Premium Deficiency Reserves - Statutory
Premium Deficiency Reserves
under
U.S. Statutory Accounting rules
Ralph Blanchard
2002 CLRS - September 24th
Premium Deficiency Reserves - Statutory
Overview
GAAP vs. Stat. requirements
Statutory calculation
Major Issues
Risk margin/conservatism
Investment income “controversy”
Actual costs versus expected costs
Grouping
Reinsurance
EBUB
Residual Markets
Multi-Tier test
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
GAAP vs. Statutory requirements
GAAP definition
“A premium deficiency shall be recognized if the sum of expected claim
costs and claim adjustment expenses, expected dividends to policyholders,
unamortized acquisition costs, and maintenance costs exceeds related
unearned premiums” (FAS 60, short duration contracts, paragraph 33)
Statutory definition
“When the anticipated losses, loss adjustment expenses, commissions and other
acquisition costs, and maintenance costs exceed the recorded unearned premium
reserve, and any future installment premiums on existing policies, a premium
deficiency reserve shall be recognized…” (SSAP 53 - Property Casualty
Contracts - Premiums, paragraph 15)
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Statutory Calculation
Same as GAAP calculation,
only the parameters and scope are different
Parameters
•No Deferred Acquisition Costs (DAC)
•No policyholder dividend projection
•Other misc. GAAP/Stat. differences (e.g., bad debt, such as Agents Bal.)
Point to remember –
PDR represents deficiency in UPR that has yet to be otherwise booked.
It works off of existing balance sheet, not economic profit/loss of policy.
If net loss expected, but already booked, then no PDR.
So need to know what was booked already!
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Statutory Calculation (cont.)
Scope (and parameters)
• One calculation per legal entity,
• per line grouping (same as GAAP grouping?)
Legal entity complication can be large
Items that can differ by legal entity
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line mix
loss ratio
payment pattern
expense ratio
investment yield
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major issues - Risk margin / conservatism
PDR is not the “possible” deficiency, it is the “expected” (GAAP) or
“anticipated” (Statutory) deficiency.
Use expected values, not conservative values. (my interpretation)
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major issues - investment income “controversy”
• Reflect the expected profit at the time the Unearned Premium Reserve
will be earned (when undiscounted reserves will be set up)?
OR
Reflect the expected profit through the runoff of policy obligations
(i.e., anticipate investment income up to loss payment)?
• GAAP rules allow consideration of investment income up to loss payment
(if reflection disclosed)
• Statutory rules currently consistent with GAAP
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major issues - investment income – part 2
• Fund balance based on Accounting method
(Starting fund equals net liabilities established)
OR
Fund balance based on funds generated
(Starting fund equals premiums received less losses, expenses paid)
• My interpretation – Accounting method is most consistent with guidance
(i.e., funds generated approach ignores the extent that
the deficiency is already recognized)
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major Issues - actual versus expected costs
Q: If an earthquake occurs on January 2nd, could it trigger a positive PDR
as of the prior December 31st?
A: No. (earthquake on January 2nd was probably not “anticipated”
as of the prior December 31st.)
Q: If a hurricane is threatening on September 30th, could it trigger a positive
PDR as of that date, even if it later avoided landfall?
A: Maybe.
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major Issues - Grouping
Statutory
“For purposes of determining if a premium deficiency exists, insurance contracts
shall be grouped in a manner consistent with how policies are marketed, serviced
and measured. A liability shall be recognized for each grouping where a premium
deficiency is indicated. Deficiencies shall not be offset by anticipated profits
in other policy groupings.” (SSAP 53, paragraph 15)
GAAP
“Insurance contracts shall be grouped consistent with the enterprise’s manner of
acquiring, servicing, and measuring the profitability of its insurance contracts to
determine if a premium deficiency exists.” (FAS 60, paragraph 32)
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major Issues - Grouping - scenario 1
Assume
Unit
“Deficiency”
A
10
B
20
C
-80
D
30
Units A, B, C, D are various products marketed to the same customers,
with management measured based on combined profitability, and
aggressive marketing of full product slate to customers
PDR = 0
(Q: How would you “allocate” this zero to the various units?)
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major Issues - Grouping - scenario 2
Assume
Unit
“Deficiency”
A
10
B
20
C
-80
D
30
Units A and B are products sold to same market, Units C and D are sold to a
second market. Company groups A&B together, and C&D together.
PDR = 30
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Premium Deficiency Reserves - Statutory
Major Issues - Grouping - scenario 3
Assume
Unit
“Deficiency”
A
10
B
20
C
-80
D
30
Units A and B are products sold to same market, Units C and D are sold to a
second market. Company treats each product as a separate market, with
separate management responsibility, even though ultimate customers may
overlap.
PDR = 60
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Premium Deficiency Reserves - Statutory
Major Issues - Grouping - scenario results
Assume
Unit
“Deficiency”
A
10
B
20
Scenario
PDR
1
0
2
30
3
60
2002 CLRS - September 24th
C
-80
D
30
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Premium Deficiency Reserves - Statutory
Major Issue – Reinsurance
PDR is calculated net of reinsurance.
But is booked UPR net or gross of reinsurance?
Don’t answer too soon!
If all reinsurance is facultative,
UPR may equal future earned on unexpired policies
If some reinsurance is treaty, covering calendar year
UPR may be implicitly gross, not reflecting future cedes as % of
future gross earned premium
Beware, and know how reinsurance affects your runoff!
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major Issue – EBUB (Earned But Unbilled, or “audit” premium)
Where audit premiums exist, EBUB must be booked.
(SSAP 53, paragraphs 9 – 12)
Two alternative ways to book
• Through WP
• Through Earned Premium
Example
Initial premium of 100, estimated audit of 20, results at 6 mos.
EBUB method
WP method
EP method
WP
120
100
pure UPR
60
50
EBUB
0
-10
ttl UPR
60
40
Pure UPR on page 3, ttl UPR on page 8, 15 (state page)
2002 CLRS - September 24th
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Premium Deficiency Reserves - Statutory
Major Issue – EBUB (cont.)
Is EBUB material for you? (If not, go to sleep.)
If material, how do you book it?
If as written, then business as usual. (i.e., go to sleep)
If as earned, then more work.
If as earned,
Which UPR are you using? (page 3 or page 8)
Anticipate audit on unexpired portion of policy
Apply loss, expense ratios to pure UPR plus audit
Anticipate cash inflow when audit collected
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Premium Deficiency Reserves - Statutory
Major Issues – Residual Markets
Residual Markets subsidies resulting from unexpired policies?
If residual market assignment already in UPR (e.g., WC pool)
then business as usual.
If not in UPR, but not material, go to sleep.
If not in UPR, and material, you may have work to do
•Can be very large for some states, lines
•May be bigger issue for monoline, monostate companies
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Premium Deficiency Reserves - Statutory
Multi-Tier test
1. Combined ratios consistently below 1.0 - STOP
2. Runoff of UPR - positive profits before investment income - STOP
3. Solve for minimum interest rate such that PDR = 0. If rate low enough - STOP
4. Conservative assumptions for values result in PDR = 0. STOP.
5. Full Analysis
May want to state that your method is the full tiered process, with stopping points.
Otherwise, a change in stopping points may trigger extra disclosure (or worse?)
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Premium Deficiency Reserves - Statutory
Observations
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May be more work for stat. than GAAP (due to legal entity issue)
Stat. reserve may be more likely to be zero (due to no DAC for stat.)
Grouping is a big issue
Investment income reflection to payment date seems to be allowed.
Work can be cut down via multi-tier approach
2002 CLRS - September 24th
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