Closing the Books: Approaches to Determine Carried Reserves

1. Closing the Books Casualty Actuarial Society Loss Reserve Seminar ALLAN R. NEIS, FCAS, MAAA September 11, 2001

2. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 “CLOSING THE BOOKS-- APPROACHES TO DETERMINE CARRIED RESERVES Al Neis, Corporate Actuary- Progressive Insurance Co. Tom Moylan, Vice President & Actuary - Liberty Mutual Ins. Co. Joe Marker, Sr. Vice President & Chief Actuary Pro National Ins. Co.

3. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 Month-End Process Friday Night Premium System Closes Claim System Closes Saturday Morning Month-End Databases Start their update Saturday Evening Feeds to the General Ledger Begin Sunday Afternoon General Ledger Postings are Complete Downstream Databases Start their Updates Sunday Evening Month-End Reports are Produced

4. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 AFTER RESERVE BALANCES ARE POSTED, SOME QUESTIONS WE FACE! • IS THE FINAL BALANCE WHAT YOU EXPECTED? • WILL THE STATE OF OHIO THINK BALANCE IS NOT ENOUGH? • OUTSIDE AUDITORS WILL QUESTION THE ADEQUACY! • IRS THINKS THE BALANCE IS OVERSTATED (10%) • GENERAL MANAGERS - AMOUNT IS TOO HIGH! • WON’T GET A BONUS BECAUSE OF THE INFLATED RESERVES • CANNOT CHARGE COMPETITIVE RATES SINCE THE INCCURRED LOSSES ARE OVERSTATED • ANALYSTS - IS THE COMPANY MANAGING RESULTS? • HIDING PROFITS • INFLATING THE BOTTOM LINE

5. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE RESERVE BALANCES ARE SET PRIMARILY USING • AVERAGE RESERVES (CASE) • FACTORS APPLIED TO HISTORIC EARNED PREMIUM (IBNR)

6. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE CASE RESERVES • AVERAGE RESERVES • VARY BY AGE OF CLAIM • DIFFER BY POLICY LIMIT GROUPS • ADJUSTED MONTHLY FOR EXPECTED INFLATION • ADJUSTER ESTIMATES ARE USED IF GREATER THAN THRESHHOLD • ADJUSTER ESTIMATES ARE INFLATED BY A FACTOR TO COVER CASE DEVELOPMENT IN LAYER ABOVE THRESHOLD (ANCR) • AVERAGE RESERVE ARE ADJUSTER MONTHLY FOR EXPECTED INFLATION

7. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE IBNR • BOOKED TO GENERAL LEDGER FROM THE RESERVE DATABASE • DETERMINED AS % OF EARNED PREMIUM BY AGE • IBNR IS GENERALLY CALCULATED FOR UP TO FOUR YEARS • LAE IBNR IS SET AS A % OF LOSS IBNR

8. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE AVERAGE RESERVES AND IBNR FACTORS MAY VERY BY A COMBINATION OF : • COMPANY • STATE • REGION • PRODUCT (AUTO, MOTORCYCLES, COMMERCIAL VEHICLE, ETC. • COVERAGE (BI, PD, ETC. THE CASE TABLE IN THE CLAIM SYSTEM INCLUDES OVER 120,000 LINES THE IBNR TABLE INCLUDES OVER 80,000 LINES

9. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE ALLOCATION OF RESERVE BALANCES TO PROFIT CENTERS • HAPPENS AS A RESULT OF ROLLING UP THE DETAIL • CASE RESERVES (AVERAGES) ARE AT THE CLAIMANT LEVEL • IBNR IS CALCULATED AT A PREMIUM SUMMARY LEVEL (CO., ST., PRODUCT, LINE COVERAGE)

10. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE RESERVE REVIEWS CONDUCTED ON SEGMENTS THAT SUPPORT INCOME STATEMENT FOR GENERAL MANAGERS LARGE ENOUGH SEGMENTS TO BE CREDIBLE, BUT SEGMENTED TO BE HOMOGENEOUS - THUS TO PROVIDE MORE ACCURACY OVERALL A SEGMENT’S SCOPE ALLOWS PROCESS CHANGES (CLAIMS) WITHIN A REGION/STATE TO BE REFLECTED IN THE INDICATIONS

11. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE RESERVE REVIEWS (CONTINUED) GENERATE • OVERAL NEEDS USING ACCIDENT PERIOD DATA • CASE RESERVE INDICATIONS USING RECORD PERIOD DATA • IBNR INDICATIONS USING ACCIDENT WITHIN RECORD PERIOD DATA • RECONCILE THE DIFFERENT INDICATIONS MULTIPLE SEGMENT RESERVE REVIEWS ALLOW • INPUT TO PRICING ON OVERALL TRENDS • CHANGE IN RESERVES IMPACT ON INCOME STATEMENT ARE DRIVEN BY PROCESSES AND EXPERIENCE WITHIN PROFIT CENTER

12. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE ACTUARIAL REPORT • COMPLETED AFTER YEAR END CLOSE • AT COMPANY LEVEL AND GENERALLY AT THE ANNUAL STATEMENT LINE OF BUSINESS • INCLUDES INDICATION OF NEEDED RESERVES NET OF REINSURANCE • ISSUES MAY ARISE WHEN MORE THAN ONE COMPANY IS WRITING IN A STATE WHICH IS THEIR PRIMARY STATE.

13. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE’S ADVANTAGE PRIMARILY PRIVATE PASSENGER AUTO • CASE RESERVES MAKE UP 80-85% OF LOSS RESERVES • LAE RESERVES ARE APPROXIMATELY 15% OF TOTAL LIABLITY • POLICY LIMITS ARE LOW ENOUGH TO LIMIT DEVELOPMENT IN EXTREME TAIL • COMPARATIVELY HIGH FREQUENCY, LOW SEVERITY ALLOWS EASY ROLL UP TO VARIOUS PROFIT CENTER

14. CASUALTY LOSS RESERVE SEMINARSeptember 11, 2001 PROGRESSIVE • RESERVES ARE OPENLY DISCUSSED AT ALL LEVELS OF MANAGEMENT • REPORTED ON IN THE “ANNUAL REPORT” • “REPORT ON RESERVING PRACTICES” IS AVAILABLE ON WEBSITE “PROGRESSIVE.COM” • RESERVES ARE NOT SET BY MANAGEMENT, THEY ARE SET BY THE CORPORATE ACTUARY

15. Closing the Books Casualty Actuarial Society Loss Reserve Seminar September 11-12, 2001

16. Closing the Books - CLRS 2001 Multiple Companies/Lines Overview I. History - Where were we? II. Objectives - Where do we want to be? III . Process - How do we get there? IV. Questions & Answers

17. Closing the Books - CLRS 2001 Multiple Companies/Lines • History - Regional Agency Markets • Between 1997 and 2000 Liberty created it’s Regional Agency Market (RAM) Strategic Business unit, primarily through acquisitions • RAM currently writes approximately $2 Billion in premium, through seven regional companies using independent agents as the sole distribution channel • The majority of the business is comprised of smaller commercial lines accounts and personal lines • The acquired companies varied in size, scope and sophistication. • Each followed different approaches to closing the books.

18. Closing the Books - CLRS 2001 Multiple Companies/Lines • History - Some Approaches to Booking IBNR • “Put all the data in (commercial reserving package - name deleted) and book what comes out” • “Wait until we get the Actuarial Report and book the indicated” • “Book to our planned loss ratio, review annually” • Book long tail lines to a loss ratio, short tail lines to a factor off of earned premium • Build up current AY IBNR as a factor off earned premium, run-off prior year IBNR based on schedule, allowing prior year case activity better or worse than anticipated to run through income.

19. Closing the Books - CLRS 2001 Multiple Companies/Lines • Objectives - Where do we want to be? • Maintain reserve adequacy in aggregate • Allow for judgement, but don’t fool ourselves • Efficient - five day close • Provide operating entities monthly income statements with minimal distortions • Allocation of IBNR to very fine segments (state/product/legal entity etc.) • Consistency between direct and ceded IBNR

20. Closing the Books - CLRS 2001 Multiple Companies/Lines • Process - How do we get there? • Region/Summary Line • Current Accident Year - Long Tail lines (WC, CMP Liability, Umbrella, Commercial and Personal Auto Liability) - Book both direct and ceded to planned loss ratios (updated quarterly). • Prior Accident Years - Long Tail Lines - Reduce direct IBNR by case activity in primary layer plus scheduled amount in excess (ceded) layer. Reduce ceded IBNR by same scheduled amount. • Short tail lines (CMP Other, Homeowners, Other Property, Commercial and Personal Auto Physical Damage) - IBNR determined by factor off of trailing 12 months earned premium. Case activity allowed to flow through income statement.

21. Closing the Books - CLRS 2001 Multiple Companies/Lines • Process - How do we get there? • State/Product Line/Legal Entity • Total IBNR by Region/Line is then allocated to finer levels of detail • Current Accident Year based on earned premium. • Prior Accident Years based on prior month ending case reserves

22. Closing the Books - CLRS 2001 Multiple Companies/Lines • Process - How do we get there? • Review Process • Quarterly Reserve reviews performed by RAM home office actuarial within six weeks of quarter close, peer reviewed by Liberty corporate. Standard lines, exhibits, methodologies. Specialized approaches where appropriate. • Company Actuaries have two weeks to recommend revised booking ratios for the current accident year. • RAM Actuary & CFO make final selections in time for close of 2nd month after end of quarter.

