SCHEDULE P: MEMORIZE ME!!!

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1 SCHEDULE P: MEMORIZE ME!!! NOTE: This skips all the prior years row calculation stuff, since it is covered pretty well by TIA (and I m sure any other manual). What are the cross-checks performed by the NAIC to? Other figures in Schedule P Other pages of the Annual Statement (AS) Schedule P data from preceding year What RBC charges are derived using Schedule P data? Reserving risk charge Written premium risk charge What does the IRS use Schedule P for? To determine loss reserve discounts Anticipated salvage and subrogation Discounts for anticipated salvage and subrogation What is the regulator s major tool to monitor company solvency and safeguard the public trust? Schedule P! Is Schedule P designed to measure loss and LAE reserve adequacy prospectively or retrospectively? Both! What purposes, other than testing reserve adequacy, does Schedule P serve? Isolate blocks of business with good/poor experience AY figures in Schedule P show effects of changes in loss reserve margins on CY results reported elsewhere in AS Provides loss payment patterns for IRS discounting procedure Provides disclosures needed for grossing up losses for interest discounts and for anticipated salvage and subrogation for IRS Provides data for RBC reserving risk and written premium risk charges Provides loss payment patterns for RBC investment income offsets Provides info for calculating RBC loss-sensitive contract offset Separates out Occurrence from CM for RBC CM offset Supports opinion of Appoint Actuary on L&LAE reserve adequacy Allows for a more accurate comparison of loss ratios by AY by showing development of EY premiums Provides info to determine tax basis EP for lines with audits or retro premium adjustments Shows Direct & Assume versus Ceded experience so effects of reinsurance on AY loss ratios can be determined

2 Shows claim count development patterns and changes in average claim severity by year, allowing better analysis of claims department performance Does the grouping of LOB s in Schedule P differ from the groupings in the U/W & Investment Exhibit? Yes. Schedule P shows experience for all lines of business. The long-tailed (casualty) lines show the 10 most recent AY s of data plus a prior years row. The short-tailed (first party property) lines show the 2 most recent AY s of data and a prior years row. How many years of data do the Summary Exhibits show? What does this mean for the shorttailed lines of business? 10; Means that 10 AY s and a prior years row must be kept even for short-tailed lines. Which Part of Schedule P is mostly audited by an independent CPA? Part 1. (I think this comes up in one of the tax papers as a reason to use Part 1 instead of Part 3 in the IRS procedure for getting payment patterns.) What does it mean if the Direct & Assumed loss ratio is higher than the net loss ratio? That ceded business may be unprofitable What is the Net loss ratio influenced by? Reinsurance market at the current time. (In soft reinsurance markets, the net loss ratio appears better than in hard markets) Which type of loss ratio, Direct & Assumed or Net, reflects the quality of the primary insurer s book of business and may be a good predictor of both direct and net loss ratios in future years? The Direct & Assumed loss ratio Are premiums in Part 1 adjusted for subsequent EBUB premiums stemming from exposure audits or accrued retrospective premium adjustments? What does this do to the loss ratios? No Part 1 premiums are recorded by CY and once entered they are frozen. Part 1 shows overstated loss ratios for the year when losses occurred and understated loss ratios for the year in which additional premiums are billed. The over- and understatement relate to over- and under-estimation of subsequent retrospective premium adjustments. The initial estimate of the future retrospective premium adjustment is included in the CY EP s. Where can loss ratios and loss development that are more accurate than the figures from Part 1 be obtained? By using info from Parts 2 & 6 What are the 3 principles that govern the 1998 definition of LAE? The classification is by type of expense, regardless of whether the expense relates to specific claims The classification is uniform for all companies; no discretion is permitted for the classification of LAE

