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2002 Casualty Loss Reserve Seminar

Surety 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 ExampleGross Ultimate Loss and Expense (000's)

Limit Low Medium High ExpectedLarge 1 $10,000 $500 $2,000 $9,500 $8,675

5% 5% 90%Large 2 $50,000 $5,000 $10,000 $25,000 $11,000

40% 40% 20%Large 3 $75,000 $500 $2,500 $80,000 $4,675

85% 10% 5%All Other NA $5,000 $5,500 $6,000 $5,500

25% 50% 25%TOTAL $11,000 $20,000 $120,500 $29,850

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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

Risk Category

Bond Size Category

Bond Type Category

Exposed Bond Limits

(Millions)Estimated Frequency

Estimated Severity

(% of Bond Limit)

Estimated Losses (000's)

1 1 Contract $100 0.2% 25.0% $502 1 Contract $200 1.0% 35.0% $700

: : : : : : :: : : : : : :: : : : : : :

5 5 Commercial $20 40.0% 90.0% $7,200TOTAL $7,500 $50,000

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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