Data Integrity: Garbage Out can be Costly Data Validation in Reserve Analysis and Loss Forecasting September 11, 2013

Sound Familiar? From your underwriter……… “Due to market conditions and your recent claims experience, we are increasing your rates by 7%” From your actuary……. “Total unpaid losses increased by approximately $300,000 due to adverse loss development” From your broker……. “The carrier has increased your collateral requirement by $2 million and the LOC needs to be in place in 30 days” From your owner……. “Section 16 of the Construction management agreement clearly states that the construction manager shall bear the cost of all deductibles” From your DCAA auditor….. “Your charge for self insurance is disallowed as it is not based on Projected Average Loss as defined under CAS 416”

Session Overview Background & basics Section 1: Loss Forecasting Section 2: Reserve analysis Section 3: Collateral

Commercial Insurance has Evolved Guaranteed Cost Retrospectively Rated Programs Large Deductible / SIR 1960s 1980s 2000+ Data Implications Insurance company data only Manual process / paper loss runs GC focus on premium minimization 100% fixed cost allocation Carrier loss data required to support retro adjustments Initial use of RMIS Profit sharing imbedded in allocations Increasing pressure to assume risk/ reduce premiums Carrier loss data standardized Widespread use of RMIS Insurance market pushing larger loss retentions Insurers will provide loss data in multiple formats (when asked) Some carriers allow access to their online systems

Variable costs represent an increasing % of TCOR RISK MANAGEMENT & SAFETY 2% INSURANCE BROKERAGE FEES 5% INSURANCE PREMIUMS 28% LOSSES & LOSS ADJUSTMENT EXPENSE 65% Contractors are under increasing pressure to validate cost of insurance to owners. Insurance Cost allocation for government work highly regulated (FAR, CAS) Increased importance on accurate measurement and forecasting of variable loss costs

Willis Construction Sample of 49 clients

Data Sources & Applications Internal Insurance Program Data (retentions, limits, rates) Premiums Loss Data Exposure Data (Payroll, CV, Vehicle counts) RM Overhead Safety & Loss Control Renewal Negotiation Collateral Analysis Accounting / Liability Accruals Project Costing Acquisition Pricing Benchmarking External Insurance Carrier loss rates, aggregate rates Industry LDFs (AM Best, NCCI) Experience Mods

Projected Ultimate Loss An estimate of total claims cost Within the deductible layer For a single policy period Once all claims are settled, paid and closed. For first party coverage (Property or Builders Risk), losses are directly measured based on property valuation whether actual cash value or replacement cost. (Short tail) For casualty lines (AL, GL and WC), due to the lengthy period of time between the occurrence of a claim and final settlement, estimation of ultimate loss is required.

Components of Loss Paid Paid Paid 3 months 6 months Claim Closed Incurred but not reported (IBNR) Incurred but not reported (IBNR) Paid Outstanding Case Reserves Paid Outstanding Case Reserves Paid 3 months 6 months Claim Closed Loss Development

Measuring IBNR Request your loss data as of a set date each year (expiration or year end)

Section 1 Loss Forecasting

Loss Forecast A Projection of ultimate losses: Applications: Within the deductible layer For the upcoming or renewal policy period Based on historical loss and exposure history Adjusted for inflation Forecast = loss rate x projected exposures Applications: Risk Transfer Premium Negotiation Renewal Year Collateral Project Cost Allocation Total Loss Exposures = Loss Rate

Case Study #1 :Loss Forecasting General Contractor just signed contract for $30,000,000 project General Liability program has a $250,000 per occurrence deductible The liability rate charged to the job needs to cover both fixed cost premiums and expected losses within the deductible Goal: Forecast an expected loss rate for the deductible

Summarize and limit loss data Individual large losses should be identified and limited Historical losses should be limited at the forecast deductible level

Apply Loss Development & Select Ultimate Loss Some actuaries reduce LDF to 1.0 when all claims are paid Carriers generally select ultimate loss based on incurred; for older years paid factors may be more appropriate

Losses and exposures are adjusted for inflation Verify trend factors are applicable. Consider separate analysis of workers compensation for states with significant benefit level adjustments.