3 The new definitions divide expenses into 2 groups: expense that vary with the amount of loss are DCC and expenses that vary with the # of claims, or which do not vary with either the amount of loss or the # of claims, are AAO The first 2 principles take precedence if they conflict with the 3 rd principle Which Schedule P Interrogatory requires the company to acknowledge if they are using the new DCC & AAO definitions? 2 Which type of LAE, DCC or AAO, includes legal fees, costs of expert witnesses, and fees to professionals working in defense of a claims? DCC Which type of LAE, DCC or AAO, includes claim department overhead such as rent? AAO What are declaratory judgment actions? The decisions made courts about coverage (e.g. court must decide if an insurer must pay for some type of claim/loss since it s deemed to be covered by an insurance policy) What are 3 views prior to codification regarding DJA s? Insurers pay these legal defense costs to absolve themselves of liability. Other legal fees are coded as DCC, so DJ legal costs should be coded as DCC, too. DJ costs are not related to defense of claims but to determination of coverage. This is similar to other adjusting costs and should be AAO. DJ costs are not related to claims handling but to policy interpretation. They should be coded as general expenses, not as LAE. What are DJ legal fees coded as under revised NAIC definitions of LAE? AAO. They do not affect the adverse loss development of IRIS tests 9 & 10. How are AAO assigned to AY? By formula How many methods are allowed to distribute paid ULAE/AAO to AY s? Basically 2: the old way and the new general guidance. The new way is preferred, but not mandated. What were the assumptions of the Previous Statutory Procedure to allocate paid ULAE to AY s? Half of the unallocated LAE are incurred when the claim is reported and half are incurred when the claim is settled 90% of claims are reported during the year when the accident occurred, and 10% are reported the following year Unallocated expenses related to claim reporting are assigned to the 2 most recent AY s in a 9 to 1 proportion, and unallocated expenses related to claim settlement are allocated in proportion to loss payments.

4 What s wrong with using this procedure for all LOB s? Long-tail lines and non-proportional reinsurance claims often are not reported until years after the accident date, and the distribution procedure assigns too much weight to more recent AY s. Assuming ½ of the AAO was proportional to the amount of loss settlement is an issue. Many components of AAO are more closely related to the number of claims rather than to size of loss. Which Interrogatory addresses the method(s) used to distribute paid ULAE/AAO to AY s? 3 What are the 3 steps to distribute the AAO to AY s in the new method? Convert dollar amounts to relativities (not affected by inflation) Compile number of claims reported, outstanding, and closed with and without payment by AY from Schedule P, Part 5 Distribute the CY AAO payments to AY s by the claim count figures and relativities How many units does each claim get? Cost of maintaining an outstanding claim through end of year = 1 unit Cost of closing a claim without payment = 2 units Cost of settling a claim with payment = 3 units Cost of reporting = 4 units The total cost of a claim reported during the year is 5 units (4 to report and 1 to keep open, since we assume that all reported claims in the sample were outstanding at the end of the year) Weighted Claims = Reported * 4 + Closed w/ Pay * 3 + Closed w/o Pay * 2 + Outstanding * 1 How do you calculate the # of claims closed without payment? Go to Part 5! Reported Outstanding at year end Closed with Payment = Closed without Payment NOTE: Transform Cumulative numbers into Incremental numbers for AAO procedure What is the distribution of AAO payments by AY proportional to? The distribution of weighted claims by AY When allocating AAO among companies in a pool, what method should be used? The same method used to allocated losses and claims to the participating companies, NOT the number of claims reported, closed, and outstanding. How much AAO is assumed by a reinsurance contract? Depends on the contract! AAO expenses are generally not ceded in reinsurance treaties though. Do the non-proportional reinsurance lines (A, B, C) need to show claim counts? No they are difficult to assign to non-proportional reinsurance

5 What might show case reserve adequacy strengthening/deterioration? A comparison of trends in (outstanding case reserves)/(outstanding claims) with trends in average paid claim costs Recall Berquist/Sherman from Exam 6 How may claims be counted? What Interrogatory addresses this issue? Per claim (i.e. per accident) or per claimant; 6 Are bulk reserves for reported claims a sign of under-reserving? Not necessarily, as long as the company sets proper total reserves Does retroactive reinsurance affect Schedule P? No What are the 2 methods to report anticipated salvage and subrogation? Case reserves in columns 13 & 14 may be shown net of anticipated salvage and subrogation Case reserves may be shown gross of anticipated salvage and subrogation, and the anticipated amounts (for both reported and IBRN claims) may be an offset to the bulk reserves in columns 15 & 16 What might an insurer place less emphasis on AAO reserves? AAO reserves is relatively small and not subject to much uncertainty AAO reserves are not included in the NAIC retrospective reserve adequacy tests Some companies dispute the need to hold AAO reserves o Feldblum doesn t like this: claims department overhead is incurred (in part) for claims that occurred during previous accounting periods; u/w department overhead is incurred for policies written during that time period so the expense flows through the income statement for that time period Why should Part 1 s Column 25 (number of claims outstanding on direct & assumed business) be used with caution? WC, auto no-fault, and accident & health provide periodic payments for the duration of a disability. The case reserves show only the remaining unpaid losses, not the entire benefits, so the ratio of case reserves to claims outstanding underestimates the value of an outstanding claim. This understatement increases as claims mature. Smaller, simpler cases are settled more quickly than larger, more complex cases. Loss development on reported cases is included in the bulk reserves shown in Column 15, not the case reserves of Column 13. Once can t include Column 15 in calculating the average value, since this column includes IBNR reserves, and IBNR claims are not included in Column 25. If there is significant loss development on reported cases, then the ratio noted above understates the value of an outstanding claim. What should be done to Schedule P data if there is a change in a company s pooling percentage? To avoid distortion, all past figures should be restated to the new participation percentage.

