State of Montana Old Fund Discussion Bruce R. Hockman Senior Vice President Towers Perrin Reinsurance Senate Bill 304 Study Committee

1 1 Current Financial Situation Risk Factors to State of Montana Risk Financing “Alternatives” Market Status Montana Old Fund Discussion

2 2 Through December 31, 2003, the following characteristics apply to the Old Fund 1253 claims with injury dates prior to June 30, 1990 Outstanding undiscounted liabilities of $106,308,545 –Indemnity$44,371,397 –Medical$61,937,148 Outstanding liabilities discounted at a rate of 5.25% of $76,329,535 –Indemnity$31,858,663 –Medical$44,470,872 Fund Equity of $761,819 Montana Old Fund Discussion

3 3 Risk Factors As there is currently a minimal amount of surplus held in the Old Fund account, it is responsible to discuss what factors may impact the fiscal soundness of the account. Growth in Reserves –Indemnity:Re-openings, Judicial Intervention –Medical:Technology, Inflation, Relatedness Findings Acceleration of Claims Payments –Primarily Medical Interest Rate Fluctuation –Medium and long-term rates of return are at a 40 year low. Montana Old Fund Discussion

4 4 Risk Factors Growth in Reserves –Reserve “Development” unfortunately is a constant since loss reserving is far from an exact science –Current trend is “adverse” driven largely by 2 factors Judicial Interpretation Medical Technology and Inflation –If Medical Reserves grew just 10% over the expected lifetime of the open cases. The account would be underfunded by $6.2mm on an undiscounted basis. Montana Old Fund Discussion

5 5 Risk Factors Acceleration of Claims Payments –The discounting of losses is based on 3 critical factors Accuracy of Reserves Expected Payment Pattern Discount Factor Applied –If claim payments accelerate beyond the current actuarial estimates, existing account funds become inadequate by an estimated $3mm Montana Old Fund Discussion

6 6 Risk Factors Interest Rate Fluctuation –The account is currently “funded” with invested assets that “match” the unwinding of the discounted liabilities at a rate of 5.45%. –Currently the interest rates on 10 year treasury notes is 3.78% –The interest rate on 20 year treasury notes is 4.67% –Other than in Baa Corporate Bonds, currently at 6.09%, there is no investment vehicle available to match the current discount rate. Montana Old Fund Discussion

7 7 Risk Financing Alternatives There are two Risk Financing Alternatives that may be of value for consideration: –Loss Portfolio Transfer (LPT) –Adverse Development Cover (ADC) Both alternatives will include assessment of the risk factors identified previously. They both involve a high degree of actuarial assessment, and the process of review involves considerable time. Montana Old Fund Discussion

8 8 Risk Financing Alternatives Loss Portfolio Transfer (LPT) For an established premium payment, a reinsurer will accept liabilities up to a finite amount for a defined period of time. Depending on interest rate assumptions, the reinsurer may be willing to provide coverage for amounts greater than existing liabilities. If actual liabilities exceed the contract limit, such "excess" liabilities will revert back to the purchaser. There are no unlimited transfers available in the market. Contracts typically include loss adjustment expense within the contract limit of liability. Premiums can be paid entirely to the Reinsurer (fund transferred) or maintained in a trust fund (funds held), established by the purchaser. Montana Old Fund Discussion

9 9 Risk Financing Alternatives Adverse Development Cover (ADC) For an established premium, a reinsurer would provide protection against unforeseen adverse development of existing case reserves. The premium is directly related to the limit of liability purchased, the reinsurers comfort with existing reserves, and the actuarial projections related to payment patterns and interest rates. Premiums can either be transferred or held by the purchaser interest (less the reinsurers margin) Premium returns, or additions are routinely provided for depending on actual results of the program. Montana Old Fund Discussion

10 Risk Financing Alternatives There is Market Support for such programs, but the cost is significant when considering the value received. Much of the business is done in "Tax Favored" countries such as Bermuda, the Caymans, and Ireland. Routine time frame for analysis, program development and placement is six months at a minimum. Montana Old Fund Discussion