Casualty Loss Reserve Seminar Loss Portfolio Transfers Presented September 18, 2000 by: Gustave A. Krause, Arthur Andersen LLP. Charles Woodman, Marsh, Inc. Bruce S. Zaccanti, Arthur Andersen LLP.

Loss Portfolio Transfers What is a Loss Portfolio Transfer (LPT): –For Many reasons an organization my have a large volume, (Portfolio) of claims/losses that have become an administrative or financial impediment for an organization. In order to try and maximize resources and reduce incurred balance sheet expenses, outstanding letters of credit, and/or cost of credit, the seller of a portfolio of losses/claims, seeks a buyer to assume the financial and administrative responsibility for the losses via a commutation or novation of the entire or significant portion of the loss portfolio.

Loss Portfolio Transfers Issues for the Seller of the Portfolio to consider: –Claim Reserving/Administration: Is the population of claim reserves accurately reserved to reflect the true ultimate exposure to the potential buyer ? In order to facilitate the study of the adequacy of each loss require the current claim administrator or insurance carrier to “Top Sheet” each loss with enough information to allow the buyer to quickly evaluate each item of the loss details. Specific items to be included in the Top Sheet should include: Date of Loss Date of Loss Report to TPA/Carrier Jurisdiction of Loss Details Description of Loss, including medical background and legal activity Potential Subrogation or Second Injury Fund Recoveries Strategy for Claim Management, including time frames for resolution Does the selling organization have a large enough staff of in-house people that could be negotiated into the agreement the buyer in order to ensure transfer of intellectual claim capital with the loss/claim population?

Loss Portfolio Transfers Finance Agreements: –What are the terms of the claim administration cost. Cradle to Grave, Life of Claim, or Two year, then time and expense? Risk Management Information Systems: –Is the current carrier capable of quickly transmitting all of the loss file and financial details from the current resident system to the buyers system? –Are the files in electronic (Paperless Format) or are they hard copy? Reinsurance Agreements : –Are the terms of the reinsurance agreement allowable or flexible enough that the buyer and seller can easily allow for the transfer of large loss payment to the buyer and will the coverage be impacted positively or negatively to either party as a result of the sale of the portfolio. Additionally, can an cut-through agreement be set-up to allow immediate cashflow from the reinsurer to the buyer ? Claim Administration Finance Agreement: –Will the seller of the claims be able to recover monies deposited in escrow accounts as soon as the loss portfolio occurs and is interest still payable during the time of transition? –Will the claim administrator or insurance carrier charge any addition fee for managing the losses while the portfolio transfer is in process?

Loss Portfolio Transfers Tax and Finance Administration: –Once the loss portfolio transfer occurs from the Seller to the Buyer how quickly can the letter of credit be returned to the selling organization? –What financial tax implications occur for the organization and is there a specific time that the Seller should consider this transaction due to the reduction of reserve expense (if recorded) and the realization of cash which now may be tax?

Loss Portfolio Transfers Actuarial Analysis: –Has the Seller a cashflow analysis of the portfolio for sale? Specific items for consideration might included: Loss Development Factors Changes in Claim Counts (Re-Opened Losses) Timing of Subrogation or Second Injury Fund Recoveries Actual versus estimate recoveries on Subrogation and Second Injury Fund claims Interest factor used to evaluate the cashflow discounts Variation in Loss Reserves (Aggregate and Large Individual Cases) Litigation or potential settlements of large blocks of losses in a short time period Increases or decreases in reported claims.

Loss Portfolio Transfers Issues for the Buyer of the Portfolio to consider: –Claim Reserving/Administration: Is the organization purchasing the portfolio of losses familiar with the line or lines of business being purchased and will the increased claim load require additional staff or cost to administer? Are the claim experts who reviewed the Top-Sheets and claim details comfortable that the loss details, action plans and case reserves accurately reflect the exposure of the losses? (Specifically, subrogation and second injury fund recoveries?) What pricing options is the seller of the portfolio likely to consider? Remember they want to exit entirely from this population of losses! (Offering and pricing Life of Claim is best)! Are the “Top Sheets” for each loss within the portfolio under consideration documented with enough accurate information to allow the buyer’s claim administration experts, underwriters and actuaries to assess the aggregate and individual loss details.