6 What patterns do treaty commutations and reinsurer insolvencies affect? Reported and paid loss development patterns What does tail coverage cover? Claims that occur during the CM period but are reported after its termination Why is the extended loss and expense reserve not a loss reserve? Because the claims have not yet occurred. Where can you find the extended loss and expense reserves? Interrogatory 1 and on the balance sheet as a write-in line on page 3 What are the 2 causes of adverse loss development? Emergence of late reported claims or pure IBNR loss emergence Increases in loss estimates for reported claims or development on known claims Why did some companies argue that CM policies should have a lower RBC reserving risk charge than occurrence policies? Since CM business has no pure IBNR loss emergence Result of argument: 20% offset for the reserving risk charge and written premium risk charge is given to CM medical malpractice business Is tail coverage grouped with occurrence exhibits or CM exhibits? Occurrence. (But, under post Codification statutory accounting rules, tail coverage with an indefinite term is like occurrence coverage and tail coverage with a definite term is like CM coverage. But, Schedule P rules are pre-codification and stipulate that all tail coverage is reported on the occurrence exhibits.) Explain the statutory accounting for tail coverage that has an indefinite term? Full premium is earned when policy is issued Bulk loss reserve is established for estimated future losses No unearned premium reserve All reserves are shown in Schedule P Explain the statutory accounting for tail coverage that has a definite term? Premium is earned over the term period Unearned premium reserve is established on the effective date of the policy and amortized over the policy term Case loss reserves are set up as the losses are reported Bulk loss reserves are needed for adverse development on known claims (not for the emergence of IBNR claims) The only reserves shown in Schedule P are those for known cases What are the various meanings of incur date for occurrence policies, CM policies, tail coverage, and for fidelity & surety? Occurrence: date that loss occurs

7 CM: date that loss is reported to insurer Tail Coverage: date that policy is issued Fidelity & Surety: date that loss is discovered What are the 3 ways that the adequacy of Schedule P reserves is monitored? Statement of Actuarial Opinion must jive with Part 1 Reserve adequacy tests performed with historical loss triangles from Parts 2, 3, 4, and 5 provide actuarial tests of reserve adequacy Periodical financial examinations by the state insurance departments provide additional tests of reserve adequacy What is the opposite of retroactive reinsurance? Commutations are the reverse of retroactive reinsurance. They have the opposite effect on Schedule P observed loss development as structured settlements have (structured settlements are similar to retroactive reinsurance). Which triangles are more affected by changes in claims department practices: Part 2 triangles or Part 3 triangles? Part 2 Which parts of the Annual Statement report CY EP? Income Statement U/W & Investment Exhibit, Part 2 Page 15 state exhibits Schedule F Schedule P, Part 1 Schedule T IEE Which parts of the Annual Statement report EY EP? Schedule P, Part 6 Which parts of the Annual Statement report PY EP? Schedule P, Part 7 for loss-sensitive contracts only Which parts of the Annual Statement report CY IL? Income Statement U/W & Investment Exhibit, Part 3 Page 15 state exhibits Schedule F Schedule T IEE Which parts of the Annual Statement report AY IL? Schedule P, Parts 1 through 4 show AY IL for occurrence policies

