Reserve Estimates: May 26, Raunak Jha

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1 Reserve Estimates: The Blended Way May 26, 2011 Raunak Jha Deloitte Consulting India Pvt. Ltd

2 Agenda Robust Reserving Process Popular Methods Blended Methods Bornhuetter- Ferguson Method The Cape Cod approach Q&A 1

3 Robust Reserving Process

4 An overview of Robust Reserving Process Company data Discussions with company personnel Other considerations Back-end diagnostics Robust Actuarial Process Industry data Pre-analysis diagnostics Variability Multiple methods and adjustments 3

5 An overview of Robust Reserving Process Company data Discussions with company personnel Other considerations Back-end diagnostics Robust Actuarial Process Industry data Pre-analysis diagnostics Variability Multiple methods and adjustments 4

6 Popular Methods

7 Popular Methods Used in the Indian Industry Paid Loss Development Method Incurred Loss Development Method Expected Loss Ratio Technique Assumptions s Payment patterns are assumed to be stable No change in case reserve adequacy Premium is an accurate measure of exposure Adva antages Original data used, no Uses all the available Can be used even if no initial i i loss estimates information i history is available Disadvantages s May generate large, volatile loss development factors & take longer to develop to ultimate Uses case reserves, which are estimates, to develop estimates of ultimate losses Pricing inconsistency distorts actual exposure and ignores actual data 6

8 Blended Methods

9 Blended Methods Description Combines loss development and exposure based information in arriving at Ultimate estimates and increases flexibility to select results based on circumstances Advantages Reduce prediction errors Avoid overreaction Future loss emergence predicted is correlated with an exposure measure Use of loss information from all the years in order to project any given year 8

10 Example of Blended Method: Bornhuetter-Ferguson(BF) Method Description Project IBNR/expected unpaid loss based on expected losses and the percentage of ultimate losses which are currently unreported/unpaid Advantages Easy to use Compromises between loss development and expected loss ratio methods actually the BF Ultimate loss is a weighted average of the LDM Ultimate and ELR Method Ultimate losses Avoid overreaction - doesn t apply development factors to an unusual claim occurrence Suitable for new or volatile lines of business Can be used for both paid & incurred data 9

11 The Cape Cod approach Description The Cape-Cod Cod method is a particular case of the Bornhuetter-Ferguson method with prior estimators of the expected ultimate cumulative losses which are based on both internal and external information Formula for Expected Loss ratio for all accident years: Where; Exp(LR) = Expected loss ratio estimate F = Decay factor (0 <F < 1) R j = trended losses for accident year j LDF j = Loss development factor to ultimate t for accident year j E j = Exposures for accident year j. 10

12 Accident Year Exposures Losses XYZ Insurance Company Cape Cod Method Trend Rate = 0.0% Trend Factor Trended Losses % of Ultimate Exposures Unreported Exposures (1) (2) (3) (4) (5) (6) (7) ,000 3, , % 5,950 1, ,000 4, , % 6,000 2, ,000 4, , % 5,400 3, ,000 3, , % 4,500 5, ,000 2, , % 2,750 8,250 Total 45,000 18,800 18,800 24,600 20,400 Accident Year Trended Developed Loss Ratio Expected Detrended Ultimate Loss Expected Loss Ratio Ratio IBNR Reserve Ultimate Losses (8) (9) (10) (11) (12) % 76.4% 76.4% 802 4, % 76.4% 76.4% 1,528 5, % 76.4% 76.4% 2,751 7, % 76.4% 76.4% 4,203 7, % 76.4% 76.4% 6,305 9,105 Total 76.4% 15,590 34,390 Notes: (1) Can be premiums,claim counts, ratemaking exposures,etc (7) =(1)X[1.0 (5)] (2) Can also be claim counts,paid losses,alae,salvage&subrogation,etc (8) =(4)/(6) (3) Can also reflect other adjustments to losses (9) =Total of(8)trended to 2010 (4) =(2)X(3) (10) =(9)/(3) (5) =1.0/(Development factor to ultimate) (11) =(7)X(10) (6) =(1)X(5) (12) =(2)+(11) 11

