AGRIP. Unallocated Loss Adjustment Expense - The six questions you always wanted to ask. Presented by: Willis Towers Watson October 3, 2016

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1 AGRIP Unallocated Loss Adjustment Expense - The six questions you always wanted to ask Presented by: Willis Towers Watson October 3, Willis Towers Watson. All rights reserved.

2 Agenda 1. What is unallocated loss adjustment expense (ULAE)? 2. Who and/or what contributes to it? 3. What makes it vary across organizations? 4. Why do you need a reserve for it? 5. How do you estimate the ULAE reserve? 6. How do you evaluate the reasonableness of your ULAE reserve? 1

3 What is ULAE? Statutory accounting defines it as All Other Defense Costs (AODC) General costs associated with the claims function Claims settlement costs that cannot be or are not directly allocated to an individual claim Claims department salaries Computer systems/phones Rent Some legal fees i.e., determination of coverage If the expense is NOT ULAE then it is Allocated Loss Adjustment Expense Defense cost for an individual claim Litigation Independent adjuster fees Independent medical exams Court and police report costs 2

4 Who and/or What Contributes to ULAE? Overhead Significant portion of ULAE is a flat cost Computer systems/phones Intake personnel Variable components Adjuster salary Coverage determination complexity 3

5 What makes it vary across organizations? Two main drivers coverage mix and staffing model. Starting with coverage: Auto physical damage Higher ULAE ratio driven by low settlement values Less complex with more uniformity across claims Workers compensation Mix of complex and simple claims Complex claims develop more ALAE costs Medical management component can be significant Wage replacement costs relatively automatic Liability coverages Mix of complex and simple claims Settlement/litigation philosophy has significant impact Use of inside or outside counsel is also a cost driver Property Higher average value of settlements creates a lower ULAE ratio CAT exposures more difficult but claim handling costs can be more readily allocated 4

6 Ultimate ULAE to loss ratios do vary considerably by coverage 20.0% Ultimate ULAE to Loss and ALAE Ratio 15.0% 15.0% Total All Coverages 10.0% 8.8% 8.7% 5.0% 6.3% 4.7% 0.0% APD WC AL GL/PL Prop Fiscal Year Source: SNL Financial 5

7 ULAE Ratios 50.0% ULAE to Loss and ALAE Ratio 40.0% 41.0% Ult ULAE / Ult Loss & ALAE 30.0% Unpaid ULAE / Unpaid Loss & ALAE 20.0% 10.0% 15.0% 8.8% 8.7% 6.3% 4.5% 3.7% 4.0% 4.7% 3.1% 0.0% APD WC AL GL/PL Prop Fiscal Year Source: SNL Financial 6

8 What makes it vary across organizations? Economies of Scale Fungibility of staff Increased specialization for adjusters of large insurers Tort caps ULAE costs take on more significance in low tort cap state Pool s focus on member service levels for claims management Typically think of this more in terms of ALAE costs Is there leakage to ULAE expenses? 7

9 Why do you need a reserve for it? Good business practice Regulatory requirements Statutory accounting requires that a reserve be established Cradle to grave agreements may not eliminate the requirement Auditor requirement Similar to loss reserves, this provision should be representative of the cost to run-off all incurred claims as of an accounting date Cost to maintain a claims staff until all claims are closed Overhead costs associated with a loss portfolio transfer A key question, though, is what does run-off mean? What level of service will members get in a run-off situation? Do members have the same incentive to cooperate in claims management/settlement? What are the implications on cost? 8

10 How do you estimate a ULAE reserve? Industry Ratios Simplest; data can be accumulated from AM Best or SNL information Assumes half of the expense is incurred when claim is reported and half when the claim is settled May not be representative of pool s actual cost structure Ratios based on Pool s Schedule P data Pool specific Requires ULAE be allocated to policy year Most pools do not produce Schedule P detail or there may be limitations in the process Paid ULAE development method Well understood approach Requires that ULAE be allocated to policy year Assumes steady state operations Paid ULAE per claim touched More involved, with focus on claims Reflects pool s own experience Does not differentiate between simple and complex claim costs Defining the term touched can be difficult 9