8 Which parts of the Annual Statement report RY IL? Schedule P, Parts 1 through 4 show RY IL for CM policies Which parts of the Annual Statement report PY IL? Schedule P, Part 7 for loss-sensitive contracts only Who uses PY data and why? Underwriters and actuaries; pricing or profitability studies Who uses AY data and why? Actuaries; used for loss reserving Who uses RY data and why? Claims personnel; claims department practices may vary by report year, and claims department efficiency is measured by report year Who uses CY data and why? Accountants; accounting statements Which type of data is secondary: PY, AY, RP, or CY data? CY: they rely upon non-ledger assets and liability (such as loss reserves and premium reserves) that are estimated from PY, AY, or RY aggregates. Which type of data may eliminate biases caused by consistent under- or over-estimation of nonledger assets and liabilities? CY What types of premiums does Part 6 include? Earned portions of: Collected premiums Billed but uncollected premiums Earned but unbilled premiums (EBUB) Accrued retrospective premiums What are the 2 purposes of Part 7? Determine the company s percentage of WP and of reserves related to loss-sensitive contracts Determine the sensitivity of premiums and of reinsurance commissions to losses on these contracts Why do loss sensitive primary policies have a higher RBC offset (30%) than reinsurance treaties (15%)? The rationale is that retrospectively rates policies have wider swings than sliding scale commissions have.

9 What does premium sensitivity depend on? Parameters of retro rating plan Shape of size-of-loss distribution Amount of standard premium Maturity of losses What are the 3 types of loss sensitive contracts? Retro rated policies Sliding scale commissions Policyholder dividends Why does RBC not consider contingent commissions loss sensitive for primary policies? Contingent commissions on direct business have narrow swings, so the sensitivity to losses is limits. In addition, contingent commissions are generally 1-sided (agent doesn t return $ for poor business). Why does RBC not consider policyholder dividends loss sensitive? Since they are optional, not contractual Why do distressed companies have an incentive to classify their business as loss sensitive, even if the loss-sensitivity is minimal? Since the RBC charges are lower for loss-sensitive business What are the 6 criteria to be classified as loss-sensitive? An increase in losses leads to an increase in net payment (must be monetary transactions). The loss sensitivity must be at least 75% on primary business and 50% on reinsurance treaties before the application of any limits. The swing of the plan must be at least 20% for primary business and 10% for reinsurance business. The maximum net payment must be at least 15% greater than the expected net payment for primary business and 7.5% greater for reinsurance treaties. The loss sensitive payments must be either premiums or reinsurance commissions; a policy with a loss sensitive policyholder dividend is not loss sensitive. The losses and loss sensitive payments must flow through the Income Statement. Why are WP not always equal to the estimated ultimate net premiums? Understated Payroll & Sales Estimates to lower deposit premiums Desire to keep deposit premiums competitive Companies may book a low written premium to defer state premium taxes or federal income taxes What is the retrospective premium reserve equal to if the WP equals the estimated ultimate premium? There is no retro premium reserve then

10 What is premium sensitivity equal to? (Billed Premium)/(Reported Losses) (Section 2 Section 3)/(Section 4 Section 5) What is the retro premium billing lag equal to? ~3 months. How is proportional reinsurance shown in Schedule P, Part 7? As assumed or ceded premiums, losses, and LAE in the exhibits for the primary lines of business. How is non-proportional reinsurance shown in Schedule P, Part 7? Assumed non-proportional reinsurance is split into 3 categories and shown separately from the primary lines of business (non-proportional property, non-proportional casualty, and financial lines). Ceded non-proportional reinsurance is reported in the same exhibit as the underlying business How is reinsurance shown in Schedule P, Part & that contains both proportional and nonproportional section? The premiums and losses for the sections are divided and reported on the appropriate lines. The proportional parts for both the ceding company and the assuming company and the nonproportional parts for the ceding company go in the exhibits for the underlying lines of business, and the non-proportional parts for the assuming company go in the reinsurance exhibits. What is the treatment of reinsurance treaties containing both proportional and non-proportional sections analogous to? It is analogous to the treatment of reinsurance treaties that are part prospective and part retroactive: the premiums and losses should be divided and treated separately for each part. Which type(s) of reinsurance affects Schedule P: prospective or retroactive? Prospective only Which type(s) of reinsurance affect RBC surplus: prospective or retroactive? Both What is the RBC ratio equal to? Adjusted surplus divided by the RBC requirements Which type of reinsurance reduces the RBC ratio: prospective or retroactive? Retroactive. The RBC reserving risk charge is > than the charge for reinsurance recoverables. Prospective reinsurance reduces RBC requirements and decreases the denominator of the RBC ratio. Retroactive doesn t have this effect. In what way is statutory treatment of retroactive reinsurance more conservative than the GAAP treatment with regards to retroactive reinsurance?