Select loss rate and apply to forecast exposures Verify projected exposures Carrier expected loss rates can be derived from collateral requirements Deductible aggregate rates identify maximum exposure

Project Allocation The deductible rates (expected and aggregate) may help provide an applicable range for project cost allocation

Common Data Issues Overstating Loss Data Incorrectly Limiting Loss Data - Not grouping multiple claims of a single occurrence Outstanding case reserves on claims that have settled and should be closed Including self insured states losses in an insured states forecast Not adjusting incurred and paid losses for recovery Developing losses in policy years where all claims are closed. (Debatable) If loss data is high, loss rate will be artificially high

Case Study Impact of Overstating Losses Case study loss rate was $1.67 If the two large losses in policy years 2008 and 2011 were the result of common occurrences, the losses in those policy years should decrease by $250,000. After correcting the losses, the rate decreases to $1.31 This results in a decrease in the forecast from $835,000 to $655,000

Common Data Issues Overstating Exposure Data Including CV/payroll that is enrolled in a CCIP or OCIP Including self insured states payroll in the insured’s state analysis Including exposures related to sold or discontinued operations If exposure data is high, loss rate will be artificially low

Case Study Impact of Overstating Exposure Case study loss rate was $1.67 If 25% of construction value was enrolled in CCIP/OCIP ,exposures should be decreased by 25% After correcting the exposures, the rate increases to $2.23 This results in a increase in the forecast from $835,000 to $1,115,000

Loss Forecasting Tips The loss forecast is only as good as the source data. Request loss data from your carrier in an excel format Know your large losses; make sure claims data is accurate. Utilize claim reviews; claim closure projects Make sure discontinued operations are excluded from historical loss and exposure data for forecasting purposes Verify that allocated loss adjustment expense is treated consistent with renewal terms. Ask your carrier for loss triangles limited at your deductible level Utilize company specific loss development factors if there is sufficient underlying data to be statistically valid. Consider an LDF of 1.0 on policy years where all claims are closed.

Section 2 Reserve Analysis

Reserve Analysis Estimating the total remaining liability: For past & current policy years As of a specific date Process: Estimate ultimate loss Generally, the actuary will use several methods and select one Subtract total paid to date Applications: Financial Reporting Collateral determination of expired policy years Valuing Acquisitions

Case Study #2 :Reserve Analysis General Contractor has an expiring Contractor Controlled Insurance Program with no new enrollment Program included a $250,000 deductible for workers compensation The GC needs to book an outstanding liability for residual risk on its balance sheet The GC wants to negotiate with the carrier for a release of collateral Goal: Interpret actuarial analysis and provide accounting with the appropriate reserve estimate

Interpreting an actuarial analysis Validate loss data before providing to actuary Know your large losses and clash claims In a primary casualty program, make sure historical loss limits are correct

Errors in loss data will be magnified when loss development is applied Your actuary will use multiple methods to estimate ultimate loss

Read the footnotes Understand the selection of projected ultimate Communicate with your actuary

Request a confidence level analysis or range to increase flexibility Inquire about discounting losses to reflect anticipated payment patterns

Reserve Analysis Tips Review the data before submitting to the actuary Know your large claims Challenge individual claim reserves if they are high based on your knowledge of the loss. (i.e. potential subrogation) Challenge losses you know have been paid that have outstanding reserves that should be closed. Watch for duplicate claims or claims that should be excluded Subguard claims should not be included on a GL loss run Notify the actuary of any multiple claim occurrences and/or clash claims Look for recovery dollars. Total incurred should be appropriately adjusted. Communicate historical deductible levels / loss limits Request a confidence level analysis or a range. Consider discounting Ask if your loss history is sufficient to produce loss Triangles / development factors based on your claims experience versus industry.

Section 3 Collateral

Insurance Collateral Assets of the insured pledged to the insurance carrier to cover deductible losses In large deductible policies, the insurer “pays on behalf” of the insured and seeks reimbursement for deductible losses creating credit risk With insufficient collateral, insurers are subject to accounting penalties (Schedule F) which result in a reduction in admitted assets For the insured, insurance collateral may restricts assets, draw on credit capacity and can create liquidity issues The payment agreement outlines the collateral terms Carriers may accept alternative forms of collateral

Request Carrier Calculation Reserve Analysis Loss Forecast

Validate the data Request carrier data at same evaluation date

Tips to Negotiating Collateral Prepare an independent analysis Save prior year carrier calculations, question more conservative calculations on old policy years Review your payment agreements Separate executed payment agreements for each policy period Look for pre-defined LDFs or collateral adjustment terms Make the carrier comfortable with your credit profile Submit financial statements Disclose recent developments Develop a relationship with the credit officer / invite your CEO & CFO Ask about paid loss credits Consider collateral implications prior to marketing your program Understand the various forms of security that your carrier will accept (LOC’s, trusts, cash/asset backed accounts)

Your response….. To your underwriter……… “According to the data , our loss rate has actually decreased as a result of our new safety initiatives” To your actuary……. “The apparent adverse loss development is actually a result of a change in TPA that is more conservative therefore IBNR should be adjusted downward” To your broker……. “It appears that the LDFs applied by the carrier are inconsistent with the payment agreement and the LOC should be decreased by….” To your owner……. “We have elected to purchase guaranteed cost coverage which unfortunately will increase the insurance allocation on your projects” To your DCAA auditor….. “Please review the attached actuarial analysis which includes the estimate of projected average loss”