1. Casualty Actuarial Society Practical discounting and risk adjustment issues relating to property/casualty claim liabilities Research conducted by PricewaterhouseCoopers Presented by Sam Gutterman, FCAS, FSA, MAAA IASB Board – February 15, PwC PwC

2. Outline Project objectives & specifications Measurement approaches
Findings
Significant issues

3. Research objectives
Given a set of fair value principles, evaluate the effect of discounting and risk adjustment on loss and loss adjustment expense (LAE) claim liabilities of US property/casualty insurance companies
Identify significant issues associated with discounting and risk adjustment in loss and LAE claim liabilities

4. Measurement objectives
Active markets for claim liabilities do not exist
Entity-specific experience was used
Claim liability measurement components
Undiscounted estimate of future payments
Assumed undiscounted losses were estimated appropriately
Discount for time value of money
Margin for risk and uncertainty (“Market Value Margin” / “MVM”)
Did not reflect correlation across lines of business
No adjustment for own credit risk other than in aggregate cost of capital

5. Research specifications
Used publicly available entity-specific loss data only
Schedule P from US regulatory Annual Statements
Lines of business studied
Personal Auto Liability (shorter tail, although in some countries this coverage would be considered long tail)
Workers Compensation (long tail – stable)
Medical Malpractice, claims-made (long tail – volatile)
Evaluated ten companies for each line of business

6. Measurement approaches
Liability elements studied and measurement approaches evaluated
Discount factor models
Duration
Matched to yield curve
MVM models
Development (Mack) method using standard deviations
Stochastic simulation using standard deviations
Stochastic simulation using percentile distribution
Return on capital

7. Measurement calibration
Calibrated to the Cost of Capital Method at calendar year-end 2002
Capital equal to US regulatory minimum Risk Based Capital requirement
10% target rate of return on capital for each company
Arithmetic average of calibrations for 3 companies
1 large, 1 medium, 1 small

8. Findings – discounting

9. Findings – discounting
Given a payment pattern, well-defined approaches are available
In general, no significant differences between duration and matching approaches were identified
Discounted results are affected by
Interest rate fluctuations
Shape of the yield curve
Expected payment pattern and tail (time until claim resolution)
Significant uncertainty can be associated with payment patterns
In most cases, will be less than for amount of ultimate losses
Will require additional calculations, but generally not onerous

10. MVM by company (increasing by size) Personal Auto Liability

11. MVM by company (increasing by size) Workers Compensation

12. MVM by method for one company Personal Auto Liability

13. MVM by method for one company Workers Compensation

14. MVM by company for one method Personal Auto Liability

15. MVM by company size Personal Auto Liability

16. Discounting & MVM by company Workers Compensation

17. Findings – MVM measurement
Indications for MVMs varied, sometimes significantly
By method, for a given company and year-end
Over time, for a given company and MVM method
The ranking of size of MVMs by method tended to vary over time
No method was consistently the highest nor the lowest
For smaller companies, MVMs tended to be larger (when measured as a percentage of claim liabilities)

18. Findings – effect on claims liabilities
Personal Auto Liability
FV claim liabilities were generally greater than undiscounted/non-risk adjusted claim liabilities
Workers Compensation
FV claim liabilities were generally less than or close to the undiscounted/non-risk adjusted claim liabilities
Medical Malpractice claims-made
We did not consider the results of our testing to be meaningful, as there was too much statistical variation in results
Impact of moving to fair value of claim liabilities tended to be greater (due to larger MVMs) for smaller companies
Based on the model calibrations

19. Findings – effect on incurred losses
Current accident year incurred Fair Value losses were generally greater than undiscounted/non-risk adjusted losses
Relativities affected by calibration benchmark applied
Accident year FV liability development benchmark would not be zero
Due to relative changes in discount and MVM
Leveraged effect of changes in claim liability would likely increase volatility of incurred losses

20. Significant issues Modeling measurement
Real data issues
Measures of variation
Releasing constraint of acceptance of booked claim liabilities as expected (unbiased) ultimate amount of losses will affect
Expected payment and claim notification patterns
Variability of experience in relation to expectations
Variation from the tail/prior accident year bucket
Affected by study period, level of aggregation and degree of homogeneity of claims selected
Risk and variation inherent in certain claim liabilities are not be easy to analyze quantitatively (e.g. asbestos and environmental)

21. Significant issues MVM estimation
Variety of approaches exist, but no single approach currently preferred or accepted
Further professional research, guidance and education needed regarding acceptable methods and calibration procedures for calculating MVMs to obtain consistent and comparable results
Single industry guideline for all lines of business and companies unlikely to be appropriate
Calibration of MVM models
Challenging
Can significantly affect the results

22. Significant issues Financial statement presentation
Based on currently available approaches, non-additivity of MVMs requires judgmental allocation among
Accident years
Lines of business
Business units
Accident year development disclosures may be confusing
Development of prior claim liabilities would not necessarily be benchmarked to zero
Component analysis of one-year development of prior year-end claim liabilities quite complicated
Solution might be triangular analysis shown on an undiscounted, non-risk adjusted basis

23. Assessment of P&C actuarial methods
Estimating undiscounted claim liabilities
Good
Discounting estimated future payments
Estimating market value margins
Developing
Calibration of MVM methods
Emerging