2006 Casualty Loss Reserve SeminarSeptember 12, 2006

Understanding Collateral Requirements in Relation to Self-

Insurance

Introduction

• Why collateral is required

• How collateral is determined

• Collateral stacking – what and why

• How insurance program structure affects operations

and collateral

• Types of collateral

• Other Key considerations before selecting the

insurance program structure and collateral

• Questions

Why Collateral?

• Credit Risk for Insurer

• Statutory Requirements

• Rating Agency Considerations

Who Best to Take Credit Risk?

• Casualty Insurer?

• Bank?

How Collateral Requirement Determined?

For Financial Reporting Year (Balance Sheet)

• Estimate of Ultimate Loss – Paid to Date

What Impacts This Calculation?

• Actual Loss Results to Date

• Loss Development Methodology

• Development Factors Used

How Collateral Requirement Determined?

For Budget Year (Fiscal Plan)

• Loss Forecast

What Impacts This Calculation?

• Historical Loss Experience

• Loss Forecast Methodology

• Development Factors Used

Collateral Stacking

• What is collateral “stacking”?

- Collateral stacking is the accumulation of

required collateral across multiple effective

periods.

• Why is collateral “stacked”?

- Paid loss emergence patterns

- Accrued loss emergence and “IBNR” losses

Collateral Stacking (cont.)

• Example 1 – No growth and no inflation scenario

• Example 2 – No growth and 4% inflation scenario

• Example 3 – 3% growth and 4% inflation scenario

Collateral Stacking

0

1

2

3

4

5

6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Example #1

No Growth/No InflationYear 10

Year 9

Year 8

Year 7

Year 6

Year 5

Year 4

Year 3

Year 2

Year 1

Collateral Stacking

0

1

2

3

4

5

6

Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Y ear 8 Y ear 9 Y ear 10

Example #1

No Growth/No Inflation

Previous Collateral Additional Collateral

Collateral Stacking

0

1

2

3

4

5

6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Example #2

No Growth/4% InflationYear 10

Year 9

Year 8

Year 7

Year 6

Year 5

Year 4

Year 3

Year 2

Year 1

Collateral Stacking

0

1

2

3

4

5

6

Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Y ear 8 Y ear 9 Y ear 10

Example #2

No Growth/4% Inflation

Previous Collateral Additional Collateral

Collateral Stacking

0

1

2

3

4

5

6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Example #3

3% Growth/4% InflationYear 10

Year 9

Year 8

Year 7

Year 6

Year 5

Year 4

Year 3

Year 2

Year 1

Collateral Stacking

0

1

2

3

4

5

6

Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Y ear 8 Y ear 9 Y ear 10

Example #3

3% Growth/4% Inflation

Previous Collateral Additional Collateral

Collateral Stacking

Comparing the 3 Examples

0

1

2

3

4

5

6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

No Growth/No Inflation No Growth/4% Inflation 3% Growth/4% Inflation

Biggest Impact on Collateral?

Actual Loss Results

Collateral Stacking

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

5% Loss Growth 0% Loss Growth 5% Loss Dec line

Insurance Program Structures Impact

• Common Insurance Program Structures

- Guaranteed cost

- Deductible

- Self-insured retention

- Retrospectively rated contracts

- Captive insurance company

Insurance Program Structures Impact (cont.)

• Balance Sheet and Income Statement Impact

• Working Capital Impact

• Credit Capacity Impact

• Compliance considerations

Insurance Program Structures Impact (cont.)

Guaranteed Cost Deductible

Self-Insured Retention

Inc. Loss

Retro. Captive

Balance Sheet Low High High High High

Income Statement High High High High High

Working Capital (Cash)

High Low Low High High

Working Capital (Credit)

Low High High Low High

Compliance Low Low High Low High

Types of Collateral

• Letter of Credit

• Cash

• Surety Bond

• Trust Account

• Promissory Note

Insurance Program Collateral Impact

Letter of Credit Cash

Surety Bond

Trust Account

Promissory Note

Working Capital (Cash)

Low High Low Low Low

Working Capital (Credit)

High Low Low Low Low

Deductible

Considerations

• Cash Position

• Effective Tax Rate

• Ability to Retain Risk

• Capacity and Cost of Collateral

• Financial Strength

Questions?

Tom Fuller

Liberty Mutual

Sr. Risk Management Consultant

314-843-0600 x214

thomas.fuller@libertymutual.com

Marn Rivelle

KPMG LLP

Senior Manager, Actuarial Services

213-533-3340

marnrivelle@kpmg.com