Casualty Loss Reserve Seminar
September 2004
Solvency SurveillanceWhat is Working and What is Not
Ron Dahlquist, FCAS, MAAA
California Dept. of Insurance
1
What isn’t working:
The Actuarial Opinion
•
•
•
•
Actuarial Opinions and supporting reports least reliable when
company is in financial difficulty
– Multiple insolvencies of CA WC specialty companies
– Companies with excessive exposure to construction defect claims
– Some multiple lines carriers
Great majority of all insolvent or impaired companies (and all of the
insolvent CA WC specialty companies) had clean actuarial opinions at
previous year end
– Only one company I can recall that self-identified an insolvency to CDI
– Reserve deficiencies the proximate cause of nearly all recent
insolvencies
Insurance Department examiners, financial analysts cannot rely on
actuarial opinions to identify inadequately reserved companies
Actuarial opinions don’t provide comfort that apparently healthy
companies are truly healthy
2
Support for Actuarial Opinions
• Actuarial Reports supporting Opinions
characterized by (overly) optimistic
assumptions
• Examples:
– California Workers Compensation
– Bornhuetter-Ferguson application, with new
and discontinued programs
– Problem areas, e.g. construction defect
3
Support for Actuarial OpinionsCalifornia Workers Compensation (1)
• Characteristics of CA WC experience,
development statistics:
– Severe medical inflation
– Marked, long-term slowdown in settlement
rates
– Marked, long-term upward trend in age-to-age
development patterns (both paid and
incurred)
4
Support for Actuarial OpinionsCalifornia Workers Compensation(2)
•
Actuarial Opinion analyses:
– Ignore incurred development method, citing apparent reserve
strengthening
• Do not adequately test reserve strengthening assumption
• Do not perform Berquist-Sherman adjustment for change in case reserve
adequacy
– Rely on paid development method (almost) exclusively
• Do not test settlement rate for changes
• Do not perform Berquist-Sherman adjustment for change in settlement rate,
citing prevalence of partial payments
• Do not make alternative adjustments to treat problem
– Use three-year averages of age-to-age factors, or longer-term
averages, despite strong upward trend in actual age-to-age factors
• Cite expectations that development must moderate on its own (it can’t stay
high forever)
• Ignore causal links to closing rate, high inflation
5
California Workers Compensation (3)
WCIRB Pure Premium Rate Analysis
Track Record
• Analysis more aggressive than Appointed Actuaries rendering
opinions on subsequently insolvent companies
• Relied exclusively on paid development method
• Trended loss development factors
– Trending used for last several filings
– Seen as aggressive
• Past estimates of ultimate loss have proven to be far short of
subsequent estimates
• Recent estimates show less adverse development
6
CALIFORNIA WORKERS' COMPENSATION
WORKERS' COMPENSATION INSURANCE RATING BUREAU ANALYSIS
ESTIMATED ULTIMATE LOSS RATIOS
Estimated Ultimate Loss Ratios:
as of
Accident
Year
1995
1996
1997
1998
1999
2000
2001
2002
2003
Earned
Premium
3,922,429,612
3,832,585,126
4,140,947,275
4,458,921,916
4,724,984,138
6,401,248,003
9,837,605,273
13,282,762,835
18,780,082,806
as of
as of
as of
as of
(1)
as of
3-31-1999 3-31-2000 3-31-2001 3-31-2002 3-31-2003 3-31-2004
79.7%
88.3%
94.5%
99.3%
81.6%
91.6%
98.3%
106.2%
110.6%
85.1%
96.7%
104.2%
116.8%
121.4%
104.9%
87.9%
100.7%
109.3%
123.8%
131.2%
116.4%
95.6%
89.9%
103.0%
112.2%
126.8%
135.6%
121.9%
105.0%
88.9%
90.3%
102.9%
112.5%
130.2%
139.8%
124.4%
110.2%
90.3%
64.6%
69,381,566,984
(1) prior to consideration of AB 227 / SB 228
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CALIFORNIA WORKERS' COMPENSATION
WORKERS' COMPENSATION INSURANCE RATING BUREAU ANALYSIS
CHANGE IN ESTIMATED ULTIMATE LOSS RATIOS
Change in Estimated Ultimate Loss Ratios:
Accident
Year
1995
1996
1997
1998
1999
2000
2001
2002
2003
Earned
Premium
3,922,429,612
3,832,585,126
4,140,947,275
4,458,921,916
4,724,984,138
6,401,248,003
9,837,605,273
13,282,762,835
18,780,082,806
3-31-1999 3-31-2000 3-31-2001 3-31-2002 3-31-2003
Total
to
to
to
to
to
Change
3-31-2000 3-31-2001 3-31-2002 3-31-2003 3-31-2004 To Date
1.9%
3.3%
3.8%
6.9%
3.5%
5.1%
5.9%
10.6%
10.8%
2.8%
4.0%
5.1%
7.0%
9.8%
11.5%
2.0%
2.3%
2.9%
3.0%
4.4%
5.5%
9.4%
0.4%
-0.1%
0.3%
3.4%
4.2%
2.5%
5.2%
1.4%
10.6%
14.6%
18.0%
30.9%
29.2%
19.5%
14.6%
1.4%
69,381,566,984
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Characteristics of CA WC Experience
WCIRB data as of 3-31-2004
Paid Medical Loss
Accident
Year
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
15 to 27
1.680
1.538
1.532
1.570
1.592
1.653
1.735
1.786
1.844
1.976
2.080
2.079
Development
27 to 39 39 to 51 51 to 63
1.201
1.177
1.181
1.166
1.188
1.208
1.221
1.243
1.272
1.318
