Atlanta, Georgia September 11, 2006 Anita Sathe, ACAS, ASA – Deloitte Consulting LLP Christopher Bozman, FCAS, MAAA – Towers Perrin Tillinghast Michael Angelina, ACAS, MAAA – Endurance Specialty Holdings Introduction To Reinsurance Reserving

22006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Agenda Reinsurance Contract Types Data Grouping Dimensions Differences Between Reinsurance and Primary that affect Loss Reserving Other Considerations & Development Methods Other Reserving Methods

32006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Agenda Reinsurance Contract Types Data Grouping Dimensions Differences Between Reinsurance and Primary that affect Loss Reserving Other Considerations & Development Methods Other Reserving Methods

42006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types Type of policies Mechanics of cession

52006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Type of Policies Treaty Reinsurance –Covers a book or class of business –Automatic reinsurance –Insured/policies are unknown at inception but become known subsequently –Typical Uses: Provide stability Increase aggregate capacity Facultative Reinsurance –Covers a specific individual risk –The reinsurer retains the right to accept or reject each risk –The one insured/policy is known to the reinsurer at inception –Typical uses: Unique exposures Hazardous exposures Provide line capacity

62006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Type of Policies Finite Reinsurance –Non-traditional treaty reinsurance –Transfers a limited amount of risk –Involves profit sharing elements –Typical uses Surplus relief “Smoothing” results

72006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Mechanics of cession Two mechanics of cession: –Pro Rata reinsurance Proportional sharing of premiums and losses –Excess of loss reinsurance Losses in excess of a given dollar retention are covered Applicable to both treaty and facultative reinsurance

82006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Mechanics of cession Pro Rata reinsurance –Quota Share Fixed percentage of premium & losses shared Dollar amount ceded varies by size of risk E.g. QS Reinsurance with 25% retention. Total Premiums = $1,000,000 Total Losses = $700,000

92006 CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Mechanics of cession Pro Rata reinsurance –Surplus Share Fixed amount (line) of losses ceded Percentage shared varies by size of risk E.g. Surplus share $200,000 xs of $150,000

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Mechanics of cession Excess Reinsurance –Per risk Applies to property risks Limit applies separately to each risk (e.g. building) –Per occurrence Typically applies to liability covers Limit applies to total loss for an occurrence regardless of number of risks or policies involved –Aggregate excess Can apply to both property and liability covers Limits and retentions stated in terms of loss ratio bands –Reinsurer’s relative participation is NOT pre-determined, but depends on the size of the loss or loss ratio

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Contract Types – Mechanics of cession Excess Reinsurance –E.g. XOL $3,000,000 xs of $400,000

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Agenda Reinsurance Contract Types Data Grouping Dimensions Differences Between Reinsurance and Primary that affect Loss Reserving Other Considerations & Development Methods Other Reserving Methods

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data Grouping Dimensions Accident Year vs. Underwriting Year –or “Losses Occurring” vs. “Risks Attaching” Casualty vs. Property Treaty vs. Facultative Excess of Loss vs. Proportional Broker vs. Direct

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data Grouping Dimensions Accident Year vs. Underwriting Year –AY allows for easiest application of standard techniques Premium fixed as of December 31 Population of claims fixed at December 31 as well, though many may be unknown May not always be an option for reinsurance –Underwriting year includes experience on all treaties written during the year –Underwriting Year is often used in reinsurance, especially for proportional contracts –UY can cover two policy years and three calendar years for losses. Current UY as of 12 months is “incomplete”

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving “Incomplete Underwriting Year” UY 2001 includes all treaties written by the reinsurer in 2001 –“Risks Attaching” and/or “Policies Incepting” –UY 2001 can span two years and three accident years At 12/31/2001, UY 2001 is “incomplete” –Standard development methods derived from the past UYs will overstate the development of UY –Historical development after 12 months includes exposures yet to be earned –Provision for these losses should not be included in reserves at the 12/31/2001 accounting date.

