2006 General Meeting Assemblée générale 2006 Chicago, Illinois Canadian Institute of Actuaries L’Institut canadien des actuaires 2006 General Meeting Assemblée générale 2006 Chicago, Illinois

Group Disability Reserving Unleash the Power of the 21st Century Canadian Institute of Actuaries October 20, 2006 Barry Senensky FCIA www.claimanalytics.com

Agenda Evolution of reserve calculations Where are we today? How can we improve the process? Summary

Evolution of Reserve Calculations Comments – closely, but FAR from perfectly, aligned to evolution of computer performance – want to talk to you about this….

Computer Performance Measure IBM 7094 c. 1967 Laptop c. 2004 Change Processor Speed (MIPS) .25 2,000 8,000-fold increase Main Memory 144 KB 256,000 KB 1,778-fold increase Approx. Cost ($2003) $11,000,000 $2,000 5,500-fold decrease Barry – you could mention here that you didn’t make a bar-graph of this chart, because it would be almost impossible – you’d need a screen the size of an IMAX in order to show the difference between the two sets of figures

1960’s

1960’s Mainframe/manual Technology Simplified formulas Evolution of Reserve Calculations 1960’s Mainframe/manual Simplified formulas Conservative assumptions Infrequent experience and table updates Technology Paper Very early computers Tapes, disks

Evolution of Reserve Calculations

Evolution of Reserve Calculations PC jr!

Evolution of Reserve Calculations 1970’s - 1980’s Mainframe calculations Move to basic principles calculations Conservative assumptions Technology Improved mainframes PCs

1990’s Tim Berners-Lee Ignites the Internet Evolution of Reserve Calculations 1990’s Tim Berners-Lee Ignites the Internet

1990’s Mainframe/PC calculations Basic principles calculations Evolution of Reserve Calculations 1990’s Mainframe/PC calculations Basic principles calculations Expected assumptions with explicit margins Deterministic scenario testing Technology Faster computers, more storage Online processing Internet

Today PC-based calculations Basic principles Stochastic modeling Evolution of Reserve Calculations Today Technology Advanced software algorithms Powerful computers with more storage, faster processing, Access to large databases of historic information PC-based calculations Basic principles Stochastic modeling Expected assumptions with explicit margins

What Have We Accomplished? Tremendous progress due to evolution of computer power Calculations now explicit and seriatim Scenarios sensitivity-tested to better evaluate risk

What do we still need to do? For group disability reserving, need appropriate reserve for each disabled life Benefits Profitability of the business is not distorted from period to period Eliminates cherry picking at quarter-ends More understandable to stakeholders Immediately captures business mix changes Better alignment of claims and management personnel

What are the specific requirements? Termination rates to reflect each disabled life’s: diagnosis residence monthly benefit tax status reporting lag Offsets and probability of offsets appropriate to each claim

Using Predictive Modeling to Calculate Reserves Appropriate for Each Claim

Claims Scoring Claims scored from 1 to 10. Scores show likelihood of return to work within a given timeframe. Scores are calibrated: Score of 1 indicates 0 – 10% chance of recovery within given timeframe, score of 2 indicates 10 – 20% chance of recovery within given timeframe, and so on. J. Spratt Score: 4 # 452135 J. Loe Score: 6 # 452009 P. Chang Score: 8 # 451156

Scoring Report Q.P. … … … … …

Five steps to developing LTD termination rates for Dave with claim scoring Dave

About Dave Sex Male Age 44 QP 90 days Diagnosis Osteoarthritis Developing termination rates for Dave About Dave Sex Male Age 44 QP 90 days Diagnosis Osteoarthritis

3 months 5.9 6 months 14.7 12 months 27.5 24 months 34.5 Developing termination rates for Dave Dave’s claim scores Likelihood of RTW (%) 3 months 5.9 6 months 14.7 12 months 27.5 24 months 34.5

Dave’s claim scores Likelihood of RTW (%) Developing termination rates for Dave Dave’s claim scores Likelihood of RTW (%)

Cumulative RTW Probabilities Developing termination rates for Dave Step One Cumulative RTW Probabilities cumulative RTW Probabilities, 1-24 Months after EP expressed as % 1 2 3 4 5 6 7 8 9 10 11 12 5.9 14.7 27.5 13 14 15 16 17 18 19 20 21 22 23 24 34.5

Interpolate between months Developing termination rates for Dave Step Two Interpolate between months choose uniform distribution, constant force or Balducci here, used uniform distribution expressed as % 1 2 3 4 5 6 7 8 9 10 11 12 2.0 3.9 5.9 8.8 11.8 14.7 16.8 19.0 21.1 23.2 25.4 27.5 13 14 15 16 17 18 19 20 21 22 23 24 28.1 28.7 29.3 29.8 30.4 31.0 31.6 32.2 32.8 33.3 33.9 34.5

Step Three Mortality rates 1 2 3 4 5 6 7 8 9 10 11 12 .27 .32 .40 .45 Developing termination rates for Dave Step Three Mortality rates Canadian Group LTD experience /1000 shown here alternative is company experience may want to make adjustments, e.g. improvement from mid-point of study 1 2 3 4 5 6 7 8 9 10 11 12 .27 .32 .40 .45 .49 .51 .52 .53 .50 13 14 15 16 17 18 19 20 21 22 23 24 .47 .46 .44 .42 .40 .38 .37 .35 .34 .32 .31 .29

Step Four Convert cumulative RTW probabilities to month-to-month RTW rates Developing termination rates for Dave # of claimants who will recover in period.  TM cumulative RTW - LM cumulative RTW 1 - LM cumulative RTW - LM cumulative death rate # of claimants still on claim at start of period.   1 2 3 4 5 6 7 8 9 10 11 12 1.97 2.00 1.99 2.96 2.98 2.97 2.15 2.12 2.11 2.10 2.09 13 14 15 16 17 18 19 20 21 22 23 24 .57 .56 .55

Calculate Termination Rates Step Five Calculate Termination Rates Termination rate = recovery rate + mortality rate Developing termination rates for Dave 1 2 3 4 5 6 7 8 9 10 11 12 2.24 2.32 2.39 3.41 3.47 3.48 2.67 2.65 2.64 2.62 2.60 2.58 13 14 15 16 17 18 19 20 21 22 23 24 1.04 1.02 1.00 .98 .96 .94 .92 .90 .88 .87 .85 .84

What to do after 24 months Produce scores for 24 months, then use traditional methods thereafter Produce scores for all future terms

This is realizable today. Summary Significant progress has been made in calculating reserves. Still needed in Group Disability reserving: DLR’s that reflect the specific factors of each claim This is realizable today.