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Industry Reserve Adequacy - Beyond The Statement of Opinion 2000 Casualty Loss Reserve Seminar Minneapolis, MN.

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Presentation on theme: "Industry Reserve Adequacy - Beyond The Statement of Opinion 2000 Casualty Loss Reserve Seminar Minneapolis, MN."— Presentation transcript:

1 Industry Reserve Adequacy - Beyond The Statement of Opinion 2000 Casualty Loss Reserve Seminar Minneapolis, MN

2 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion2 Presenters n Sarah Hibler - Vice President & Senior Credit Officer, Moody’s Investors Service n Myron Picoult - Senior Advisor FIG, Wasserstein Perella Securities, Inc. n Bill Wilt - Vice President & Senior Analyst, Moody’s Investors Service

3 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion3 Discussion Topics n Overview of Reserve Adequacy –Results of Moody’s Top 50 Analysis n Use of Reserves in Credit Analysis –How and why reserve charges impact credit ratings n Equity Markets and Reserve Adequacy –Wall Street’s view of loss reserve charges

4 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion4 Goals of Session n Provide different perspective on loss reserves n Provide insight into as to how ‘outsiders’ analyze loss reserves n Demonstrate importance of reserves in different contexts: –Credit Analysis –Equity Analysis

5 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion5 Top 50 Analysis n Moody’s Analyzed Top 50 P/C Groups –Approx. 60% of industry reserves and surplus n Used annual statement data and internal reserve model –Excluded A&E, reinsurance lines –Reviewed 75% of each company’s carried reserves n Tested results against independent analyses where available –Despite limitations, annual statement data can provide credible starting point

6 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion6 Top 50 Analysis Benefits of Analysis –Critical component of capital adequacy and credit analysis –Provides greater insight in discussions with companies –Independent verification of results –Insight into developing trends: quality of earnings, current rate adequacy –Separate supportable facts from unsubstantiated rumors in market

7 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion7 Top 50 Analysis Retrospective View of Adequacy

8 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion8 Top 50 Analysis Conclusions n Reserve margins largely depleted –Estimates Top 50 at 12/99 »Redundancy 0.5% surplus and reserves –Estimates Top 50 at 12/98 »Redundancy 3% surplus and reserves n Rate of decline steepest among commercial insurers n Personal insurers maintain modest redundancy

9 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion9 Top 50 Analysis - Personal Lines Writer’s Current Position

10 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion10 Top 50 Analysis - Retrospective View of Personal Insurer’s Adequacy

11 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion11 Top 50 Analysis n Findings - Personal Insurers –Moderate redundancy despite release of $3.6 B in reserves. –The story in 1999/2000 »Declining rates meet positive loss trends »Reserve releases for some carriers, isolated reserve charges for others –Outlook for 2000 »Most carriers raising rates »Positive loss inflation, severity seems to vary »Reserve cushion likely to remain

12 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion12 Top 50 Analysis - Commercial Writer’s Current Position

13 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion13 Top 50 Analysis - Retrospective View of Commercial Insurers

14 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion14 Top 50 Analysis n Findings - Commercial Insurers –Reserve adequacy falling fast; nearing outer bounds of reasonable range –The story in 1999/2000 »Price firming -- tempered by inflation? »Minimal reserve releases, divergence in AY L/R selections »Flat L/R for 1997-1999 aided by reinsurance? –Outlook for 2000 »Upside from rates clipped by reserves, reinsurance? »Thin margins for new latent losses »Troubling if rally does not hold

15 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion15 Top 50 Analysis Conclusions –The party is over -- AY and CY results to converge –Aggregate trends seem dangerous, improving fundamentals may avert reserve crisis –Lessons from 1999 »“Material” -- what does it mean to you? »Reserve charges can shatter investor, policyholder confidence n Reserves Used in Variety of Ways by Many Constituencies…Think Beyond Statement of Opinion

16 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion16 Industry Reserve Adequacy -- Beyond the Statement of Opinion Role of Loss Reserves in Credit Analysis

17 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion17 Industry Reserve Adequacy -- Beyond the Statement of Opinion n n Moody’s analytical approach n n Property & casualty rating trends n n Analytical example: reserve charge n n What do creditors/policyholders want?

18 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion18 Moody’s Analytical Approach

19 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion19 Moody’s Analytical Approach -- Beyond the Numbers Focus on the Franchise: n n Heavy emphasis on qualitative factors n n Look for sustainable competitive advantage n n Avoid over-reliance on quantitative models to determine ratings

20 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion20 Moody’s Property & Casualty Rating Trends n n Downgrades and negative rating actions (reviews, outlooks) outweigh positive actions n n Severe financial distress felt by many companies highlights a myriad of risks: – –Reserves – –Data – –Growth – –Confidence sensitivity n n Trough reached -- perhaps?

21 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion21 Analytical Example: Reserve Charge ABC Holding Company Investment in Affiliate $1,000Senior Debt: $350 Equity: $650 ABC Operating Company Total Assets: $3,500 Loss Reserves: $2,000 Other Liab. $500 Surplus:$1,000

22 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion22 Analytical Example: Reserve Charge Assumptions n n Holding Company’s Cash Needs: – –Debt service: assume $350M @ 8% = $28 million annually – –Other needs: administrative and shareholder dividends n n Normal Year – –Net income @ 10% of surplus = $100M – –Debt needs plus other expenses allow for organic growth of surplus.

23 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion23 Analytical Example: Impact of a Reserve Charge

24 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion24 Analytical Example: Reserve Charge Assumptions n n Reserve Charge – –Reserve charge @ 15% of reserves = $300 M – –Net loss of $98 M – –Year end surplus of $902 M (before dividend) n n Dividend Paying Capacity? – –Greater of net income or 10% of surplus => $90 M – –Lesser of net income or 10% of surplus => Alternative Liquidity? – –Cannibalize Insurance Operations to service debt (and provide return to shareholders)

25 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion25 Analytical Example: Reserve Charge Assumptions

26 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion26 What do Creditors/Policyholders Want? n Absolute repayment n Minimize likelihood of loss of principal; benchmark is risk-free rate n Which translates into: –Conservative corporate governance –Prudent capital and financial management –Capital cushion –Strong earnings and cash flows

27 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion27 Credit vs. Equity Analysis Credit vs. Equity Analysis Contrasting Analytical Styles - Example n ABC’s creditors/policyholders have NO upside

28 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion28 Industry Reserve Adequacy -- Beyond the Statement of Opinion The Equity Perspective

29 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion29 Industry Reserve Adequacy -- Beyond the Statement of Opinion APPENDIX Retrospective View of Reserve Adequacy by Line of Business

30 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion30 Industry Analysis - Retrospective View of Homeowners

31 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion31 Industry Analysis - Retrospective View of Private Passenger Auto

32 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion32 Industry Analysis - Retrospective View of Commercial Auto Liability

33 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion33 Industry Analysis - Retrospective View of Workers Compensation

34 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion34 Industry Analysis - Retrospective View of Commercial Multi Peril

35 2000 CLRSIndustry Reserve Adequacy - Beyond The Statement of Opionion35 Industry Analysis - Retrospective View of Other Liability Occurrence


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