Report of the Tail Factor Working Party Steven C. Herman, FCAS, MAAA San Diego, California September 10-11, 2007

Tail Factor Working Party Co-Chairs Steven C. Herman Mark R. Shapland Members Mohammed Q. Ashab Richard Kollmar Joseph A. Boor Rasa V. McKean Anthony R. Bustillo Michael R. Murray David A. Clark Bernard A. Pelletier Robert J. Foskey Anthony J. Pipia Sejal Haria F. Douglas Ryan Bertram A. Horowitz Scott G. Sobel Gloria A. Huberman

Tail Factor Working Party Disclaimer: While this paper is the product of a CAS working party, its findings do not represent the official view of the Casualty Actuarial Society. Moreover, while we believe the approaches we describe are very good examples of how to address the issue of estimating development of loss and loss adjustment expense payments from a given evaluation to ultimate disposition, we do not claim they are the only acceptable ones, nor do they represent all possible applications of the specific methods presented.

The Motivation Tail factors used to estimate additional development occurring Tail factors used to estimate additional development occurring –after the eldest maturity in a given loss development triangle, or –after the eldest credible link ratio. Over the years, many valuable contributions have been made to the CAS literature describing methods for calculating tail factors. Over the years, many valuable contributions have been made to the CAS literature describing methods for calculating tail factors. However no overall paper compiling these contributions existed. However no overall paper compiling these contributions existed.

The Paper The CAS Tail Factor Working Party prepared this paper on the methods currently used by actuaries in estimating loss development tail factors. The CAS Tail Factor Working Party prepared this paper on the methods currently used by actuaries in estimating loss development tail factors. Standard terminology for discussing aspects of link ratios and tail development is communicated within the paper. Standard terminology for discussing aspects of link ratios and tail development is communicated within the paper.

The Paper Included are Included are –Descriptions of advantages and disadvantages of each method and –Identification of what entities (companies, rating bureaus, or consulting firms) typically use each method.

Paper Description Organized by “Type” of Method Organized by “Type” of Method Sections Describe: Sections Describe: –Mechanics of each method, –Examples for most methods, –Results of our Testing, and –Results of our Surveys

Paper Description Standard Notation: Standard Notation: –Consistency, –Started with Notation from Reserve Variability Working Party –Added new notation where lacking Summarize Areas for Future Research Summarize Areas for Future Research

Section Description Bondy-Type Methods Bondy-Type Methods Algebraic Methods Algebraic Methods Benchmark Methods Benchmark Methods Open Claim Methods Open Claim Methods Curve Fitting Methods Curve Fitting Methods Lifespan Methods Lifespan Methods Miscellaneous Methods Miscellaneous Methods

Bondy-Type Methods Description Bondy Method Bondy Method –Use last link ratio: Modified Bondy Method Modified Bondy Method –Double or square: Generalized Bondy Method (Weller) Generalized Bondy Method (Weller) –For 0<B<1: Fully Generalized Bondy Method (Gile) Fully Generalized Bondy Method (Gile) –Let Vary by Accident Year

Bondy-Type Methods Description Advantages Advantages –Simple to Implement –Pattern Described with One Factor –Only Requires Cumulative Paid Data Disadvantages Disadvantages –Not Always Useful for Incurred Data –Will Fail with Increasing Development –May Fail with “More Complicated” Patterns

Algebraic Methods Description Equalizing Paid & Incurred Loss Estimates Equalizing Paid & Incurred Loss Estimates –Use Cumulative Incurred / Cumulative Paid Boor’s Method Boor’s Method –Adjust Case Reserves Mueller’s Method Mueller’s Method –Adjust Incremental Factors NCCI Method NCCI Method

Algebraic Methods Description Advantages Advantages –Simple to Implement –Only Requires Cumulative Data –Statistically Unbiased Disadvantages Disadvantages –May Not be Sophisticated Enough –Subject to Case Reserve Distortions –Some Methods Not Generally Well Known

Benchmark Methods Description Benchmark Development / Link Ratios Benchmark Development / Link Ratios Adjusted Benchmark Development / Link Ratios Adjusted Benchmark Development / Link Ratios –Use Link Ratios to Adjust Tail Factor Benchmark Average Severity Benchmark Average Severity Benchmark Adjusted by Claims Audit Benchmark Adjusted by Claims Audit

Benchmark Methods Description Advantages: Advantages: –Supplement when Little Data –Adds Credibility –Various Degrees of Sophistication Disadvantages: Disadvantages: –Need Similar Data –Claim Handling Procedures –Relative Case Reserve Strength

Open Claim Methods Description Maximum Possible Loss Maximum Possible Loss Judgment of Open Claim Costs / Audit Judgment of Open Claim Costs / Audit

Open Claim Methods Description Advantages: Advantages: –Incorporates Particulars of Open Claims –Uses Knowledge of Claim Staff –Can Provide Bounds Disadvantages: Disadvantages: –Requires Access to Individual Claims –Subject to Judgment/Availability of Auditors –May Underestimate Severe or IBNR/Reopened Claims

Curve Fitting Methods Description Exponential Decay Exponential Decay –Constant Rate of Factor Decay McClenahan’s Method McClenahan’s Method –Constant Monthly Incremental Paid Decay Skurnick’s Method Skurnick’s Method –Simplify Using Annual Decay Sherman’s Method Sherman’s Method –Use “Inverse Power” Curves England-Verrall Method England-Verrall Method –Smooth & Extrapolate Incremental Data

Curve Fitting Methods Description Advantages: Advantages: –Straightforward & Intuitive –Extrapolate Beyond End of Data –Various Levels of Sophistication Disadvantages: Disadvantages: –May Underestimate Tail for Long-Tail Lines –Sub-Optimal If Pattern Not Consistent –Sometimes No Closed Form Solution

Lifespan Methods Description Static Mortality Method Static Mortality Method –Frequency / Severity Using Mortality Rates Trended Mortality Method Trended Mortality Method –Greatest Impact on “Distant” Years Sherman-Diss Method Sherman-Diss Method –Separate Impact of Inflation & Mortality Corro’s Method Corro’s Method –Modeling of “Pension” Claims

Lifespan Methods Description Advantages: Advantages: –Extrapolate “Very-Long” Tail –Can Include “Increasing” Factors –Detailed Assumptions/Some Non-Subjective Disadvantages: Disadvantages: –More Complex –Need “Very Old” Data to Parameterize –Need Specific Mortality Rates

Miscellaneous Methods Description Restating Historical Experience via a Claims Audit Restating Historical Experience via a Claims Audit –Adjust for Changes

Miscellaneous Methods Description Advantages: Advantages: –Improves “Other” Methods –Adjustments Readily Understood –Add Claim Professional Judgment Disadvantages: Disadvantages: –Difficult to Reconstruct Old Claim Files –Auditor Must Ignore Prior Development –Auditor Must Evaluate at Multiple Points