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving “Incomplete Underwriting Year” 1/1/20011/1/20021/1/20031/1/2004 Sample Time Line Underwriting Year 2001 Covers Policies Incepting During this Period Accident Year 2002 Accident Year 2003 Accident Year 2001 Underwriting Year 2001 Covers Losses Occurring During this Period

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data Grouping Dimensions Casualty vs. Property –Casualty business generally has a longer development tail –Line of business (LOB) detail is often not available to the reinsurer, but if it is you might want to further subdivide by LOB as different LOBs may develop differently

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data Grouping Dimensions Treaty vs. Facultative –These display different development patterns, all else equal

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data Grouping Dimensions Excess of Loss vs. Proportional –Can be more important to split than line of business –Different development patterns –Possible reserve adequacy mix Excess of Loss - Case reserves generally reviewed by reinsurer claim dept and “ACRs” established Proportional - Case reserves booked as reported by ceding company without reinsurer review –Split Excess by layer - low, high, catastrophe

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data Grouping Dimensions Broker vs. Direct –Reinsurers obtain business either directly from cedant or through broker (or both) –Data flowing through broker may create additional reporting lag and result in different development patterns

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Agenda Reinsurance Contract Types Data Grouping Dimensions Differences Between Reinsurance and Primary that affect Loss Reserving Other Considerations & Development Methods Other Reserving Methods

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Differences Between Primary and Reinsurance Reporting Lag/Development Lag Data Increased Variability Tailor-Made or Atypical Contracts or Features “Accumulation of Issues”

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reporting Lag/Development Lag –Primary losses develop faster than reinsurance losses due to time lag for data to reach reinsurer –Proportional business: Accounts not due to reinsurer until days after quarter close It is possible that losses booked by ceding company in calendar year “X” will be realized and booked by reinsurer in calendar year “X+1” –Excess business: Reporting lag compounds with development lag Reinsurer not notified immediately of the loss The losses do not “hit” the reinsurer’s data until they exceed the threshold established in the Excess reinsurance contract Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reporting Lag/Development Lag –Excess business: Reporting lag compounds with development lag Example: –$400,000 excess of $100,000 per risk cover –Loss occurs in Year 1, reserved for $25,000 –Year 3 - reserve increased to $50,000, reinsurer verbally notified that loss MAY eventually reach their contract –Year 5, reserve increased to $150,000, reinsurer incurs loss 4 years after the primary company Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Primary vs. Reinsurer Reproduction of RAA 2001 Historical Loss Development Study Graph Primary Company Data Source: A.M. Best Company

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reporting Lag/Development Lag –Premium Estimates Needed in reinsurance more than for primary insurance Reserves must be set against premium earned as of the accounting date Reporting lag can cause large earned premium amounts to be unreported to the reinsurer as of the accounting date Creates a need to estimate premium and losses associated with this premium Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Data –Quantity The “infinite” detail of primary company data is often lost when reported to reinsurers as data gets “collapsed” along several dimensions – Accident dates not reported – Lines of business not reported Industry benchmarks by line of business or accident year can thus be difficult to use –Quality – affected by “varied quantity” Some ceding companies report more detail to reinsurers than do others As reinsurance data for reserving is organized at the level of common detail in terms of reported data fields, this has an impact on the quality of the analysis Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Increased Variability –Primary insurers purchase reinsurance (among other reasons) to make their results less variable (i.e. from catastrophes) –Reinsurer data is subject to this reinsured variation –Depending on the type of reinsurance cover, reinsurer data may BE this variation Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Primary Experience Gross of Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Primary Experience Net of Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reinsurance Experience

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Tailor-made or Atypical Contracts or Features –Many (possibly large) reinsurance contracts have features that affect the way their experience will develop relative to other contracts with which they would otherwise be grouped Examples: Stop loss arrangements, loss corridors, sunset clauses, etc Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving “Accumulation of Issues” –Each primary insurer faces issues (e.g. changes in reserve adequacy, settlement patterns, etc.) –Issues affect company’s loss reserving data, and reserving analyst has tools to neutralize the effects –Reinsurance loss reserving data is an accumulation of primary data each of which may have these issues –Adds a further complication to the reinsurance loss reserving process Differences Between Primary and Reinsurance

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Agenda Reinsurance Contract Types Data Grouping Dimensions Differences Between Reinsurance and Primary that affect Loss Reserving Other Considerations & Development Methods Other Reserving Methods

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Applications, Complications, and Considerations Application of Projection Methods –Loss Development Method –Loss Ratio Method –Bornhuetter-Ferguson Method –Other Methods

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Applications, Complications and Considerations Complications –parameter uncertainty Volatility in report-to-report (RTR) factors Result can be very leveraged by tail factor selection Loss trend factors Expected loss ratios –data constraints Line of business definition Claim count information often lacking Other considerations –qualitative information Often lack information on claims and underwriting changes at cedant level

