Construction Defects Casualty Loss Reserve Seminar September 24, 2002 Panelist: Carolyn Yau, ACAS

2 Overview  Background  Actuarial Issues  Methodologies  Current Issues

3 Background  Montrose Decision Continuous trigger theory applied to pollution case  Stonewall Insurance Company vs. City of Palos Verdes Estates  Carriers respond to claims on prorata basis Frequency rises Severity falls  Insureds coverage is generally maximized  Reinsurers less exposed  Indemnity apportioned based on time on risk  Expense apportioned based on number of carriers

4 Example: $3 Million Claim

5 Actuarial Issues  Uncertain determination of accident date Varies by company and frequently within a company  Uncertain determination of future development pattern Appears to be lengthening Influx of claim activity along recent accident year diagonals  Uncertain determination of tail factor selection One assumption to use is no more development after 13 years for California Not sure if it will hold

6 Methodology: Obtain Program Knowledge  What is exposure mix (general contractor, designer/builders, subcontractors)  Is exposure residential or commercial construction  Which states have construction defect exposure  Is exposure information available  What is the definition of a construction defect claim  How is accident date determined  What reinsurance agreements are in place

7 Methodology: Data Organization  California vs. Non California (or other specific states)  General Contractors vs. Subcontractors  Accident year vs. report year data  Separate ALAE

8 Methodology: Analysis  Accident Year Methods  Report Year Methods  Exposure Based Methods

9 Methodology: Accident Year Analysis  Traditional Loss Development Method is not appropriate  Montrose Adjustment Method Aids in selection of development factors and tail selection  Transactional Count / Incremental Paid Loss Method Count times Severity Approach Key is estimating the ultimate reported counts

10 Methodology: Report Year Analysis  Estimate Development on Known Claims and Pure IBNR separately  Pure IBNR Count times Severity Approach Estimate reporting pattern of the remaining claims Fitted Distribution Empirical Distribution

11 Methodology: Exposure Analysis  Ideal method if data is available  Develop list of policy holders Compare policy holders with list of claimants to determine remaining exposure Determine future reported claims by extrapolation or market share analysis  Earned GL premium for contractors is also useful

12 Issues in Construction Defects One Year Ago  Frequencies 1994 – 1999 rising 2000 flat  Severities 1994 – 1999 stable 2000 flat to declining  ALAE to loss ratios Rising over time Recommend monitoring separately from loss as still evolving

13 Issues in Construction Defects Today  Mold Claims (Texas) Schools and public buildings Statute of limitations is shorter  Additional Insured ALAE (Southern California) Presley Homes, Inc. v. American States Insurance Company (2001) As general contractors reach their polity limits or go bankrupt, they are looking for coverage under the subcontractor policies where they are listed as an “additional insured” Sharing of defense costs among insurers

14 Issues in Construction Defects Other States  Areas of rapid increase in population Baby boomers retiring – NV, FL, TX, AZ, CO Seen increase in activity but legal landscape is different Statute of limitations shorter Minimal use of continuous trigger theory Claim frequency is rising