11 How do you estimate a ULAE reserve? (cont d) Johnson method More involved than ULAE per claim touched method Reflects pool s own experience Differentiates between cost to open and maintain claims Can be expanded to include additional transaction types (e.g. cost to pay, close, reopen) Conger/Nolibos method Similar to the Johnson method Includes additional transaction types Creates relativities among transaction types rather than dollar basis; assumption is that relativities do not change dramatically over time Reflects pool s own experience Can be performed on a claim count or a loss dollar basis Loss dollar basis assumes costlier claims require more handling Claims operation time and expense study Requires extensive recordkeeping from claims staff over period of time; technology may aid in summarization of data Potentially more precise Data may get stale if too costly to update parameters frequently 10

12 Examples of Methods 11

13 Industry Ratio (From SNL) Accident Year Direct ULAE Unpaid Direct Case Outstanding Direct IBNR Unpaid ULAE to (50%xCase O/S) + IBNR Selected (1) (2) (3) (4) (5)=(2)/[(3)x.5+(4)] (6) ($000s) 2009 & Prior Subtotal $1, ,200 $5,500 $18,800 2,200 3,065 3,980 4,750 5,225 3,560 $41,580 $31,450 3,800 5,000 6,750 10,400 15,300 21,400 $94, Accident Year Direct Case Outstanding Direct IBNR Indicated ULAE Reserve (1) (7) (8) (9)=[(7)x.5+(8)]x(6) Pool ULAE Reserve Indication as of December 31, 2016 ($000s) Total $ ,200 2,000 1, $7,000 $ ,400 2,000 3,600 4,300 $12,110 $ $781 12

14 Pool Schedule P Data In Thousands Financial Statement Date Accident Year Data Included Cumulative Gross Paid Loss Cumulative Gross Paid ALAE Cumulative Gross ULAE Calendar Year Paid Loss & ALAE Calendar Year ULAE Paid ULAE to Loss & ALAE (1) (2) (3) (4) (5) (6)=(3), Year (3) Year (1)+(4), Year (4),Year 1 (7)=(5), Year (5) Year (1) (8)=(7) / (6) 12/31/ $13,200 $27,700 $10,200 12/31/ ,000 33,500 11,300 $11,600 $1, /31/ ,800 29,000 11,000 12/31/ ,000 35,500 11,800 $9,700 $ /31/ ,000 30,000 11,400 12/31/ ,000 35,000 12,400 $16,000 $1, Total/Average $108,000 $190,700 $68,100 $37,300 $2, Selected

15 Pool Schedule P Data (cont d) Pool ULAE Reserve Indications as of December 31, 2016 ($000s) Accident Year Direct Case Outstanding Direct IBNR Indicated ULAE Reserve (1) (9) (10) (11)=[(9) x.5 + (10] x (8), Selected 2010 $200 $10 $ ,200 1, ,000 2, ,800 3, , Total $7,000 $12,110 $1,093 14

16 Paid ULAE Development Accident Year Report-to-Report Development Factors Selected Cumulative

17 Paid ULAE Development (cont d) Accident Year Paid ULAE As of 12/16 ($000s) Development Factor to Ultimate Estimated Ultimate ULAE ($000s) Estimated Unpaid ULAE ($000s) (1) (2) (3) (4) = (2) x (3) (5) = (4) (2) 2006 $ $850 $ , , , , , , , , , , , , , , , , Total $13,385 $14,543 $1,158 16

