George m levine fcas maaa senior manager kpmg llp september 9 2003 chicago illinois
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Establishing the Expected Loss Ratio. George M. Levine, FCAS, MAAA Senior Manager, KPMG LLP September 9, 2003 Chicago, Illinois. Ultimate Loss Ratio (Losses/Premium) expected to be incurred a-priori before consideration of actual experience

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George m levine fcas maaa senior manager kpmg llp september 9 2003 chicago illinois l.jpg

Establishing the Expected Loss Ratio

George M. Levine, FCAS, MAAA

Senior Manager, KPMG LLP

September 9, 2003

Chicago, Illinois


Expected loss ratio definition l.jpg

Ultimate Loss Ratio (Losses/Premium) expected to be incurred a-priori before consideration of actual experience

Loss Ratio discussed as REASONABLENESS check for reserves in CAS Loss Reserve Principles

ELR is basis of ratemaking:

Actual Loss Ratio/ELR –1=Rate Change

Expected Loss Ratio(Definition)


Expected loss ratio why important now l.jpg

Several important changes on the Landscape a-priori before consideration of actual experience

HARD MARKET—Past Loss Ratios not indicative of Future Loss Ratios

SARBANES OXLEY 404 REQUIREMENTS—Internal Control over Financial Reporting

Expected Loss Ratio Why important now?


Expected loss ratio hard market l.jpg

Loss Ratios decrease in times of Increasing Rates a-priori before consideration of actual experience

Expected Loss RatioHard Market


Sarbanes oxley 404 audit of internal control l.jpg

Management’s annual report on internal control must: a-priori before consideration of actual experience

State management’s responsibility for establishing and maintaining adequate internal controls

Contain management’s assessment as of year-end of effectiveness of internal control structure

Independent Auditor must attest to and report on management’s assessment in accordance with standards issued or adopted by the PCAOB (Public Company Accounting Oversight Board)

SARBANES-OXLEY 404Audit of Internal Control


Sarbanes oxley 404 audit of internal controls l.jpg

COSO: Committee on Sponsoring Organizations of Treadway Commission (AICPA is one organization)

COSO’s 5 Areas of Internal Control

CONTROL ENVIRONMENT

RISK ASSESSMENT

CONTROL ACTIVITIES

INFORMATION + COMMUNICATION

MONITORING

Conclusion: ELRs, the bridge between ratemaking and reserving, is important element for insurance controls

SARBANES-OXLEY 404Audit of Internal Controls


Expected loss ratio considerations experience rating l.jpg

Loss Development Commission (AICPA is one organization)

Loss Trend

Premium Rate Changes

New Business Penalty

# of Years to Consider

Expected Loss Ratio Considerations: Experience Rating


Experience rating expected loss ratio example l.jpg

5% Commission (AICPA is one organization)On-Level

Devl. Trended Earned Earned Loss

YearLosses LossesPrem.Prem.Ratio

1999 5.2 6.3 6.0 8.0 79%

2000 6.0 6.9 7.0 8.5 81%

2001 5.6 6.2 7.5 8.3 75%

2002 7.0 7.4 8.0 8.0 93%

Total 23.8 26.8 28.5 32.8 82%

2003 Select 90%

Experience Rating Expected Loss Ratio Example


Experience rating elr further adjustments l.jpg

Split History Into New and Renewal Business Commission (AICPA is one organization)

Homogeneity and Credibility Considerations

Self-Insureds: Often Exposure Bases utilized for Expected Loss Rates instead of Expected Loss Ratios, with same concepts applying

Industry Experience Important for Self-Insureds

Experience Rating ELRFurther Adjustments


Expected loss ratio considerations exposure rating l.jpg

Exposure Bases Commission (AICPA is one organization)

Industry Expected Loss Ratios/Loss Rates

Extension of Exposures

Expected Loss Ratio Considerations: Exposure Rating


Reserving methods initial expected loss ratio selections l.jpg

Bornhuetter-Ferguson Method (PCAS 1972) Commission (AICPA is one organization)

Cape Cod Method/Stanard-Bulhmann Method

Comments: Quarterly Adjustments

Reserving Methods: Initial Expected Loss Ratio Selections


Initial expected loss ratio bases l.jpg

Bornhuetter-Ferguson Method (PCAS 1972) Commission (AICPA is one organization)