1.353
1.375
1.094
1.084
1.095
1.097
1.086
1.093
1.111
1.129
1.139
1.158
1.180
1.194
1.049
1.052
1.056
1.054
1.056
1.062
1.075
1.089
1.098
1.111
1.124
63 to 75
75 to 87
87 to 99
1.034
1.034
1.037
1.039
1.042
1.045
1.055
1.065
1.075
1.088
1.023
1.024
1.027
1.025
1.030
1.038
1.051
1.057
1.062
1.017
1.018
1.019
1.020
1.024
1.032
1.041
1.048
99 to 111 111 to 123
1.014
1.012
1.013
1.016
1.025
1.028
1.035
1.010
1.010
1.012
1.016
1.021
1.029
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Characteristics of CA WC Experience
WCIRB data as of 3-31-2004
Ultimate Reported Indemnity Closed Claim Ratios
Accident
Year
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Evaluated as of months:
15
27
39
45.2%
43.6%
42.5%
41.2%
39.7%
38.1%
36.1%
32.9%
32.5%
32.5%
65.1%
66.0%
63.8%
63.1%
61.8%
59.9%
57.5%
54.5%
50.7%
48.4%
75.1%
78.6%
78.8%
77.9%
77.1%
75.8%
73.3%
70.6%
68.2%
63.2%
51
83.5%
85.5%
87.0%
86.9%
86.1%
85.0%
83.9%
81.2%
79.6%
76.7%
63
90.6%
90.1%
91.1%
91.7%
91.0%
90.2%
89.4%
88.1%
86.5%
84.5%
75
87
99
111
94.0%
94.0%
93.9%
94.5%
94.0%
93.4%
92.7%
91.9%
90.9%
89.3%
95.9%
95.9%
96.2%
96.2%
95.6%
94.8%
94.2%
93.6%
92.6%
97.1%
97.3%
97.3%
97.1%
96.5%
95.9%
95.6%
94.7%
97.8%
98.0%
97.9%
97.8%
97.3%
96.7%
96.2%
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California Workers Compensation
Conclusions
• Trending the medical development factors was the right
thing to do in last year’s analysis
– Paid loss development factors continue to increase
– Closing rate continues to decline- with possible
exception of AY 2003
• Choice of three-year (or longer) average factors:
– Appears to have been overly optimistic last year
– Still appears to be overly optimistic for pre-reform analyses
• No apparent support for assumption that development will
revert to older, lower levels without effects of reforms
• Incurred development method should be given weight;
paid development can’t seem to catch up
11
Bornhuetter-Ferguson Expected
Loss Ratios
• We have seen the following:
– Credit given to company “improvements” in
operations, without solid evidence to back up
assumptions
– Optimistic trends assumed
– Optimistic development assumptions used
– Too much weight given to immature years, which may
not be appropriately developed
– Too little weight given to more mature years
– Adverse experience in some years discounted
– Adverse experience in similar programs discounted
12
Problem Segments of Business
• Failure to identify, isolate, and separately
analyze problem segments (i.e.
construction defect) has been the
apparent cause of several insolvencies
• Proper questioning of underwriting and
claims personnel can usually identify these
• Failure of due diligence
• Some companies better than others at this
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Observations and Conclusions
• My personal opinion:
– In situations of potential financial difficulty, actuarial
opinions and supporting reports usually give
impression that Appointed Actuary has taken role of
company advocate rather than impartial estimator of
company’s reserve adequacy
– Emphasis seems to be on presenting reasons why
reserves could be reasonable, rather than on what an
appropriate reserve level would be
– This becomes an obstacle for the regulator to
overcome, not an aid to evaluating companies
– This has implications for the value of the Actuarial
Opinion and the public perception of the profession
14
Signs of Advocacy
• Analyses are not conservative
– Reasons for fiscal conservatism:
• Time needed for results to be known
• Surprises tend to be adverse rather than favorable
• cost of underestimation not the same as cost of overestimationdelays or prevents corrective action
• Analyses don’t make proper use of available methods
– Provide rationales why methods that yield higher estimates may be
distorted- yet don’t apply standard adjustments to remove distortions
– Provide rationales why methods that yield lower estimates, but are
clearly distorted, may apply- again, don’t apply standard adjustments or
adjust in any way
• Analyses don’t seem to react to consistent pattern of
underestimation
– Methods should be made more responsive to current conditions in this
case
– We see this responsiveness in ratemaking analyses but not in reserving
15
Successes
• Internal financial modeling has provided early
identification of some problem companies
• Skeptical internal approach has also provided early
identification and led to close monitoring
• This has reduced the cost of some insolvencies, may
have prevented others
• Flexible approach to troubled companies has allowed:
– Some to obtain outside capital or be acquired
– others to transfer books of business and go into orderly runoff
– Has avoided some insolvencies, reduced the costs of others
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