Budgets, Evaluations, Reserves and Loss Development: What Defense Lawyers Need to Know Fall 2016 ABA National Legal Malpractice Conference Chicago, IL
Panelists: Dina Cox David Moore Steve Couch Attorney, Lewis Wagner LLP Indianapolis, IN President, Moore Actuarial Consulting, LLC Oak Brook, IL President and CEO, Ohio Bar Liability Insurance Company Columbus, OH Moderator: Dan Zureich President and CEO, Lawyers Mutual Liability Ins. Co. of NC Cary, NC
Preliminary Items
Which of the following best describes your current role? A. Legal counsel B. Insurance claim professional C. Underwriter D. Actuary E. Other
What are reserves? Reserves = insurance company s estimate at point in time of ultimate exposure for unpaid Loss and Loss Adjustment Expenses ( LAE ) Loss: amount that will ultimately be paid to claimant for damages LAE: amount company will pay to defend claim until resolution, settlement or disposition
What are Loss Adjustment Expenses? Allocated LAE ( ALAE ): Amounts assignable to specific claim, including attorneys fees Attorneys fees comprise largest component Also include items such as court costs, expert witness fees, fees for depositions and travel Unallocated LAE ( ULAE ) Amounts that cannot be assigned to specific claim Include salaries for internal claims personnel and company overhead Disclosure: The terminology changed in the late 1990s, but most people still use Loss and ALAE (now Defense and Cost Containment) / ULAE (now Adjusting and Other)
Why do reserves matter? Primary Causes of U.S. P/C Impairments (1969 2014) Source: A. M. Best Impairment Study 2015 * A. M. Best defines impairment as any type of restrictive regulatory action 1. Deficient reserves and inadequate pricing (correlated) are the major cause of insurance company impairments. 2. Reserves are usually the most significant component of rating agency capital. 3. Accurate reserves allow actuaries to more accurately determine rate needs and set aggregate loss reserves, and also provide a more accurate picture of a company s financial health. 4. Reserves are usually the most significant liability for insurance companies.
Have you have reviewed insurance company financial statements? A. Yes B. No
Insurance Accounting 101 Basic Concepts Balance Sheet - Assets - Liabilities = Policyholder Surplus Income Statement - Match Revenues and Expenses / Costs - Loss Ratio = Loss and LAE Incurred / Net Premiums Earned (Premiums Earn Evenly Throughout the policy period) - Combined Ratio = Loss Ratio + Expense Ratio - Underwriting Profit/Loss = Net earned premium net incurred losses, LAE, and operating expenses - Investment income - Net income (in a perfect world )
Example: Effect of Reserve Development on Financial Statements 1. Claims reported during 2011, expenses reserved at $2,500,000 liabilities increase, 2011 calendar year loss ratio increases, surplus declines and 2011 calendar year pre-tax profit reduced by amount of reserves. 2. Expense reserves on 2011 report year claims increased by $2,500,000 in 2012 calendar year liabilities may increase, 2012 calendar year loss ratio may increase, surplus may decline and 2012 calendar year pre-tax profit may be reduced by amount of reserve increase. 3. Expense payments of $2,500,000 made in 2013 assets and liabilities reduced by amount of payment. No effect on policyholder surplus or income statement. 4. Expense reserves increased by $2,500,000 in 2014 liabilities likely increase, 2014 loss ratio likely increases, surplus likely declines and 2014 calendar year pre-tax profit likely reduced by amount of reserve change.
What are components of reserves on an insurer s balance sheet? A. Case loss reserves B. IBNR loss reserves C. Defense and Cost Containment reserves D. Adjusting and Other reserves E. All of the above
What does the acronym IBNR stand for? A. Incurred but not reserved B. Incurred but not reported C. Incurred but not received D. Incurred but not relevant E. None of the above
Impact of LPL defense costs LAE (Defense and Cost Containment Expenses) average just over 80% of Total Loss for NABRICO group. We re talking huge numbers for the industry.
What are causes of loss development? A. Late reporting of claims B. Re-opening of claims C. Additional information on known claims D. A, B & C E. B & C Only
Loss Development Incurred Loss & ALAE Development Triangle As of 12/31/2015 Accident Year 12 24 36 48 60 72 Incurredto-Date LDF Estimated Ultimate 2010 1,957 3,488 5,846 6,890 7,594 7,896 7,896 1.100 8,686 2011 2,342 4,189 5,846 6,852 7,420 7,420 1.144 8,487 2012 2,221 3,944 7,737 9,296 9,296 1.250 11,617 2013 3,457 7,468 12,935 12,935 1.482 19,167 2014 2,371 4,896 4,896 2.512 12,300 2015 2,773 2,773 4.880 13,534 Historical Age-to-Age Loss Development Factors Accident Year 12-24 24-36 36-48 48-60 60-72 72 -Ultimate 2010 1.782 1.676 1.179 1.102 1.040 2011 1.789 1.396 1.172 1.083 2012 1.776 1.962 1.202 2013 2.160 1.732 2014 2.065 All Yr Wtd Avg 1.942 1.695 1.186 1.093 1.040 Selected 1.942 1.695 1.186 1.093 1.040 1.100 Age-to-Ultimate 4.880 2.512 1.482 1.250 1.144 1.100
LML Loss and ALAE development Direct Loss & LAE Ratio 120% 100% 80% Direct Loss Ratio 60% 40% 20% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Accident Year This graph shows LML s direct (before reinsurance) Loss and LAE ratio development from each accident year through December 31, 2015. Initial Current
General Comparison of Actuarial Reserving vs. Pricing Some companies have pricing and reserving performed by different groups of actuaries (checks and balances) Some use the same actuaries for both functions (efficiency) Both use historical loss data to project ultimate losses Actuarial methods may be similar There will be some differences due to the intended purposes Strong communication between underwriting, claim, finance and actuarial is critical for both Reserving Pricing Retrospectively focused Balance sheet focused Adequacy of reserves Solvency Prospectively focused Income Statement focused Adequacy of premiums Profitability
Life Cycle of a Claim Date Description Carrier Activity Status 01/15/2010 Error / omission occurs 06/15/2010 Insured learns of error 08/30/2010 Error reported to carrier Nothing Nothing Incident Included in IBNR Included in IBNR 11/24/2010 Claim Made Claim Case Reserves Set 02/14/2011 Reserves Revised Upward 07/15/2011 Claim Settled / Payment Clears Adverse Development Payment Increase Case Reserves Case Reserves Reduced by Payment. Difference, if any, is Development.
