September 2001 Casualty Loss Reserve Seminar Surety Loss Reserving Issues Joseph Malsky, ACAS St. Paul Companies

September 2001 CLRS 2 Agenda What drives surety losses? Unique reserving aspects of surety? Reserving techniques and considerations?

September 2001 CLRS 3 Overview Surety is not like insurance A surety extends credit much like banks do Surety Default s Collateral Principal Obligee Contract Money Econom y Underwriting Construction Spending

September 2001 CLRS 4 Surety Loss Trends Economy key driver of surety results 1990’s fantastic decade for surety industry Contract Surety v. Commercial Surety

September 2001 CLRS 5 Economic Trends Source: U.S. Department of Labor; Federal Reserve Board Release; Bureau of Economic Analysis, AM Best

September 2001 CLRS 6 Public Construction Spending v. Surety Industry C/R Source: AM Best’s Aggregates & Averages; U.S. Census Bureau.

September 2001 CLRS 7 Contractor Failure Rates & Liabilities Source: Dunn and Bradstreet Business Failure Record

September 2001 CLRS 8 Selection of Actuarial Reserving Methods Selection will vary with –Size of company –Available data –Nature of surety business Considerations influencing selection of method –Analysis of controls and reporting –Handling of contract monies –Peculiar Large Claims –Recoveries –External influences

September 2001 CLRS 9 Unique Reserving Issues Surety in theory priced and underwritten to be loss free Accident Date Collateral & Salvage ALAE reserving

September 2001 CLRS 10 Accident Date How to define for contract surety? When was the default on the bond? What if the notice of loss is outside the bond period? Should it be consistent for all claims/bonds for a principal?

September 2001 CLRS 11 Collateral & Salvage Evaluation for open known claims generally different than for IBNR claims Types of Collateral: –Contract Money –LOC’s –Indemnity –Project Shares –Mortgages

September 2001 CLRS 12 Gross Loss Development

September 2001 CLRS 13 Gross Loss Development

September 2001 CLRS 14 Putting it all together… Unique Reserving IssueReserving Technique / Consideration Volatility of losses Expected loss method Early period frequency Collateral & Salvage Analyze separately by type of recovery Accident Year Consistent Methodology Policy Year better for evaluating u/w actions Earning Premiums & Exposures If appropriate, adjust premiums ALAE & ULAE Reserving May need to add contract money if using paid-paid ALAE method Claim counting procedure

September 2001 CLRS 15 Summary Surety losses are not fortuitous, but are sensitive to the economy Collateral and Salvage play a big role in reserve analyses Understand your underlying data and mix of business Know your underwriters and claim attorneys

September 2001 CLRS 16 Future Study Loss development analysis based on credit ratings for commercial surety? Application of loss distributions? Cat reserving techniques? Can PML and default rate studies benefit reserve analyses?

September 2001 CLRS 17 Where to Get More Information SAA and SIO NASBP seminars Principles of Suretyship, by Fitzgerald, et.al. Surety Rate-Making, by Backman