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Development Method – Assumptions Assumes the relative change in a given year’s reported loss & ALAE from one evaluation to the next will be similar to the relative change in prior years’ reported loss & ALAE at similar evaluation points RTR factors measure change in reported loss & ALAE at successive evaluations tail factor allows for development beyond the observed experience Assumes the relative adequacy of the company’s case reserves has been consistent over time Assumes no material changes in the rate claims are paid or reported

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Development Method Suggestions for Tail Factors Industry benchmarks –RAA for excess Reinsurance industry data going back 40+ years Available for treaty vs. facultative and by attachment range –Primary sources lagged for pro-rata ISO A.M. Best NCCI Curve fitting –Compare to benchmarks for reasonability

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Development Method How to deal with variability in Historical Development Refine data –Line of business mix At the very least need to split property vs. casualty & pro-rata vs. excess –Treaty vs. facultative Development patterns may differ –Attachment points/limits Need to understand attachment points on from ground up (FGU) basis How are attachment points/limits changing over time –Assess whether or not data is still credible after making refinements

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Adjust for unique situations and claims –Commutations Remove from analysis, otherwise projections will be distorted –Treat any finite contracts separately E.g. aggregate stop loss covers – will not develop similarly to per occurrence excess Be watchful of traditional contracts with “finite” features –Annual aggregate deductibles, loss corridors –Asbestos, pollution, mass tort claims should be subdivided and reviewed separately If these claims are included in development data, the tail factor will be overstated for more recent periods –Segregate cats, 9/11 losses, other large/unusual losses Loss Development Method How to deal with variability in Historical Development

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Supplement with benchmarks –Utilize benchmark (or weighting of benchmarks) that is most appropriate for the book of business being analyzed. Consider: Nature of underlying exposure (e.g. products versus premises) Attachment points/limits Actual historical development Ceding company profile –Insolvent ceding companies will cause reporting delays Loss Development Method How to deal with variability in Historical Development

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Development by Line of Business Source: RAA Historical Loss Development Study, 2005 Edition.

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Treaty vs. Facultative – General Liability Source: RAA Historical Loss Development Study, 2005 Edition.

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Impact of Attachment Points – General Liability Source: RAA Historical Loss Development Study, 2005 Edition.

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Development Method Application same as for primary business Results leveraged –no claims = no IBNR –large claims = large IBNR

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Development Method Paid Loss Development Method not very common for reinsurance reserving –Payment pattern is often extremely slow and erratic –may be appropriate for property or low limit proportional business (e.g. nonstandard auto liability)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Ratio Method Useful for new business or immature years Need premium base and a priori expectation regarding loss ratio Advantage: stability –ultimate loss estimate does not change unless the premium or loss ratio are revised Potential problem: lack of responsiveness –ignores actual loss experience as it emerges

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Ratio Method Ultimate Loss = Earned Premium x ELR

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Loss Ratio Method Selecting the loss ratio: –historical experience paid and incurred loss experience LDF projection adjusted to appropriate year –rate changes –trends –coverage changes –underwriting considerations underwriting files actuarial pricing market considerations –benchmarks (industry results)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Adjustment for Incomplete Years Recent underwriting or policy years may not be fully earned as of the evaluation date –may need to scale back loss development projections –apply ultimate loss ratio to earned premium as of evaluation date Ensure that resulting IBNR is reasonable Ultimate Loss Ratio = Ultimate Loss / Ultimate Premium Ultimate premium –project development –seek underwriter input

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Agenda Reinsurance Contract Types Data Grouping Dimensions Differences Between Reinsurance and Primary that affect Loss Reserving Other Considerations & Development Methods Other Reserving Methods

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Reserving Methods - Bornhuetter-Ferguson Essentially a blend of LDF method and Expected Loss method –begins with an a-priori estimate of expected losses IELR (Initial Expected Loss Ratio) x Earned Premium –splits a-priori estimate into two pieces expected reported losses = (IEL x % reported) expected unreported losses(IBNR) = (IEL x % unreported) –replaces expected reported losses with actual reported (case incurred) losses Restated ultimate loss estimate equals –expected unreported(IBNR) plus actual reported (case incurred)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Bornhuetter-Ferguson Method - an Example

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Bornhuetter-Ferguson Method - an Example (Con’t)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Bornhuetter-Ferguson Method - Advantages Allows for smoothing of results –LDF method understates when case incurred losses are small overstates if losses large (ELR may understate in this instance) Incorporates changes in the environment –attachment point, coverage changes, layer restructuring, price strengthening/deterioration Balances stability and actual loss emergence Estimates IBNR when loss activity is sparse –ideal for long tailed lines (umbrella, xs casualty) –redundant for short tailed lines (approximates LDF method) Reflects potential information found in underwriting files –underlying limits profile

