Milliman Asbestos Valuation 2004 Casualty Loss Reserve Seminar Las Vegas, Nevada September 13, 2004 Claus S. Metzner, FSA, FCAS, MAAA, Aktuar – SAV Actuary, Milliman, Inc.

Milliman 1 Asbestos Valuation  Asbestos Reserve Valuations have received and are receiving a great deal of publicity  Asbestos Reserve Valuations have led to substantial restatement of reserves for many companies – both primary insurers and re-insurers – “surprises” are commonplace  Asbestos Reserve Valuations are an on-going concern of rating agencies and regulators  Why this level of concern? This level of uncertainty? What are our options?  Complexity of valuation – “black box” effect - increases uncertainty and anxiety  What can we learn from the “Asbestos” Experience?

Milliman 2 Asbestos Valuation What are we faced with? a large number of claimants multiple defendants long latency periods a number of coverage years different coverages (products; premises/ops, etc.) varying policy limits limited information complex financial arrangements What are we to do?

Milliman 3 Asbestos Valuation  Develop techniques to deal with:  A gigantic allocation problem between The manufacturer/installer/distributor: the insured defendant The insurers of the manufacturer, etc The re-insurer The retrocessionaire  Need to obtain/quantify expert knowledge from claim and legal staff to master the problem  Need to develop monitoring/reporting tools that help avoid “surprises” and mitigate the “black box” effect

Milliman 4 Asbestos Valuation  Step I: The Insured  Develop the “Universe” of claims for each insured  Consider the type of claim: products versus premises/operations, etc.  Consider the length of the reporting period  Consider legal costs  Consider inflation (all kinds)  Consider issues of bankruptcy

Milliman 5 Asbestos Valuation  What do we know/what can we find out for Step I?  Historical reporting patterns  Historical frequency and severity  Claim knowledge  Legal knowledge  Goal: develop a set of assumptions and a model for the projection of the ultimate claims and the allocation to coverage period  Quantifying the “expert knowledge”  Developing Monitoring Tools Claims function Management function

Milliman 6 Asbestos Valuation  After we have all the assumptions, how do we model the results ?(the assumptions are developed with the help of claim and legal experts!)  Assumptions are generally not just a best estimate  Assumptions have a distribution, a range, of possible outcomes  Model on a stochastic basis (note: less than perfect approximations are useful – the output of the model provides information as to the sensitivity of key assumptions)  The assumptions form the basis for monitoring: “actual” versus “expected”

Milliman 7 Asbestos Valuation  Step II: The Insurer  Once we have obtained the model output (note – this is a range of outputs!) can apply coverage charts to obtain the range of ultimate losses  Policy limits important  Primary versus excess  Other special coverage conditions (manuscript forms)

Milliman 8 Asbestos Valuation  Having developed the range of ultimate losses for each insured, can now subtract the payments to date to obtain a range of reserves for each insured  Note 1: pay special attention to validation routines on an account by account basis – the “smell test” – using the collective knowledge of claim and legal experts  Note 2: consider if a covariance adjustment is appropriate – i.e. will everything go bad at the same time? - if no co-variance adjustment is used, the range may be misstated on the high side; if complete independence assumed, the range may be misstated on the low side  Each company’s mix of business by state, by type of insured, etc. should be considered

Milliman 9 Asbestos Valuation  “Smaller” insureds with reported asbestos claims – some alternatives for the valuation  Use the information gained from the modeling process for large accounts to group small accounts  Treat each group as if it were a single account and model  Use a review of emerging claims to assess products and premises/operations coverage  Use a review of the types of accounts to evaluate potential impact of policy limits

Milliman 10 Asbestos Valuation  IBNR  A very difficult subject but note the following Major asbestos defendants have long since been identified and are presumably already modeled – see Step I Minor defendants are emerging - model how many additional accounts may report claims in the future and apply frequency/severity assumptions per account – in the alternative, model number of emerging claims (note that policy limits may not apply – c.f. reinsurance impact) Consider where you are on the “reporting” curve May want to consider issues of “modeling risk” as part of IBNR

Milliman 11 Asbestos Valuation  Step 3: Assess Reinsurance Recoverable  Reinsurance Program for each coverage/underwriting year can be applied to each outcome of the ultimate losses to develop a range of reinsurance recoverable consistent with the gross ultimate losses  Consider: dimunition/exhaustion of coverage due to other types of claims and previous payments  Consider: facultative/treaty/etc.  Consider: what accounts are generating IBNR and will the emergence of the IBNR claims even trigger reinsurance  Consider: creditworthiness

Milliman 12 Asbestos Valuation  The previous steps have taken us through the process of developing a gross and a net liability for the primary insurer  Now we come to the re-insurer

Milliman 13 Asbestos Valuation  What are some key differences between the primary insurance valuation problems and the reinsurance valuation problem?  Re-insurer has less information than the primary insurer  Potentially more heterogeneous book of business  Generally higher attachment points  Generally longer lags until claims are reported  Potential that primary companies’ reserving problems lead to a (massive) understatement of reinsurance recoverable by primary companies and understatement of re-insurer’s liability

Milliman 14 Asbestos Valuation  Possible remedies for the lack of data  For primary companies representing a large portion of the exposure, investigate who the major insured accounts were for the years in question – then follow primary process with superimposed reinsurance program  Adjust reported data for Perceived reserve inadequacies For better/worse than average reporting of data –Quality and timeliness and relative case basis reserve adequacy are important  Consider the limits profile of the primary company  Consider the source of the primary company’s IBNR (products vs non- products; size of claim anticipated )

Milliman 15 Asbestos Valuation  Retrocessionaire Issues  Even less data available  Longer report lags  “Spiral” may be critical – e.g. London Excess Market  IBNR very important, but the least amount of information is available  Consider if the market under review – e.g., LMX – can be viewed as a pool

Milliman 16 Asbestos Valuation  Management Information/Monitoring  Assumptions provide the basis for monitoring on a quarterly basis Monitoring doesn’t mean changing the answer Monitoring means assessing when we should “drill down” Monitoring means an on-going information flow and dialogue with –Claim/legal experts –Management –Others –Explanation of “what’s going on”

Milliman 17 Asbestos Valuation  Monitoring Tools  Actual versus expected payments  Actual versus expected newly reported accounts  Actual versus expected number of new claimants  Actual versus expected average values  Etc.

Milliman 18 Asbestos Valuation  Summary  Key issues Long latency period Multiple coverage years Complex legal issues Complex financial structures Lack of data

Milliman 19 Asbestos Valuation  Summary  Key Approaches Gain as much information as possible Use expertise of claim and legal staff to develop assumptions Model results stochastically –Assumptions are documented –Can measure impact of change in environment as reflected in revised assumptions Use consistent underlying assumptions to model primary, excess, reinsurance layers

Milliman 20 Asbestos Valuation  Summary  Expect to be “surprised”  Keep monitoring and updating We are engaged not just in a loss reserve project but in financial reporting Remove the “black box” effect  Stay in close contact with claim and legal professionals  What Else Do We Know  Similar reserving problems in other areas: Construction Defect, for example  Similar approaches to reserving may be our best opportunity to stay current with emerging liabilities