PwC
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
NCCI
October 12, 2004
IASB Board – February 15, 2005
PwC
PwC
Outline
• Project objectives & specifications
• Measurement approaches
• Findings
• Significant issues
Slide 2
Research objectives
1. 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
2. Identify significant issues associated with discounting and risk
adjustment in loss and LAE claim liabilities
Slide 3
Measurement objectives
•
Active markets for claim liabilities do not exist
− Entity-specific experience was used
•
Claim liability measurement components
1. Undiscounted estimate of future payments
− Assumed undiscounted losses were estimated appropriately
2. Discount for time value of money
3. Margin for risk and uncertainty (“Market Value Margin” / “MVM”)
− Did not reflect correlation across lines of business
•
Slide 4
No adjustment for own credit risk other than in aggregate cost of
capital
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
Slide 5
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
Slide 6
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
Class
Personal Auto Liability
Workers Compensation
Medical Malpractice
Slide 7
Development Method
SD Multiple
Stochastic Method
SD Multiple
Stochastic Method
Percentile
1.2
1.0
1.5
2.0
1.5
2.3
90%
92%
95%
Findings – discounting
Average discount factor by year for Personal Auto Liability
Discount factor
10.0%
9.0%
8.0%
7.0%
6.0%
Duration
5.0%
Matched
4.0%
3.0%
2.0%
1.0%
0.0%
1998
1999
2000
Year
Slide 8
2001
2002
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
Slide 9
MVM by company (increasing by size)
Personal Auto Liability
MVM by Company at Year-End 2002
100%
90%
80%
MVM %
70%
60%
ROC MVM
50%
40%
30%
20%
10%
0%
0
2
4
6
Company
Slide 10
8
10
12
MVM by company (increasing by size)
Workers Compensation
MVM by Company at Year-End 2002
100%
90%
ROC MVM
80%
MVM %
70%
60%
50%
40%
30%
20%
10%
0%
0
2
4
6
Company
Slide 11
8
10
12
MVM by method for one company
Personal Auto Liability
MVM by Method - Company C(M)
18%
16%
14%
Develop SD
MVM %
12%
Stoch SD
10%
Percentile
ROC
8%
6%
4%
2%
0%
1998
1999
2000
Year-End
Slide 12
2001
2002
MVM by method for one company
Workers Compensation
MVM by Method - Company K(L)
70%
60%
Develop SD
MVM %
50%
40%
Stoch SD
Percentile
30%
ROC
20%
10%
0%
1998
1999
2000
Year-End
Slide 13
2001
2002
MVM by company for one method
Personal Auto Liability
MVM by Company at Each Year-End (Development Model)
A (S)
120%
B (S)
H (S)
100%
MVM (%)
I (S)
80%
V (S)
C (M)
60%
F (M)
G (M)
40%
D (L)
20%
E (L)
Average
0%
1997
1998
1999
2000
Year-End
Slide 14
2001
2002
2003
MVM by company size
Personal Auto Liability
MVM for All Companies and All years
70%
60%
MVM (%)
50%
MVM vs.
Company
Size
40%
30%
20%
10%
0%
0
200,000
400,000
600,000
Reserves ($000)
Slide 15
800,000
1,000,000
Discounting & MVM by company
Workers Compensation
FV Factor by Company at Year-End 2002
80%
FV Factor %
60%
40%
20%
ROC FVF
0%
0
2
4
6
-20%
-40%
Company
Slide 16
8
10
12
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)
Slide 17
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
Slide 18
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
Slide 19
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)
Slide 20
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
Slide 21
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
Slide 22
Assessment of P&C actuarial methods
Slide 23
Estimating undiscounted claim liabilities
Good
Discounting estimated future payments
Good
Estimating market value margins
Developing
Calibration of MVM methods
Emerging