13 Accident Year Exposures Losses XYZ Insurance Company Cape Cod Method Trend Rate =7.0% Trend Factor Trended Losses % of Ultimate Exposures Unreported Exposures (1) (2) (3) (4) (5) (6) (7) ,000 3, , % 5,950 1, ,000 4, , % 6,000 2, ,000 4, , % 5,400 3, ,000 3, , % 4,500 5, ,000 2, , % 2,750 8,250 Total 45,000 18,800 21,767 24,600 20,400 Accident Year Trended Developed Loss Ratio Expected Detrended Ultimate Loss Expected Loss Ratio Ratio IBNR Reserve Ultimate Losses (8) (9) (10) (11) (12) % 88.5% 67.5% 709 4, % 88.5% 72.2% 1,445 5, % 88.5% 77.3% 2,782 7, % 88.5% 82.7% 4,548 8, % 88.5% 88.5% 7,300 10,100 Total 88.5% 16,783 35, Notes: (1) Can be premiums,claim counts, ratemaking exposures,etc (7) =(1)X[1.0 (5)] (2) Can also be claim counts,paid losses,alae,salvage&subrogation,etc (8) =(4)/(6) (3) () Can also reflect other adjustments to losses (9) () =Total of(8)trended () to 2010 (4) =(2)X(3) (10) =(9)/(3) (5) =1.0/(Development factor to ultimate) (11) =(7)X(10) (6) =(1)X(5) (12) =(2)+(11) 12

14 Accident Year Exposures Losses XYZ Insurance Company Cape Cod Method Decay Rate = 0.75 Trend Rate = 7.0% Trend Factor Trended Losses % of Ultimate Exposures Unreported Exposures (1) (2) (3) (4) (5) (6) (7) ,000 3, , % 5,950 1, ,000 4, , % 6,000 2, ,000 4, , % 5,400 3, ,000 3, , % 4,500 5, ,000 2, , % 2,750 8,250 Total 45,000 18, ,767 24,600 20,400 Accident Year Trended Developed Loss Ratio Expected Ultimate Loss Ratio Detrended Expected Loss Ratio IBNR Reserve Ultimate Losses (8) (9) (10) (11) (12) % 86.1% 65.7% 690 4, % 87.4% 71.3% 1,427 5, % 89.7% 78.3% 2,821 7, % 89.8% 83.9% 4,616 8, % 90.9% 90.9% 7,499 10,299 Total 88.5% 17,052 35, Notes: (1) Can be premiums,claim counts, ratemaking exposures,etc (7) =(1)X[1.0 (5)] (2) Can also be claim counts,paid losses,alae,salvage&subrogation,etc (8) =(4)/(6) (3) Can also reflect other adjustments to losses (9) =Total of(8)trended d to 2010 (4) =(2)X(3) (10) =(9)/(3) (5) =1.0/(Development factor to ultimate) (11) =(7)X(10) (6) =(1)X(5) (12) =(2)+(11)

15 XYZ Insurance Company Cape Cod Method Decay Rate = 0.75(a) Calculation of a priori loss ratio for 2007(b) Calculation of a priori loss ratio for 2010(b) Accident Year Exposures Lag Trend Factor based on lag Weighted Exposure Trended Ultimate Loss Ratio Accident Year Exposures Lag Trend Factor based on lag Weighted Exposure Trended Ultimate Loss Ratio (1) (2) (3) (4) (5) (6) (1) (2) (3) (4) (5) (6) , , % , , % , , % , , % , , % , , % , , % , , % , , % , , % Total 24,600 18, % Total 24,600 13, % Notes: (2) From earlier exhibit (3) =absolute value of difference between (b) and (1) (4) =(a) raised to power of (3) (5) =(4)X(2) ( ) (6) From earlier exhibit, Column 8 for Individual years. Total is (a) Selected judgementally, based on observed diagnostic tests results 14

16 Points to consider When should loss development methods be used? When should exposure-based methods be used? Whenever an appropriate exposure base has been identified, the actuary could rely on a loss reserving method that mixes loss development methods with exposure-based expected loss methods What is an appropriate way to determine e e the expected ed ultimate loss ratio? The expected ultimate loss ratio could be determined using the Generalized Cape Cod (GCC) method described. The expected ultimate loss ratio is based on a combination of factors, namely: (a) maturity of data, (b) volume of data and (c) decay What items should be considered when selecting the exposure base for the GCC method? The exposure base should be a leading indicator for the quantity being projected The exposure base requiring a fewer adjustments would be preferred What exposure base is generally used for projecting ultimate losses in the GCC method? As long as there is a stable environment, ultimate reported claim counts are generally used as exposure base when projecting ultimate losses using the GCC method 15

17 References Applying a Robust Actuarial Reserve Analysis to Long-Tailed General Insurance Coverage (by Charles Cicci, Debashish Banerjee and Raunak Jha, Deloitte Consulting) Using Best practices to Determine a Best Reserve Estimate (by Paul J. Struzzieri and Paul R. Hussain, Milliman & Robertson Inc.) Balancing Development and Trend in Loss Reserve Analyses (by Gluck, Spencer) 16

18 Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its member firms. 17

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