What is the average life cycle of an LPL claim? A. 18 months B. 24 months C. 3.5 years D. 5 years E. It cannot be measured given the vast differences among claims
How can Defense Counsel Help? Set goal to reach resolution ASAP Monthly monitor progress toward that end Pro-actively move case toward resolution / end-point Establish case management plans / scheduling orders, even where not required Request trial dates and mediation deadlines within 12 months Offer early & specific case evaluation Offer prompt & timely significant development reports Include conclusion RE: impact on evaluation and next steps designed to bring case to conclusion
Budgeting & Evaluating Reserving Reserves are estimates of unpaid loss. Major goals of reserving: Set aside funds for future payments so that insurer is able to meet its claim obligations. Allow for reasonably accurate evaluation of carrier s financial condition to be made at any given point in time. Detailed defense counsel budgets and evaluations are integral part of carrier s reserving process. The more accurate the budgets and evaluations, the more accurate the case reserves. And, the more reliable and valuable defense counsel becomes to the carrier.
Tips for Defense Counsel Understand carrier s reserving process & how budget/evaluation fits in Provide timely budgets & evaluations Follow carrier s time frame Adjusters under pressure to set timely, accurate reserves Discuss budget & evaluation with adjuster as you develop, not after Communicate Collaborate
Tips for Defense Counsel Don t blue sky your budget. Be realistic. Helps manage expectations Helps carrier avoid adverse development Avoid stair-stepping budgets, estimates, etc. Carriers want accurate budget that gets them all the way to settlement, resolution or disposition. Carriers appreciate that you may have to update your budget, but should the reasons for the update have been accounted for in the original budget? If you do update your budget, do it on a timely basis. Note: Most carriers track data and measure deviations from budget.
True or False? 1. If you don t have enough information to offer a preliminary evaluation, it is prudent to say so and advise that an evaluation will be forthcoming upon the receipt of additional information. A. True B. False 2. Offering an evaluation of liability at 50/50 is not helpful. A. True B. False 3. Defense counsel should provide a best case scenario evaluation of the claim so as to positively impact the carrier s financial statement. A. True B. False
Tips for Defense Counsel DO DON T Offer preliminary evaluation ASAP upon receipt of assignment, and no later than when due per guidelines Consider external factors, such as plaintiff s counsel, venue, judge, and inadmissible evidence, if you think it will affect what carrier will have to spend to defend or resolve Mention what you don t know that may influence evaluation or reference what is subject to change based upon future conditions Wait to be asked for your evaluation or budget, or send it late Say you don t have enough information to offer evaluation Evaluate liability at 50/50 Send deposition summary or significant development report without commenting on impact of evaluation Fail to update budget when landscape of case changes
Tips for Defense Counsel DO DON T Support gut impression of value against historical data with jury verdict research Adjust values based upon likeability and other impressions of parties and key witnesses Provide credibility assessment and impressions of key witnesses Start with strong initial evaluation and provide significant development reports as case progresses to justify increase or decrease Provide a huge range of jury verdict potentials Tell the client or carrier what you think they want to hear in order to look tough; they want/need honest, realistic evaluations Don t just increase evaluation because that s what you think it will take to resolve the case Give a lowball evaluation and then ask for substantially more money to try to settle the case or at mediation
Tips for Defense Counsel DO DON T When offering reports on significant developments, include commentary regarding impact on evaluation Ask billing/accounting department to set alert when you ve reached 75% of proposed budget, so you can work on updated budget Don t bury evaluation updates on page 10 of significant development report Don t bury significant dates and deadlines in lengthy reports
Appendix - Insurance Accounting Definitions Accident Date The date of the event that gave rise to a claim Accident Year A method of arranging loss and exposure data of an insurer within a book of business, so that all losses associated with accidents occurring within a given calendar year and all premium earned during that same calendar year are compared. Calendar Year Loss experience calculated by matching the total value of all losses incurred during a 12 month period with all premiums earned during that period. Incurred includes development on claims from prior accident years. IBNR Incurred but not reported. Reserves to reflect values for losses which have occurred, but have not been reported, conversion of incidents to claims and claims on extended reporting endorsements. Incident Facts or circumstances which the insured reasonably believes may give rise to a claim. Incurred Losses paid plus changes in loss reserves. Report Date The date an insurer receives notice of an incident or claim. Report Year A method of arranging loss and exposure data of an insurer within a book of business, so that all losses associated with claims reported within a given calendar year and all premium earned during that same calendar year are compared.