11 SAP doesn t allow a reduction of statement reserves In what way is statutory treatment of retroactive reinsurance more liberal than the GAAP treatment with regards to retroactive reinsurance? SAP allows full (up-front) surplus relief, whereas GAAP recognizes the profit from retroactive reinsurance ratably over the lifetime of the claims What do the seven Interrogatories address? 1) Extended loss and expense reserves on CM policies for Medical Malpractice, Other Liability, and Products Liability 2) Compliance with new NAIC LAE definitions 3) Distribution of AAO payments and reserves by AY 4) Discloses loss reserve discounting and the resulting difference between the Underwriting & Investment Exhibit 5) Discloses net premiums in-force for Fidelity & Surety business 6) Discloses whether claims counts are per claim or per claimant 7) Relates to estimates of reserve adequacy; asks for any material events/changes/etc. that should be considered What are some examples of things that should be addressed in Interrogatory 7? Changes made to method of counting claims The intercompany pooling of only a portion of the business Changes in the intercompany pooling arrangement Other material changes, like a revision to its tabular discount What happens to the CY U/W results for a long-tailed LOB if the held reserves at the beginning of the CY were inadequate? The adverse loss development will dampen the current year s reported results What happens to the CY U/W results for a long-tailed LOB if inadequate reserves were set up for newly reported claims? The CY reported results will look better than they actually were What are 3 commonly held propositions about reserve margins? Companies tend to move together Lines of business tend to move together Reserve margin changes tend to offset earnings volatility over the course of the U/W cycle Why might loss reserves be inadequate? Unforeseeable future developments cause mis-estimation of reserve indications (e.g. asbestos) Companies in financial distress may hide their weakness by reducing bulk reserves for long-tail lines Companies writing long-tail LOB s may value their reserves at a non-zero valuation rate

12 The Statement of Actuarial Opinion must comment on the reasonableness of the reserves for six items. How many of these items come from Schedule P? 3: Reserve for unpaid losses Direct & Assumed (Schedule P, Part 1, Summary exhibit, totals from columns 13 15) Reserve for unpaid LAE Direct & Assumed (Schedule P, part 1, Summary Exhibit, totals from columns 17, 19, and 21) Extended loss and expense reserves (Schedule P, Interrogatory 1) What are the 3 General Principles for accounting for audits and retrospective adjustments? For statutory statements, companies have a choice of 2 methods (Method 1 or Method 2) to record WP for policies with audits or retro adjustments UPR can be reported either gross or net of EBUB and accrued retro premiums There are 2 ways to determine the non-admitted portion of the accrued retro premiums What does Method 1 do? Added unbilled premium to WP What does Method 2 do? Adds the earned part of the unbilled premium to the EP Do Method 1 and Method 2 provide the same answer for EP? Yes Do Method 1 and Method 2 provide the same answer for WP and UPR? No Which Method would lead a smaller for taxable income? Method 2. Method 1 speeds up the income tax liability. Which Method do tax regulations require companies to use? Method 1. Can companies use Method 1 for some policies and Method 2 for other policies? Yes Why does the statutory balance sheet show the UPR gross of EBUB and accrued retro premiums? It shows separate assets for EBUB and accrued retro premiums to allow the computation of the non-admitted portion of the EBUB and accrued retro premiums assets What are the 2 methods of computing the non-admitted portion of the accrued retrospective premium asset? 10% of the unsecured accrued retro premium asset is not admitted The non-admitted portion varies by policy, depending on the credit rating of the insured

13 Do companies need to use the same method for computing the non-admitted portion of the accrued retrospective premium asset for all policies? Yes Why must companies establish reserves for audit premiums and accrued retro premiums? For tax purposes What are the 3 terms the Annual Statement has for the reserves for audit premiums and accrued retro premiums? EBUB o Shown in total on balance sheet, page 2 line 10.2 o Shown by LOB on U/W & Investment Exhibits Part 2A, page 8 column 3 Accrued Retrospective Premiums Based on Experience o Shown in total on balance sheet, page 2 line 10.3 o Shown in U/W & Investment Exhibit Part 2A, page 8 line 35 column 5 Reserve for rate credits and retrospective premiums based on experience o Shown by LOB on U/W & Investment Exhibit Part 2A, page 8 column 4 What if accounting Method 1 is used for EBUB? WP & UPR are affected. EBUB are included in columns 1 and 2 of U/W & Investment Exhibit Part 2A page 8. They are not included in column 3. What if accounting Method 2 is used for EBUB? WP and UPR are unaffected. The EBUB are included in column 3 of the U/W & Investment Exhibit Part 2A page 8. These entries are negative amounts; they offset the UPR shown in columns 1 and 2. Is the accrued retrospective premium an asset, a liability, or a contra-liability? Contra-liability