18 Paid Per Claim Touched Fiscal Year Calendar Year Reported Claims Open (Case Reserve) Claims at Year End Average Open Claim Inventory Total Claims Touched per Calendar Year Calendar Year Paid ULAE ($000s) Paid ULAE Per Claim Touched (1) (2) (3) (4) (5) (6) (7) , ,000 1,180 1,190 4,190 $1,090 $ ,500 1,250 1,215 3,715 1, ,300 1,300 1,275 3,575 1, ,000 1,300 1,300 4,300 1, ,100 1,200 1,250 5,350 1, ,000 1,350 1,275 4,275 1, (8) Selected $330 (2) From actual claim data. (3) From actual claim data. (4) = Average of current year-end and prior year-end. (5) = (2) + (4). (6) From actual claim data. (7) = (6) / (5) x 1,000 x annual trend to

19 Paid Per Claim Touched (cont d) Fiscal Year Calendar Year Reported Claims Open (Case Reserve) Claims at Year End Average Open Claim Inventory Total Claims Touched per Calendar Year Calendar Year Paid ULAE ($000s) Paid ULAE Per Claim Touched (1) (2) (3) (4) (5) (6) (7) ,025 1,475 $487 $ Total 635 2,743 $931 (2) Estimated based on reporting patterns. (3) = (3), prior claims closed during year + (2). (4) = Average of current year-end and prior year-end. (5) = (2) + (4). (6) = (5) x (7) / 1,000. (7) = (8), from prior slide x trend factor. 18

20 Johnson Method Derive a cost per claim based on historical calendar year paid ULAE and the number of claims opened and maintained 1. Cost per claim opened $ Expected claims opened in 2017 through Total ULAE for opened claims: (1) x (2) $190, Cost per claim maintained $ Expected claims maintained in 2017 through , Total ULAE for maintained claims: (4) x (5) $843, Total ULAE liability: (3) + (6) $1,033,700 19

21 Conger/Nolibos Method ULAE liability can be broken down into three basic groups: 1. Cost per claim opened Cost load Claims to be reported Total Liability 2. Cost per claim maintained Factor load Expected paid on open claims Total Liability 3. Cost per claim closed Factor load Ultimate cost of claims closed Total Liability $ $114, $18,000,000 $972, $23,000,000 $207, Total ULAE liability $1,293,300 20

22 Time and Expense Study This approach could take multiple forms Look at cost by type of claim or by severity Modern claims systems may capture the time spent on claims adjuster activities Use various techniques to project future claims activity (counts or dollars) to estimate the ULAE liability May not be cost effective for smaller operations Expense of initial study and maintenance of assumptions Volatility of results could skew results 21

23 How do you evaluate the reasonableness of your ULAE reserve? Compare the liability estimate to the annual ULAE paid does the relationship make sense Longer tail coverages should typically have liability that is some multiple over the annual spend Shorter tail coverages could have liability below the annual spend (e.g. APD) Indications may not be representative of pool s actual cost structure Use an average of multiple methods Similar to the loss and ALAE analysis Divergence of methods could indicate parameters that are outdated May give more stability than using a single method Does the result make intuitive sense The answer is highly dependent on the characteristics of the pool Coverages written Loss retention levels Existence of tort caps Claims settlement philosophy Litigation atmosphere/claimant attitudes Workers compensation laws/requirements (e.g., can medical be settled) 22

24 Comparison of Methods Summary of ULAE liability indications from all methods 1. Industry ULAE ratio $781, Pool Schedule P ratio $1,093, ULAE development $1,158, Cost per claim touched $931, Johnson Method $1,034, Conger/Nolibos Method $1,293,000 23

25 How do you evaluate the reasonableness of your ULAE reserve? (cont d) Comparison for our example Calendar Year Annual ULAE Paid 2011 $1,090, $1,145, $1,100, $1,180, $1,200, $1,270,000 The methods range from $0.8 million to $1.29 million; similar to annual expenditures For shorter tailed coverages (e.g., APD, Property, Auto liability) this estimate may be reasonable For workers compensation or professional liability - may need to investigate the assumptions and parameters more closely 24

26 Discussion and Questions 25