1. Considerations in Evaluating Reserves
Intermediate Track I
Considerations in Evaluating Reserves
2001 CLRS
New Orleans, Louisiana

2. Introduction
Purpose: Discuss a number of topics or concepts that are important beyond the rote application of simple techniques to reserving data
Intermediate Tracks II through IV will provide additional insights and techniques useful in addressing several of these issues

3. Considerations Timing Loss adjustment expense Operations
Limits and deductibles
Extrapolation/Interpolation
Model diagnostics

4. Considerations Timing Loss adjustment expense Operations
1. Average Closed Value is not the same as Average Open Value
2. Closed Savings are not the same as Open Redundancy
3. Early Reported Claims are not the same as Late Reported Claims
Loss adjustment expense
Operations
Limits and deductibles
Tail factors
Model diagnostics

5. Consideration #1
The average value of claims currently closed is often a poor estimator of the ultimate average settlement value of claims still open.

6. Consideration #1 (cont.)
Accident Year 1986
Why might this frequently be true?

7. Consideration #1 (cont.)
Claims that close early are often smaller
For example in Workers Compensation:
The cases that close quickly are for minor injuries, and may involve just medical-only costs.
The cases open for a long period represent severe injuries and may include:
Major Medical Expenses
Lifetime Pension Benefits

8. Consideration#2
Savings on closed claims may be a poor estimator of case reserve adequacy for open cases.

9. Consideration #2 (cont.)
Examples include:
Often cases that are more adequately reserved settle more quickly (a closer “meeting of the minds”)
Back injuries for Workers Compensation
Changes in Case Reserves Before Settlement
An adjuster may review 20 back cases. Those who return to work earlier than expected close for “Savings”. Others may later be classified as permanently disabled, at a much higher cost than initially expected and not closed for decades.
It is not unusual for an estimate of an individual case reserve to be strengthened just prior to closing, and then show “savings”. This may/may not reveal anything about case reserves further from settlement. Therefore, a comparison of settlement costs to the corresponding prior case reserves just before closing can be a very misleading comparison.

10. Consideration #3
The average costs for late reported claims may differ materially from those reported earlier.

11. Consideration #3 (cont.)
Reason: Often, late reported claims have a very different nature than those reported early.
(1) General Liability:
Product Liability cases are often reported later
Product cases are often more complex, requiring expert testimony and lengthy litigation
Product cases reported very late may involve latent injury or cumulative exposure, cases which are difficult to define in terms of date of loss, party at fault, number of occurrences, and type or extent of injuries

12. Consideration #3 (cont.)
(2) Workers Compensation:
Most Workers Compensation cases are reported within the first 18 months. However, when there are late reported claims they often involve occupational diseases, rather than trauma that is quickly identified and assignable to a single accident date and/or policy.

13. Considerations Timing Loss adjustment expense Operations
4. The ratio of Paid Allocated Loss Expense (ALAE) to Paid Loss increases over time
5. Segregate ALAE into Components
Operations
Limits and deductibles
Interpolation/extrapolation
Model diagnostics

14. Consideration #4
For an accident year, the future ratio of ALAE to loss may be materially higher than has been true for payments to date.

15. Consideration #4 (cont.)
Reasons:
1) Cases open for lengthy periods often involve costly litigation.
2) Legal payments are occasionally disbursed later than loss payments.

16. Consideration #4 (cont.)

17. Consideration #4 (cont.)
This pattern by company can be influenced by many factors, such as the mode of payment of legal bills, which may vary by company between:
Interim Case Billing
End of Case Billing
Other influences can include:
Geographical Differences
Use of Staff Counsel vs. Outside Counsel
Classes of Business
Primary vs. Excess Contracts

18. Consideration #5
Where ALAE costs are rising, it may be useful to split ALAE into components such as:
Outside Attorney Fees
In-House Attorneys
Other Legal
Expert Witnesses
Medical Audits/Reviews

19. Consideration #5 (cont.)
Reasons:
(1) Legal expense are typically the fastest growing component of ALAE, with a growth rate exceeding trends in loss costs.
(2) Many companies have attempted cost savings steps such as:
Use of staff counsel, rather than independent attorneys, in some situations
Use of companies which audit legal bills
More vigorous defense (which may slow payment patterns on loss side)
Initiating contact with the claimant sooner

20. Consideration #5 (cont.)
The recent change in the definition of ALAE and ULAE may result in distortions in ALAE development. This recent definition re-defined ALAE to include expenses associated with defense, litigation or medical cost containment expenses, whether internal or external.

21. Considerations Timing Loss adjustment expense Operations
6. Rate adequacy can impact reserving
7. Positive Development does not mean a Claim Department problem
8. Operational changes affect reserving
Limits and deductibles
Interpolation/extrapolation
Model diagnostics

22. Consideration #6
Loss ratios based on prior years’ experience, used in reserving, must be adjusted for any material changes in rate adequacy.
Rate adequacy often changes over time for reasons including:
Industry pricing cycles
Internal company initiatives
Growth strategies etc.

23. Consideration #6 (cont.)

24. Consideration #7
Upward case development does not necessarily demonstrate something “needs fixing” in the Claims Department.