23. Closing the Books - CLRS 2001 Multiple Companies/Lines • Current AY Review Exhibit

24. Questions & Discussion

25. CLOSING THE BOOKS WITH PARTIAL INFORMATION By Joseph Marker, FCAS, MAAA CLRS, New Orleans, September 2001

26. Closing the Books with Partial information - CLRS 2001 Loss and LAE Reserves The loss and loss expense reserve is the balance sheet item with the most uncertain value. This reserve is studied in great detail at periodic intervals. Often the books are closed with no reserve study done in time for the closing, such as ·At quarterly valuations, when reviews are not done every quarter, ·At quarterly valuations, if current reserve review cannot be done in time. ·At monthly intervals, if reviews are done every quarter. From here on, assume that we are dealing with quarterly closings.

27. Closing the Books with Partial information - CLRS 2001 Information Available at Closing At closing time, various levels of information may be available: 1. A full reserve review on data as of the current quarter, or 2. No reserve review, but actual loss development through the current quarter, e.g.: • Paid and outstanding loss and loss expense by accident year. • Paid and outstanding claim counts. • Earned premiums and earned exposures. 3. Payment information only. We assume that information described in (2) is available.

28. Closing the Books with Partial information - CLRS 2001 Expected Loss Development: Exhibit 1 Company XYZ is closing its books as of 3/31/2001. A full loss reserve review is available as of 12/31/2000. XYZ uses Exhibit 1 to determine its expected development during the 1st quarter. ·Shows the “chain ladder” methods (paid and incurred) through 2/31/2000. ·Separates calendar period development into current year vs. future. ·Separates current calendar year development into current quarter vs future. Requires a “selected” ultimate loss as of 12/31/2000 by accident year.

29. Closing the Books with Partial information - CLRS 2001 Loss development: Current quarter vs. Future Additional development on each accident year equals selected ultimate minus developed loss to date (12/31/2000) The proportion developing in the next calendar year (2001) is given by: [ LDF (to next age) – 1.0 ] divided by [ LDF (to ultimate) – 1.0 ] We need to know the proportion of the annual development expected in the 1st quarter.

30. Closing the Books with Partial information - CLRS 2001 Loss development: Current quarter vs. Future We need to know the proportion of calendar year 2000 development expected to emerge in the 1st quarter. This proportion is determined externally: • May be based on quarterly development studies. • For long-tail lines, the number may be close to 25%. • For short-tail lines, the number may be close to 100%. • Most difficult to assess for the immediate past accident year.

31. Closing the Books with Partial information - CLRS 2001 Exhibit 1 output From the incurred (paid) development exhibit, we get: • Projection of IBNR (Paid) emergence during the current year. • Projection of IBNR (Paid) emergence during the current quarter. Limitations of Exhibit 1: • Uses only the standard age-to-age LDF methods. • Does not estimate the loss amount for the current accident year. Exhibit 1 is easily modified to handle Bornhuetter-Ferguson method.

32. Closing the Books with Partial information - CLRS 2001 Expected Claim Counts Applying Exhibit 1 logic to claim counts rather than loss dollars, we get: • Projection of number of new claims in the current year and partial year. • Projection of number of claims paid in the current year and partial year. Apply projected counts to estimated severity to project loss dollars.

33. Closing the Books with Partial information - CLRS 2001 Actual Development Exhibit 2 brings in the actual paid and developed loss for the quarter. Differences between actual and expected development lead to Recalculation of the ultimate loss It is important that the exhibit show quantities meaningful to management. • Exhibit 2 uses expected quarterly development, actual development and expected future development. • It asks for the revised development expected after the current quarter.

34. Closing the Books with Partial information - CLRS 2001 Revising the Ultimate Loss: XYZ Company How might we revise our estimate of ultimate loss? Look at several methods for clues. Exhibit 2 implies that payments are accelerating. However, payments are greater than the corresponding reserve takedowns. The temptation is to conclude that: The revised expected future payments will be faster than previously thought The revised expected future development will be upward

35. Closing the Books with Partial information - CLRS 2001 Revising the Ultimate Loss: XYZ Company To validate the conclusion we may compare: • Development on reported claims versus reporting of new claims. • Expected versus actual claim counts. It is important to separate case development vs “pure” IBNR. To do this, • Separate development between case and IBNR in the exhibits, or • Run the exhibits by report year rather than accident year. Talk with Claims to gain insight into unexpected development.

36. Closing the Books with Partial information - CLRS 2001 Current Accident Year We have not discussed setting reserves for the current accident year 2001. To do this, use exhibits where projections are based on: • Bornhuetter-Ferguson methods rather than straight LDF methods • Pricing projections will most likely be the key information used. Common methods for estimating the current accident year are • Fix the loss ratio based on pricing studies • Use the fixed loss ratio along with a projected payout pattern and adjust the loss ratio for the difference between actual and expected payments. • Use frequency-severity methods and track claim count reporting.

37. Closing the Books with Partial information - CLRS 2001 Summary When closing the books without a current reserve evaluation, Use the actual development to date to modify previous reserve estimates. Deal with quantities that make sense to management, such as Actual versus expected development. Keep the explanatory exhibits simple and few. Use the exhibits to enlist help from other departments in explaining variances.