CASUALTY LOSS RESERVE SEMINAR HOW A.M. BEST EVALUATES RESERVE ADEQUACY Matthew C. Mosher Managing Actuary September 28, Meeting

DISCUSSION OUTLINE t Purpose t Sources of Information t Methods Used t Determining Ultimates t Discount Calculation

PURPOSE OF RESERVE ADEQUACY t Capitalization - Key to Solvency t Allocation of Capital t Determine True Profitability

INFORMATION SOURCES t Statutory Annual Statement t Actuarial Work Papers t Supplemental Rating Questionnaire

INTERNAL RESERVE MODEL OVERVIEW t Three Paid Loss Development Based Methods t Three Incurred Loss Development Based Methods t LDF’s by Line t Dollar Weighted Age-to-Ultimate LDF’s t Fixed Loss Ratio Override t Credibility Weighted By-Line

INTERNAL RESERVE MODEL LAYOUT t By Line, By Accident Year ã Adequacy Projection of Each Method ã Credibility Weighted Adequacy ã Carried Reserves ã Loss & ALAE Ratios t By Line Equity ã Net Carried Loss & LAE Reserves ã Statutory Discount ã Estimated Deficiency ã Calculated Discount ã Loss Reserve Equity

INTERNAL RESERVE MODEL METHODS t Company-Based ¬ Paid LD - Based on Previous AY Projections ­ Paid LD - Based on Previous AY Sch P, Part 2 ® Incurred LD - Based on Previous AY Projections ¯ Incurred LD - Based on Previous AY Sch P, Part 2 t Industry-Based ° Paid Loss Development ± Incurred Loss Development

METHOD 2 - COMPANY PAID LOSS DEVELOPMENT t Prior Years and AY 1988 ã Part 2 Incurred equals ultimate t AY 1989 AY89 Ult. = AY89 x AY88 Pt2 AY88 t AY 1997 AY97 Ult. = AY97 x AY94, AY95, AY96 Pt2 AY94, AY95, AY96

METHOD 4 - COMPANY INCURRED LOSS DEVELOPMENT t Prior Years and AY 1988 ã Part 2 Incurred equals ultimate t AY 1989 AY89 Ult. = AY89 x AY88 Pt2 AY88 t AY 1997 AY97 Ult. = AY97 x AY94, AY95, AY96 Pt2 AY94, AY95, AY96

METHOD 1 - COMPANY PAID LOSS DEVELOPMENT t Prior Years Req. Res. = Carr. Res. x 1 + 3Yr Dev in PY’s 2 PY Carr t AY 1988 AY88 Ult. = AY88 Pt3 + Carr. Res. x 1 + 3Yr Dev in PY’s & AY88 PY & AY88 Carr

METHOD 1 - COMPANY PAID LOSS DEVELOPMENT t AY 1989 AY89 Ult. = AY89 x AY88 Proj Ult AY88 t AY 1990 AY90 Ult. = AY90 x AY88, AY89 Proj Ult AY88, AY89 t AY 1997 AY97 Ult. = AY97 x AY94, AY95, AY96 Proj Ult AY94, AY95, AY96

METHOD 3 -COMPANY INCURRED LOSS DEVELOPMENT t Prior Years Req. Res. = Carr. Res. x 1 + 3Yr Dev in PY’s 2 PY Carr t AY 1988 AY88 Ult. = AY88 Pt3 + Carr. Res. x 1 + 3Yr Dev in PY’s & AY88 PY & AY88 Carr

METHOD 3 - COMPANY INCURRED LOSS DEVELOPMENT t AY 1989 AY89 Ult. = AY89 x AY88 Proj Ult AY88 t AY 1990 AY90 Ult. = AY90 x AY88, AY89 Proj Ult AY88, AY89 t AY 1997 AY97 Ult. = AY97 x AY94, AY95, AY96 Proj Ult AY94, AY95, AY96

METHOD 5 - INDUSTRY INCURRED LOSS DEVELOPMENT t Prior Years Required Reserves = PY Carr. Res. x Industry Tail Factor t AY 1988 Ultimate = AY88 Pt3 + AY88 Carr. Res. x Ind. Tail Factor t AY 1989 Ultimate = AY89 Pt3 x Industry 108-to-Ult. Paid LDF t AY 1997 Ultimate = AY97 Pt3 x Industry 12-to-Ult. Paid LDF

METHOD 6 - INDUSTRY INCURRED LOSS DEVELOPMENT t Prior Years Required Reserves = PY Carr. Res. x Industry Tail Factor t AY 1988 Ultimate = AY88 Pt3 + AY88 Carr. Res. x Ind. Tail Factor t AY 1989 Ultimate = AY89 Pt2 - Pt4 x Industry 108-to-Ult. Incurred LDF t AY 1997 Ultimate = AY97 Pt2 - Pt4 x Industry 12-to-Ult. Incurred LDF

FIXED LOSS RATIO OVERRIDE t Used If LDF > 4.0 t AY 1997 Loss Ratio = AY97 Ind. LR x AY95 Co. Ult. LR + AY96 Co. Ult. LR AY95 Ind. Ult. LR + AY96 Ind. Ult. LR t AY 1997 Ultimate = AY97 Loss Ratio x 1997 Net Earned Premium

WEIGHTING OF METHODS t Early Years vs. Latest Years t Paid vs. Incurred Methods t Company Credibility Based on Variation in Loss Development Pattern

CREDIBILITY t Sum the Coefficient of Variance over First Six Development Periods t Compare to Industry Levels t Minimum of 40% Credibility

DISCOUNTING t Calculated By Line of Business t Uses Company Payment Patterns, if Stable t Uses IRS Payment Pattern Calculation t Three Calendar Year Average t Uses a 5% Discount Rate

QUALITATIVE/ QUANTITATIVE REVIEW t Qualitative ¶ Schedule P Development Pattern · Avg. Premium Per Policy vs. AY Loss Ratio Trends t Quantitative ¶ Model Projection · Paid to Incurred Ratios ¸ Reserves to Earned Premium

DISCUSSIONS WITH MANAGEMENT t Actuarial Work Papers t Understand Distortions in Data t Reconcile Differences, if Possible

RATING IMPLICATIONS t Confidence in Reserve Practices t Feeds into Capital Adequacy t Impacts Appraisal of Profitability