Loss Portfolio Transfers –Again, specific items to be included in the Top Sheet should include: Date of Loss Date of Loss Report to TPA/Carrier Jurisdiction of Loss Details Description of Loss, including medical background and legal activity Potential Subrogation or Second Injury Fund Recoveries Strategy for Claim Management, including time frames for resolution

Loss Portfolio Transfers Finance Agreements: –Are the are the terms of the claim administration and loss portfolio (insurance, captive, self- insurance, etc..) agreements flexible or cost efficient to allow the buyer to integrate or incorporate the new portfolio into a new or existing plan. Some consideration to contemplate should include; Tax Implications? Letter of Credit? Cost of Credit? Claim Administration Fees? Risk Management Information System Fees & Storage costs? Impact of cash payment to current surplus, equity, share price, etc... Risk Management Information Systems: –Is the Buyers system(s) capable of quickly accepting and incorporating the functionality required of the claim administrators, underwriters, and accounts? –Again, if the files in an electronic format can the Buyers system handle the storage capacity and operational flexibility required with all pertinent loss details for administration without losing timing for potential subrogation or second-injury fund recoveries.

Loss Portfolio Transfers Reinsurance Agreements : –Again, are the terms of the reinsurance agreement allowable or flexible enough that the buyer and seller can easily allow for the transfer of large loss payment to the buyer and will the coverage be impacted positively or negatively to either party as a result of the sale of the portfolio? Claim Administration Finance Agreement: –We suggest that several options be presented to the seller of the claims in order to allow them to transfer the loss portfolio as easily and economically as possible for both parties, however, the, most common terms sought from a seller to a buyer is life of the claim. Life of the claim charges allow the buyer and seller certainty in the negotiation and final sale of the entire portfolio of claims.

Loss Portfolio Transfers Tax and Finance Administration: –Once the loss portfolio transfer occurs from the to the buyer to the seller how quickly will the buyer, if at all be required to adjust it current credit of collateral position? What is the financial impact of these transactions to other strategic objectives or activities planned for the organization?” –Again, what financial and/or tax implications occur for the organization and is there a specific time that the buyer should consider this transaction due to the potential increase of incurred expense and the disbursement of cash which may impact surplus or operations goals and objectives?

Loss Portfolio Transfers Actuarial Analysis: –Has the buyer requested enough loss detail and claim history and cashflow detail to perform an analysis of the portfolio for sale on a standalone and combined book of business basis? Again, some specific items for consideration might included: Loss Development Factors Changes in Claim Counts (Re-Opened Losses) Timing of Subrogation or Second Injury Fund Recoveries Actual versus estimate recoveries on Subrogation and Second Injury Fund claims Interest factor used to evaluate the cashflow discounts Variation in Loss Reserves (Aggregate and Large Individual Cases) Litigation or potential settlements of large blocks of losses in a short time period Increases or decreases in reported claims.

Loss Portfolio Transfers What Does the actuary do?

Loss Portfolio Transfers What Does the actuary do? –Estimate Needed Reserves

Loss Portfolio Transfers What Does the actuary do? –Estimate Needed Reserves –Estimate Payment Cash Flows

Loss Portfolio Transfers What Does the actuary do? –Estimate Needed Reserves –Estimate Payment Cash Flows –Estimate Present Values

Loss Portfolio Transfers What Can/Should the actuary do?

Loss Portfolio Transfers What Can/Should the actuary do? –Assist in the Negotiation

Loss Portfolio Transfers What Can/Should the actuary do? –Assist in the Negotiation –Help Commute Reinsurance

Loss Portfolio Transfers What Can/Should the actuary do? –Assist in the Negotiation –Help Commute Reinsurance –Test Scenarios to Quantify Risk

Loss Portfolio Transfers What Can/Should the actuary do? –Assist in the Negotiation –Help Commute Reinsurance –Test Scenarios to Quantify Risk –Review Contract Wording