Insurance and Reinsurance Reserving in Overseas Markets Peter A. Royek Toa Reinsurance Company of America Casualty Loss Reserve Seminar Scottsdale, Arizona September 13, 1999

Birth of a Session “Affiliate” Membership & “Mutual Recognition” One Actuary’s Recent Experience with “Overseas” Markets –Japan –Canada

Broad Overview of Session General Discussion of Differences Involving Reserving Among World Markets Insurance and Reinsurance Reserving in the United Kingdom

General Discussion of Differences Involving Reserving Among World Markets Dimensions for Differentiation International Reserving Example

Dimensions for Differentiation Methods Reserve Categories Data Accounting Rules Role of the Actuary

Methods (or the lack thereof) Japan –Strict formula for IBNR calculation Automobile –Earned Premium for current year X 3% Personal Accident, Liability, and WC –Earned Premium for current year X 8% All Other Lines –0 –Need for change in the future? Europe (Outside the UK) –Tendency toward a more theoretical, statistical approach

Methods (or the lack thereof) Others –Argentina Automobile “IBNR” –Italy New Requirement for IBNER –Brazil New IBNR Requirement Clearly “Standard” Methods are Not Currently Used in these Markets

Rate Inadequacy => Reserve Inadequacy Two Companies Writing the “Same” Risk Company A - Charges Tariff Rate –Premium = 1,000 –IBNR = 80 (8% x 1,000) Company B - Deviates Off Tariff Rate –Premium = 700 –IBNR = 56 (8% x 700)

Reserve Categories Premium Deficiency Reserve - Canada –Amount by which UPR is insufficient to cover future loss and expense, liability (if any) must be posted –Appointed Actuary must opine on the adequacy –Similar to Unexpired Risk Reserve in the UK –GAAP adjustment in the US

Reserve Categories Contingency (or Extraordinary Loss) Reserve - Japan –Pre-event loss fund with strict rules for build-up and draw-down –Coming to the US? See next session - “Tax- Exempt, Pre-Event Catastrophe Reserves, in the Wind?”

Reserve Categories Equalization Reserve - Germany –Can be used for smoothing of results –Like “Topside” or “Corporate” reserves in US companies?, but NOT a separate statutory item –Somewhat like Extraordinary Loss Reserve due to the tax-free feature of these reserves, but NOT the strict rules to build-up or draw-down

Data Benchmarks –Not as publicly-available as in the U.S. AM Best,RAA,etc –“Private” collections do exist Consultants Companies –Canada Some industry data for Auto Runoff exhibit in Annual Return NOT by LOB, unlike Schedule P –Japan

Data Other Issues –Not enough data How to reserve for small or incidental foreign exposure with lack of benchmarks? Even if no statutory requirement for IBNR, may need to reserve for US Annual Statement purposes –Too much data A “stew” of otherwise-heterogeneous data in a single reserving class –Due to credibility concerns or ceding company reporting?

Accounting Rules Tax Rates Basis for Accounting Different Statutory Statement Items Fiscal Year/Reporting Frequency

Accounting Rules Tax Rates on Underwriting Income Japan - 30% –Recent History % 1990 through % % United Kingdom - 30%

Accounting Rules Tax Rates on Underwriting Income USA - 35% Canada % Federal, plus... –Combined Federal + Provincial Rates Manitoba % Ontario % Quebec (for “Active/eligible” Companies)

Accounting Rules Basis for Accounting Differences when comparing to US Statutory or US GAAP Accounting –Example: Valuation of Assets in Japan Impacts the calculation of “Surplus” Due to change to “market-based” valuation in 2000/2001 Companies are making US GAAP Adjustments –Some previously-mentioned items go away –Allows for level comparison of companies

Accounting Rules Different Statutory Statement Items Examples: –Premium Deficiency Reserves –Extraordinary Loss Reserves –Runoff Exhibit in Canadian Annual Return

Accounting Rules Fiscal Year/Reporting Frequency Accounting year-end dates –Japan - 3/31 –Australia - 6/30 In some markets, results are reported (and IBNR is calculated) only at fiscal year-end

Role of the Actuary Canada –Best Estimate The “minimum” to be carried by the company Margins above are disclosed Contrast these with the US –Codification/Best Estimate Reserving coming to the US? –Discounting/PFADs Discounting only allowed by OSFI for AB CIA requires reserves be discounted and a Provision for Adverse Deviation (PFAD) be added –Discounted Reserve + PFAD must be >(or =) Company Carried

Role of the Actuary Canada (continued) –DCAT Companies operating in Canada now subject –Opining on Premium Liabilities

Role of the Actuary Japan –Duties of the Actuary listed in “Insurance Business Law” –No Actuarial Judgment in Reserving –Now a Need for Rating Expertise –“Actuarial Full Employment Act”?

