril (4) — net hindsight

Industry CMP, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

8%
6%
4%
2%

0% 2% 4% 6% 8% 10% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium f

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Commercial multi-peril (5) — gross hindsight

Industry CMP, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

6%
4%
2%

0% 2% 4% 6% 8% 10% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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Commercial multi-peril (6) — ceded hindsight

Industry CMP, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

10%
5%

0% 5% 10% 15% 20% 25% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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Medical malpractice, claims-made (1) — total liability gap

Industry MM-CM: over/(under)-estimation of year-end liabilities

20%
10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Financial statement year Percent of actuarial liability estimate

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Medical malpractice, claims-made (2) — AY gap

Industry MM-CM, accident year net ultimate loss ratios at 12 months

45% 55% 65% 75% 85% 95% 105% 115% 125% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium Industry ULR Actuarial ULR

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Medical malpractice, claims-made (3) — AY gap

Industry MM-CM: over/(under)-estimation of accident year ULR at 12 months

30%
20%
10%

0% 10% 20% 30% 40% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium

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Medical malpractice, claims-made (4) — net hindsight

Industry MM-CM, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

30%
20%
10%

0% 10% 20% 30% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium f

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Medical malpractice, claims-made (5) — gross hindsight

Industry MM-CM, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

30%
20%
10%

0% 10% 20% 30% 40% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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Medical malpractice, claims-made (6) — ceded hindsight

Industry MM-CM, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

30%
20%
10%

0% 10% 20% 30% 40% 50% 60% 70% 80% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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Other liability, occurrence (1) — total liability gap

Industry OL-Occ: over/(under)-estimation of year-end liabilities

20%
15%
10%
5%

0% 5% 10% 15% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Financial statement year Percent of actuarial liability estimate

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Other liability, occurrence (2) — AY gap

Industry OL-Occ, accident year net ultimate loss ratios at 12 months

55% 60% 65% 70% 75% 80% 85% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium Industry ULR Actuarial ULR

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Other liability, occurrence (3) — AY gap

Industry OL-Occ: over/(under)-estimation of accident year ULR at 12 months

8%
6%
4%
2%

0% 2% 4% 6% 8% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium

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Other liability, occurrence (4) — net hindsight

Industry OL-Occ, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

8%
6%
4%
2%

0% 2% 4% 6% 8% 10% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium f

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Other liability, occurrence (5) — gross hindsight

Industry OL- Occ, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

6%
4%
2%

0% 2% 4% 6% 8% 10% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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Other liability, occurrence (6) — ceded hindsight

Industry OL- Occ, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

10%
5%

0% 5% 10% 15% 20% 25% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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Workers compensation (1) — AY ULR development from 12 months

Industry WC, accident year net ultimate loss ratios at 12 months

60% 70% 80% 90% 100% 110% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium 12 months 120 months or latest

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Workers compensation (2) — net hindsight

Industry WC, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

25%
20%
15%
10%
5%

0% 5% 10% 15% 20% 25% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium f

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Workers compensation (3) — gross hindsight

Industry WC, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

30%
20%
10%

0% 10% 20% 30% 40% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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Workers compensation (4) — ceded hindsight

Industry WC, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

30%
20%
10%

0% 10% 20% 30% 40% 50% 60% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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All lines (1) — AY ULR development from 12 months

Industry summary, accident year net ultimate loss ratios at 12 months

60% 65% 70% 75% 80% 85% 90% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Accident year Percent of net premium 12 months 120 months or latest

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All lines (2) — net hindsight

Industry summary, deviation from booked net ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

8%
6%
4%
2%

0% 2% 4% 6% 8% 10% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of net premium

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All lines (3) — gross hindsight

Industry summary, deviation from booked gross ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

8%
6%
4%
2%

0% 2% 4% 6% 8% 10% 12% 14% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of direct and assumed premium

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All lines (4) — ceded hindsight

Industry summary, deviation from booked ceded ULR at 12 months

AY1995 AY1996 AY1997 AY1998 AY1999 AY2000 AY2001 AY2002 AY2003 AY2004 AY2005 AY2006 AY2007

10%
5%

0% 5% 10% 15% 20% 25% 30% 12 24 36 48 60 72 84 96 108 120 Maturity in months Percent of ceded premium

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Summary

The industry in the aggregate reserved inadequately when prices were known to be low, and conversely, over-reserved when prices were high. A mechanical liability estimation approach usually came closer to the later-known ultimate loss ratios than the booked loss ratios (compare slides 1 & 3 for each line).