State of Montana Old Fund Discussion

1. Senate Bill 304 Study Committee State of MontanaOld Fund Discussion Bruce R. Hockman Senior Vice President Towers Perrin Reinsurance 215-963-7744 bruce.hockman@towersperrin.com

2. Montana Old Fund Discussion • Current Financial Situation • Risk Factors to State of Montana • Risk Financing “Alternatives” • Market Status

3. Montana Old Fund Discussion Through December 31, 2003, the following characteristics apply to the Old Fund • 1253 claims with injury dates prior to June 30, 1990 • Outstanding undiscounted liabilities of $106,308,545 • Indemnity $44,371,397 • Medical $61,937,148 • Outstanding liabilities discounted at a rate of 5.25% of $76,329,535 • Indemnity $31,858,663 • Medical $44,470,872 • Fund Equity of $761,819

4. Montana Old Fund Discussion Risk Factors As there is currently a minimal amount of surplus held in the Old Fund account, it is responsible to discuss what factors may impact the fiscal soundness of the account. • Growth in Reserves • Indemnity: Re-openings, Judicial Intervention • Medical: Technology, Inflation, Relatedness Findings • Acceleration of Claims Payments • Primarily Medical • Interest Rate Fluctuation • Medium and long-term rates of return are at a 40 year low.

5. Montana Old Fund Discussion Risk Factors • Growth in Reserves • Reserve “Development” unfortunately is a constant since loss reserving is far from an exact science • Current trend is “adverse” driven largely by 2 factors • Judicial Interpretation • Medical Technology and Inflation • If Medical Reserves grew just 10% over the expected lifetime of the open cases. The account would be underfunded by $6.2mm on an undiscounted basis.

6. Montana Old Fund Discussion Risk Factors • Acceleration of Claims Payments • The discounting of losses is based on 3 critical factors • Accuracy of Reserves • Expected Payment Pattern • Discount Factor Applied • If claim payments accelerate beyond the current actuarial estimates, existing account funds become inadequate by an estimated $3mm

7. Montana Old Fund Discussion Risk Factors • Interest Rate Fluctuation • The account is currently “funded” with invested assets that “match” the unwinding of the discounted liabilities at a rate of 5.45%. • Currently the interest rates on 10 year treasury notes is 3.78% • The interest rate on 20 year treasury notes is 4.67% • Other than in Baa Corporate Bonds, currently at 6.09%, there is no investment vehicle available to match the current discount rate.

8. Montana Old Fund Discussion Risk Financing Alternatives • There are two Risk Financing Alternatives that may be of value for consideration: • Loss Portfolio Transfer (LPT) • Adverse Development Cover (ADC) • Both alternatives will include assessment of the risk factors identified previously. They both involve a high degree of actuarial assessment, and the process of review involves considerable time.

9. Montana Old Fund Discussion Risk Financing Alternatives Loss Portfolio Transfer (LPT) • For an established premium payment, a reinsurer will accept liabilities up to a finite amount for a defined period of time. • Depending on interest rate assumptions, the reinsurer may be willing to provide coverage for amounts greater than existing liabilities. • If actual liabilities exceed the contract limit, such "excess" liabilities will revert back to the purchaser. There are no unlimited transfers available in the market. • Contracts typically include loss adjustment expense within the contract limit of liability. • Premiums can be paid entirely to the Reinsurer (fund transferred) or maintained in a trust fund (funds held), established by the purchaser.

10. Montana Old Fund Discussion Risk Financing Alternatives Adverse Development Cover (ADC) • For an established premium, a reinsurer would provide protection against unforeseen adverse development of existing case reserves. • The premium is directly related to the limit of liability purchased, the reinsurers comfort with existing reserves, and the actuarial projections related to payment patterns and interest rates. • Premiums can either be transferred or held by the purchaser interest (less the reinsurers margin) • Premium returns, or additions are routinely provided for depending on actual results of the program.

11. Montana Old Fund Discussion Risk Financing Alternatives • There is MarketSupport for such programs, but the cost is significant when considering the value received. • Much of the business is done in "TaxFavored" countries such as Bermuda, the Caymans, and Ireland. • Routine time frame for analysis, program development and placement is sixmonths at a minimum.