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Bornhuetter-Ferguson Method - Disadvantages Reporting pattern –expected percentage reported = 1 / LDF –difficulty in estimating pattern for LDF method also applies here Initial expected losses –IBNR is directly related to a-priori estimate double the expected losses ----> double the IBNR –importance of IELR may be lost in the analysis need to step back and determine % of total IBNR that is loss ratio driven Ultimate Premium –most recent year may be difficult to estimate booked premium is probably under-reported due to timing lags seek underwriting estimate

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Bornhuetter-Ferguson Method - Alternative Sources of Initial Expected Losses Loss Ratio Method (incorporates pricing indices) Underwriting estimate from pricing study –by definition it is the a-priori estimate verify that parameters for pricing and reserving are consistent Increased limits factors and direct premium –may be used if you feel primary company’s higher limits pricing is inadequate should have been incorporated in pricing study –may also be used for changes in layer and/or attachment point Stanard-Buhlman estimates Frequency/Severity estimates

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Example of change in layer structuring Effect on IELR

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Stanard-Buhlman Estimate Essentially the Bornhuetter-Ferguson estimate with “on average” perfect information Uses actual loss ratio indices multiplied by average loss ratio –incorporating loss trend and pricing changes Balances the expected average loss ratio so that: –expected reported losses = actual reported losses

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Stanard-Buhlman - an Example

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Stanard-Buhlman - an Example (continued)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Stanard-Buhlman - an Example (continued)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Stanard-Buhlman - Bornhuetter-Ferguson Method (continued)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Frequency Based Method - Basic Steps - Including Policy Limit Impact Estimate the annual number of claims above the data limit –37.5 claims greater than $150,000 Use size of loss curves to project the number of claims above the reinsurance retention –11.3 (of 37.5 claims) greater than $300,000 Use size-of-loss curves to project average severity of claims in reinsurance layer –$239,751 average severity of claims in $700,000 excess of $300,000 layer Multiply the frequency and the severity projections to estimate the total ultimate losses Incorporate frequency/severity estimate into Bornhuetter- Ferguson method

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Frequency/Severity - Estimate of claim counts above data limit

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Frequency/Severity - Estimate of claim counts above data limit (Con’t)

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Frequency/Severity - Estimation of excess losses using pareto distribution

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Frequency/Severity - Bornhuetter-Ferguson Method

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Recap of Methods - Ultimate Loss and ALAE

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Recap of Methods - Ultimate Loss and ALAE Ratios

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Final Selection of Ultimates Rules of Thumb LDF methods for older, more mature accident/policy periods –look at LDF/ percentage reported to determine maturity umbrella versus auto physical damage Expected Loss techniques for newer, less mature accident/policy periods –most recent or two most recent accident years Bornhuetter-Ferguson/ Stanard Buhlman, anywhere in between –requires judgment: (GL, umbrella, excess casualty) Frequency/Severity: similar to expected loss techniques –better estimate when loss ratio is unstable/unreliable high layers, single treaties Benchmarks –IBNR to case O/S ratios; loss ratios

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Other Thoughts Look for trends, stability, shocks –are they reasonable ? Communicate with the underwriting and claims departments – good fodder for next underwriting audit or pricing season Gather knowledge on reserving philosophy (level of ACRs) –make adjustments where necessary to benchmarks How to handle new lines of business with no history –benchmarks, underwriting files, actuarial pricing analysis Incomplete underwriting year –ultimate loss & ALAE ratio using ultimate premium apply to estimated earned premium; look at actual case incurred Difficult Coverages (Agg XS, deductibles, reinstatements) –requires modeling of underlying exposures

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Other Approaches (Con’t) Asbestos, Pollution, Other Health Hazards –Need to handle separately Cedant information, industry data, benchmarks Results of exposure based modeling techniques Large Events / Market Losses (WTC losses) –Seek input from claims department –Utilize market information / knowledge Property Catastrophes –Results of models (may need to adjust) –Underwriter estimates –Traditional top-down techniques

CASUALTY LOSS RESERVE SEMINAR An Introduction to Reinsurance Reserving Contact Information Anita Sathe, ACAS, ASA Deloitte Consulting LLP Phone: (860) Christopher Bozman, FCAS, MAAA Towers Perrin Tillinghast Phone: (215) Michael Angelina, ACAS, MAAA Endurance Specialty Holdings, Ltd Phone: (441)