Milliman SOP 97-3 and Other Balance Sheet Reserves CLRS 2004 Las Vegas, Nevada September 13, 2004 Claus S. Metzner, FSA, FCAS, MAAA, Aktuar – SAV Actuary, Milliman, Inc.

Milliman 1 Other Balance Sheet Reserves  Reserves  Premium Revenue Recognition Reserve  Retro Rated Premium Reserve  Reserves for Contingent Commissions  Premium Deficiency Reserves  Policyholder Dividend Reserves  Will be discussing these reserves/assets from the insurer perspective and the insured perspective  “Impacts” if Reserve not Set Appropriately  Remember  Materiality is, as always, a consideration  Consider “consistency” between loss reserving assumptions and assumptions underlying “Other” reserves

Milliman 2 Other Balance Sheet Reserves Premium Revenue Recognition Reserve Arises from delays in premium reporting –Estimated premium is higher/lower than final premium since exposures (payroll, sales) initially estimated Impacts: Insurer –Mismatch of revenue/expense »B-F loss ratio implications »Combined Ratio too low/high –Balance Sheet – Asset (general situation) is missing »Capital understated due to missing asset Impacts: Insured –Mismatch of revenue/expense –Balance sheet – liability (general situation) is missing »Capital overstated

Milliman 3 Other Balance Sheet Reserves Retro Rated Premium Reserve Arises from loss reporting/loss settlement pattern –Interim adjustments lead to premium recorded to date that is higher/lower than final contractual premium since losses are not yet fully settled Impacts: Insurer –Mismatch of revenue/expense »B-F loss ratio implications »Combined Ratio too low/too high Impacts: Insured –Mismatch of revenue/expense –Balance sheet – liability is missing

Milliman 4 Other Balance Sheet Reserves Contingent Commission Reserve Arises from Agency contracts –May be based on “revenue” targets –May be based on “profit” targets –May be a combination of various targets Impacts: Insurer –Mismatch of revenue/expense »Combined Ratio too low/too high »Capital misstated (note: specific contract terms should be reviewed and the contingent commission program could be modeled in relation to the underlying loss ratio performance) Impacts: Agency –Mismatch of revenue/expense –Capital misstated

Milliman 5 Other Balance Sheet Reserves Premium Deficiency Reserve Projection of Loss arising from obligations entered into but where premium has not yet been earned –Considerations »By Line? »By Business Unit? »By Company? –Source of Data »Calendar/Accident Year »Policy Year Impacts: Insurer –Capital misstated (note: loss ratio performance, adjusted for the premium revenue recognition reserve, is critical; a good paper on this evaluation, is Ralph Blanchard’s article in the 2000 Fall CAS Forum)

Milliman 6 Other Balance Sheet Reserves Dividend to Policyholder Reserve Need to consider the impact of –Premium Revenue Recognition Reserve –Reflection in Variable Dividends of Loss Ratio changes due to »Premium Revenue Recognition Reserve »“knowledge” gained from Premium Deficiency Reserve evaluation Impacts: Insurer –Capital misstated

Milliman 7 Other Balance Sheet Reserves  Summary  Other Balance Sheet Reserves are important To the Insurer and to the Insured May need to be considered within the scope SOP 97-3 for non-insurers (materiality?)  Other Balance Sheet Reserves are probably impacted by Loss and Loss Adjustment Reserve Evaluations – need to assure consistency