SOP 97-3 and Other Balance
Sheet Reserves
CLRS 2004
Las Vegas, Nevada
September 13, 2004
Claus S. Metzner, FSA, FCAS, MAAA, Aktuar – SAV
Actuary, Milliman, Inc.
Milliman
Other Balance Sheet Reserves
 Reserves
 Premium Revenue Recognition Reserve
 Retro Rated Premium Reserve
 Reserves for Contingent Commissions
 Premium Deficiency Reserves
 Policyholder Dividend Reserves
 Will be discussing these reserves/assets from the insurer perspective
and the insured perspective
 “Impacts” if Reserve not Set Appropriately
 Remember
 Materiality is, as always, a consideration
 Consider “consistency” between loss reserving assumptions and
assumptions underlying “Other” reserves
Milliman
1
Other Balance Sheet Reserves
Premium Revenue Recognition Reserve
• Arises from delays in premium reporting
– Estimated premium is higher/lower than final premium since
exposures (payroll, sales) initially estimated
• Impacts: Insurer
– Mismatch of revenue/expense
» B-F loss ratio implications
» Combined Ratio too low/high
– Balance Sheet – Asset (general situation) is missing
» Capital understated due to missing asset
• Impacts: Insured
– Mismatch of revenue/expense
– Balance sheet – liability (general situation) is missing
» Capital overstated
Milliman
2
Other Balance Sheet Reserves
Retro Rated Premium Reserve
• Arises from loss reporting/loss settlement pattern
– Interim adjustments lead to premium recorded to date that is
higher/lower than final contractual premium since losses are
not yet fully settled
• Impacts: Insurer
– Mismatch of revenue/expense
» B-F loss ratio implications
» Combined Ratio too low/too high
• Impacts: Insured
– Mismatch of revenue/expense
– Balance sheet – liability is missing
Milliman
3
Other Balance Sheet Reserves
Contingent Commission Reserve
• Arises from Agency contracts
– May be based on “revenue” targets
– May be based on “profit” targets
– May be a combination of various targets
• Impacts: Insurer
– Mismatch of revenue/expense
» Combined Ratio too low/too high
» Capital misstated
(note: specific contract terms should be reviewed and the
contingent commission program could be modeled in
relation to the underlying loss ratio performance)
• Impacts: Agency
– Mismatch of revenue/expense
– Capital misstated
Milliman
4
Other Balance Sheet Reserves
Premium Deficiency Reserve
• Projection of Loss arising from obligations entered into but where
premium has not yet been earned
– Considerations
» By Line?
» By Business Unit?
» By Company?
– Source of Data
» Calendar/Accident Year
» Policy Year
• Impacts: Insurer
– Capital misstated
(note: loss ratio performance, adjusted for the premium revenue recognition reserve,
is critical; a good paper on this evaluation, is Ralph Blanchard’s article in the
2000 Fall CAS Forum)
Milliman
5
Other Balance Sheet Reserves
Dividend to Policyholder Reserve
• Need to consider the impact of
– Premium Revenue Recognition Reserve
– Reflection in Variable Dividends of Loss Ratio changes
due to
» Premium Revenue Recognition Reserve
» “knowledge” gained from Premium Deficiency
Reserve evaluation
• Impacts: Insurer
– Capital misstated
Milliman
6
Other Balance Sheet Reserves
Summary
 Other Balance Sheet Reserves are important
• To the Insurer and to the Insured
• May need to be considered within the scope SOP
97-3 for non-insurers (materiality?)
 Other Balance Sheet Reserves are probably
impacted by Loss and Loss Adjustment
Reserve Evaluations – need to assure
consistency
Milliman
7