25. Consideration #7 (cont.)
To illustrate, assume:
The company’s reserving philosophy is to set the best estimate of ultimate cost given solely the facts at the time.
For an accident year, there are 100 back injury cases (Workers Compensation)
At 24 months, all injuries appear similar given medical evaluations (etc.) at that time.
However, the Claim Department accurately estimates 97 of the 100 at 24 months, but as facts emerge over the ensuing years, 3 workers are determined to be permanently disabled.

26. Consideration #8
Internal company changes can dramatically affect patterns in reserving data, and distort the result of basic reserving methodologies.
Examples of Such Changes:
Mix: Until 2 years ago, the company’s workers compensation book primarily covered flower shops. It now contains significant exposures for general contractors.
Likely implications: The more recent accident years will involve more serious injuries and longer future development
Growth: The company is expanding, with an increasing percent of the book being new business. This new business may come with higher loss ratios and may have an uneven distribution of writings throughout the year.
Claims Management:
A new computer system is implemented, speeding up the recording of claims and payments
A new case reserving form is developed to help claim technicians more readily consider all costs.
A change in TPA (third party claims adjuster)

27. Consideration #8 (cont.)
For example, suppose the company changed TPA’s 12 months ago, and now has the following triangles:

28. Consideration #8 (cont.)
Paid to Reported Ratios are an example of a diagnostic tool which can be used to check for:
Case reserve strengthening (this example)
Case reserve weakening
Change in rate of payment
Later sessions will discuss methods, such as the Berquist & Sherman approach to correct for these kinds of changes.

29. Considerations Timing Loss adjustment expense Operations
Limits and deductibles
9. Higher limits mean more future development
10. Higher attachment points mean more future development
Interpolation/extrapolation
Model diagnostics

30. Consideration #9
When reinsurance retentions and/or policy limits increase, the portion of ultimate losses that are reported at each given maturity tends to decrease.

31. Consideration #9 (cont.)

32. Consideration #10
When attachment points increase for reinsurance, excess, umbrella or self-insured coverages, then the percentage of ultimate dollars that is reported at each given maturity tends to decrease.

33. Consideration #10 (cont.)

34. Considerations Timing Loss adjustment expense Operations
Limits and deductibles
Interpolation/extrapolation
11. Incomplete accident years can be deceiving
12. Tail development is important
Model diagnostics

35. Consideration #11
Estimating ultimate losses for an incomplete accident year requires special adjustments.

36. Consideration #11 (cont.)
Factors to consider in estimating ultimate losses for an incomplete accident year:
Loss development may not be even throughout the accident year:
Seasonality in accident dates, reporting patterns, or settlement patterns
Exposure changes during the year
When the traditional loss development method is applied to accident year data, ultimate losses are projected for the entire accident year, even if losses are evaluated at an interim date

37. Consideration #11 (cont.)

38. Consideration #12
“Tail Development” can have a dramatic effect on reserve needs.
Industry WC Schedule P
Illustration of Leverage
Ultimate incurred loss and ALAE for accident years 1990 through 1999 = $206.8 Billion
If tail factor for these years is short by 1%, the additional reserve ($2.068 billion) will increase the IBNR from $24.0 billion to $26.0 billion, an increase of 8.6%.

39. Consideration #12 (cont.)
Some examples of when development occurs beyond 10 years
Products
Workers
Compensation
Medical
Malpractice
Complex issues (Who’s liable? How to prove injury was caused by product? Date of loss?)
Occupational Disease
Life pension cases, with escalation clauses in some states’ benefit structures
Medical costs on life pension cases
Child injured at delivery reaches legal age
Delayed manifestation, with subsequent complex issues

40. Consideration #12 (cont.)
Techniques To Derive Tail Factors
1. Examine broader data sources
e.g. ISO, NCCI, RAA, AM Best
(Caution: Learn the limitations of such data)
2. Curve Fitting
3. Generalized Bondy Method

41. Consideration #12 (cont.) - Broader Data Sources

42. Consideration #12 (cont.) - Example

43. Consideration #12 (cont.) -- Curve Fitting
There are numerous types of curves which are typically used to project tail factors.
One of the common ones is the POWER MODEL:
y = a b X
where: Y = Loss Development Factor
X variable = Time (in months)
a, b are constants
a and b can be estimated using linear regression techniques by taking the logs of each side of the equation twice.

44. Consideration #12 (cont.)
y = a b X
a = 2,003.6
b =

45. Consideration #12 (cont.) -- Bondy Method

46. Considerations Timing Loss adjustment expense Operations
Limits and deductibles
Tail factors
Model diagnostics

47. Consideration #13
Reserving models are just that -- models. As such, modeling assumptions should be identified and the assumptions should be tested.
Industry WC Schedule P
Illustration of Leverage
Ultimate incurred loss and ALAE for accident years 1990 through 1999 = $206.8 Billion
If tail factor for these years is short by 1%, the additional reserve ($2.068 billion) will increase the IBNR from $24.0 billion to $26.0 billion, an increase of 8.6%.

48. Consideration #13 (cont.)
For example the typical development factor model:
Cumulativet = bCumulativet-1
This is a regression through the origin. We can test if the intercept of this regression is zero, e.g.:

49. Consideration #13 (cont.)
Industry Total GL, Source: Best’s Schedule P

50. Conclusions
It is seldom sufficient to simply manipulate the numbers. The actuary must actively seek a thorough understanding of...
...the loss and claims process
...the business and the exposures involved
underwriting
pricing
reinsurance
…techniques and models to deal with the available data