kpmg 2002 Casualty Loss Reserve Seminar Surety Reserving Mike Rozema, ACAS, MAAA KPMG LLP

kpmg Overview Reserving Considerations One Loss Reserve Estimation Approach Premium Deficiency Reserves -Considerations -Use of Bond Default Rates to estimate future losses

kpmg Reserve Estimate Approach Gather data Understand large claim potential Assign probabilities and scenarios to claims with high bond limits Estimate gross reserves for all other losses Estimate ceded reserves Simulation

kpmg Step 1 – Gather Data Bond limits profile Large claim information Type of business mix Reinsurance program

kpmg Step 2 - Understand the potentially large claims Review all open claims with significant exposure -One principal, many bonds -Review claims files -Read the contracts -Do not ignore losses with low case reserves

kpmg Step 3 - Assign probabilities and scenarios to potentially large losses Interview Claims Personnel -What would you settle these claims for? -What is our maximum exposure? -What is the claims handling strategy? -What is the subrogation potential? -What is the expected payment pattern? Low, Medium, High, and Other Scenarios -Assign Probabilities and Severities

kpmg Step 4 – Estimate reserves for all other losses Use traditional actuarial techniques -Development methods -Bornhuetter-Ferguson -Frequency/Severity Development patterns affected by bond type -Expense -Subrogation -Statute (Workers Comp Self-insured Bonds)

kpmg Actuarial SOP No. 36 Explanatory paragraph required when actuary believes that there are risks and uncertainties that could result in material adverse deviation. -Identify the amount judged to be material -Describe the major factors and particular conditions underlying the risks and uncertainties Expected value estimate is better than the median or mode when expected value estimates can be significantly greater than other measures.

kpmg An Example

kpmg Step 5 – Reinsurance Surety Treaty Provisions -Surety reinsurance is unique, usually separate from other lines of business Facultative Reinsurance Estimate ceded losses for each large loss and for all other claims for each scenario.

kpmg Step 6 – Simulation Simulate Gross Losses -Use Large Loss Scenario Probabilities -Use triangle techniques to estimate aggregate reserve distribution for all other claims -Consider correlation between large loss scenarios and other reserves Estimated Ceded Losses for each Simulation Result

kpmg Simulation Results Net and Gross Aggregate Loss Distributions are helpful -Range of reasonable estimates -Identifying and quantifying risk of material adverse deviation -Effectively communicating risk to management -Quantifying reasonable risk loads by bond type

kpmg Premium Deficiency Reserves SSAP No. 53 – Property Casualty Contracts - Premiums -When anticipated losses, loss adjustment expenses, commissions, and other acquisition costs exceed the recorded UPR, a premium deficiency reserve is required. -Insurance policies shall be grouped in a manner consistent with how policies are marketed, serviced, and measured.

kpmg Premium Deficiency Reserves Considerations -Surety is generally marketed on its own and therefore should be segmented for PDR estimate -Non-cancelable contracts -Multiple year contracts – understand how premium is earned -Restrictive reinsurance market -Regulatory constraints to premium increases -Recession increases frequency

kpmg Premium Deficiency Reserves – Loss and ALAE estimates Group principals homogeneously -Bond Type (e.g. Commercial, Contract) -Bond Limit -Financial Strength Use rating agency corporate bond default rates to estimate claim frequency Use historical data to estimate claim severity as a percentage of bond limit

kpmg PDR Loss Estimate - Example

kpmg Summary Understand Bond Mix, Limits Profile and Reinsurance Provisions Large Exposures need detailed analysis Scenario/simulation approach is useful Market/economic conditions may result in premium deficiencies