External Source for Initial Expected Costs

Ultimate Costs Implied by Development Method,

ILC= LDF X AMT/EXP, where

LDF is Ultimate Development Factor,

AMT is Current Reported (Paid),

EXP is Exposure

ILC is Indicated Loss Cost

Initial Expected Loss Ratio Bases


Initial expected loss ratio bases13 l.jpg

Cape Cod Method Commission (AICPA is one organization)

ULC=AMT/ (EXP/LDF)

Where ULC= Undeveloped Loss Cost

Weights here are (EXP/LDF) for All Periods

Generalized Cape Cod Method:

Unique Expected Loss Cost for Each Accident Period as Weighted Average of Surrounding Accident Periods

Initial Expected Loss Ratio Bases


Bornhuetter ferguson method 95 initial expected loss ratio l.jpg

Earned Expected Reported Expected Commission (AICPA is one organization)

YearPrem.IELRLossesLossesUnreported %

2000 6.0 95% 5.7 5.8 .031

2001 5.6 95% 5.3 4.8 .142

2002 7.0 95% 6.7 4.3 .394

Expected

UnreportedUltimate Ultimate

YearLossesLossesLoss Ratio

2000 0.2 6.0 100%

2001 0.8 5.6 99%

2002 2.6 6.9 99%

Bornhuetter-Ferguson Method95% Initial Expected Loss Ratio


Bornhuetter ferguson method 70 ielr how judgment affects l.jpg

Earned Expected Reported Expected Commission (AICPA is one organization)

YearPrem.IELRLossesLossesUnreported %

2000 6.0 70% 4.2 5.8 .031

2001 5.6 70% 3.9 4.8 .142

2002 7.0 70% 4.9 4.3 .394

Expected 70%IELR 95% IELR

UnreportedUltimate Ultimate Ultimate

YearLossesLossesLoss RatioLoss Ratio

2000 0.1 5.9 99% 100%

2001 0.6 5.4 96% 99%

2002 1.9 6.2 89% 99%

Bornhuetter-Ferguson Method70% IELR—How Judgment Affects


Cape cod method initial expected loss ratio l.jpg

On-Level (3)x(5) Commission (AICPA is one organization)

Earned Earned Reported Expected Expected

YearPrem.Prem.LossesUnreported %Unrep.Loss

(1) (2) (3) (4) (5) (6)

2000 6.0 7.3 5.8 .031 .2

2001 5.6 6.2 4.8 .142 .9

2002 7.0 7.0 4.3 .394 2.8

Total 18.6 20.5 14.9 3.9

Cape Cod IELR =14.9/(20.5-3.9) =90%

Actual Reported/Expected Reported

Cape Cod MethodInitial Expected Loss Ratio


Cape cod method 90 initial expected loss ratio l.jpg

Earned Expected Reported Expected Commission (AICPA is one organization)

YearPrem.IELRLossesLossesUnreported %

2000 6.0 90% 5.4 5.8 .031

2001 5.6 90% 5.0 4.8 .142

2002 7.0 90% 6.3 4.3 .394

Expected Cape Cod 95%

UnreportedUltimate Ultimate B-F

YearLossesLossesLoss RatioUlt. LR

2000 0.2 6.0 99% 100%

2001 0.7 5.5 98% 99%

2002 2.5 6.8 97% 99%

Cape Cod Method90% Initial Expected Loss Ratio


Quarterly estimates @ 6 02 bornhuetter ferguson method l.jpg

Earned Expected Reported Expected Commission (AICPA is one organization)

YearPrem.IELRLossesLossesUnreported %

2000 6.0 90% 5.4 5.5 .067

2001 5.6 90% 5.0 4.6 .242

6/02 3.5 90% 3.2 2.0 .741

Or 6/02 7.0 90% 6.3 2.0 .741

UnreportedUltimate Ultimate

YearLossesLossesLoss Ratio

2000 0.4 5.9 98%

2001 1.2 5.8 104%

6/02 2.3 4.3 124%

Or 6/02 4.7 6.7x.5=3.4 95%

Quarterly Estimates @ 6/02Bornhuetter-Ferguson Method


Conclusions l.jpg

Expected Loss Ratio ever-increasing scrutiny in loss reserving due to changing landscape and hard market

Choice of Initial Expected Loss Ratio subject to judgment, but sophisticated techniques exist to assist in choosing IELRs

Conclusions


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