International Reserving Example Introduction The “same” piece of business (Treaty/Certificate/Policy) will be run through 4 different scenarios in 3 different jurisdictions The effects of local reserving rules and tax rates will be run against the same underwriting results

International Reserving Example “Simplifications” Each company writes only this one account –IBNR thus allocated to this account Investment Income –Simplified Investment Income calculation, meant only to show that II will vary due to the effect of reserve rules + tax rates on cash available for investment –No variation of investment yield by country –No variation between tax rates on investment income and tax rates on underwriting income

International Reserving Example “Simplifications” All premium is earned in the first year –No UPR at year end > No “Premium Liability” Issues Discounting for US tax purposes is NOT performed

International Reserving Example Framework LOB = Auto Premium = 1,000 units Expenses = 250 units, all paid on 1st day Expense Ratio = 25% Investment yield = 5% Ultimate Loss Ratio = 70% –“Reasonable Range” (for US) is (65%,75%) Account closed after 5 years –Account history in years 1 through 5 Payment pattern - 100,100,200,200,100 Case reserves held at year-ends - 100,100,100,50,0

International Reserving Example Framework Taxes paid at year end on annual underwriting + investment income Investment income calculated on average cash funds held (oversimplified in this example) Over- or Under-reserving (where applicable) is adjusted in year 5

International Reserving Example Framework All scenarios will produce an underwriting income of 50 All scenarios will produce a loss ratio of 70%, and expense ratio of 25%, and a combined ratio of 95% Net Income and Cash are the items which will vary

International Reserving Example Scenarios Japan –IBNR = 30 at Year 1 Released after Year 1 as all premium is earned –Tax rate = 30%

International Reserving Example Scenarios Canada –Company sets loss ratio to the Best Estimate of 70% –IBNR is held to achieve 70% until final settlement –Tax rate used is Federal + Ontario provincial rate = 44.62%

International Reserving Example Scenarios USA #1 –Company sets loss ratio to the high end of the range - 75% –IBNR is held to achieve 75% until final settlement –Tax rate = 35%

International Reserving Example Scenarios USA #2 –Company sets loss ratio to the low end of the range - 65% –IBNR is held to achieve 65% until final settlement –Tax rate = 35%

International Reserving Example Results Japan –IBNR lowest Year 1, then 0 –Takes largest underwriting profit & pays most tax in Year 1. Takes largest U/W losses next 3 years –Overall pays least taxes (lowest rate) –Overall makes least II (while paying overall least taxes, paid a lot in Year 1) –Total Net Income = 60.04

International Reserving Example Results Canada –Sets loss ratio to the “correct”70%, incurs all loss in Year 1 –Earns II between the two US scenarios as it holds reserve level between the two –Overall pays most taxes (highest rate) –Total Net Income = 51.65

International Reserving Example Results USA #1 –Company sets high loss ratio 75% –Takes underwriting gain in Year 5 with downward adjustment –Most NI & tax in Year 5 –Overall makes the most II as it holds more reserves longer –Total Net Income = 62.31

International Reserving Example Results USA #2 –Company sets loss ratio - 65% –Takes underwriting loss in Year 5 with upward adjustment –Least NI & tax in Year 5 –II greater only than Japan –Total Net Income = 59.98

International Reserving Example “Conclusion” The differing reserving rules and tax rates among jurisdictions do impact the results of the “same” account. However: –Factors that were “simplified”or ignored in this example will affect the magnitude and can affect the comparative magnitude of the results –Factors that can vary from those in this example will also affect the magnitude and can also affect the comparative magnitude of the results