P&C reserve cycle
Reserve changes and communication by
the P&C Actuary
Benny Yuen and Phil Natoli
29 July 2016
What is the reserve cycle?
What is the reserve cycle?
Reserve cycle: cyclical behavior observed when measuring reserve development of
prior accident years by calendar year.
►
Reserve development on prior accident years ($000) - workers' compensation
4,000,000
Prior year reserve development ($000)
3,000,000
2,000,000
1,000,000
0
-1,000,000
-2,000,000
-3,000,000
-4,000,000
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Calendar year
Source: Aggregated NAIC Annual Statement filings
Page 3
29 July 2016
P&C reserve cycle
Accident years tend to develop in one direction from
initial estimate
Consistent upward development from initial estimate of ultimate loss
►
Development of 2002 accident year - workers' compensation
21,500,000
99,180
64,670
147,101
91,584
100,114
21,000,000
168,588
Reserves ($000)
279,026
268,888
20,500,000
87,663
20,000,000
19,500,000
19,000,000
2002
2003
2004
2005
2006
2007
Calendar year
Source: Aggregated NAIC Annual Statement filings
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29 July 2016
P&C reserve cycle
2008
2009
2010
2011
Accident years tend to develop in one direction from
initial estimate
Consistent downward development from initial estimate of ultimate loss
►
Development of 2005 accident year - workers' compensation
27,000,000
1,772,175
26,000,000
Reserves ($000)
25,000,000
1,455,443
24,000,000
549,380
23,000,000
281,796
169,100
22,000,000
95,370
107,823
189,477
53,419
21,000,000
20,000,000
2002
2003
2004
2005
2006
2007
Calendar year
Source: Aggregated NAIC Annual Statement filings
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29 July 2016
P&C reserve cycle
2008
2009
2010
2011
In a given calendar year, similar directional development
is exhibited by many prior accident years
►
►
Prior accident years tend to move together in years with adverse/favorable
development
Causes of adverse/favorable development impact multiple accident years
Count of favorably/adversely developing accident years – workers’ compensation
4,000,000
8
3,000,000
Count of accident years
6
2,000,000
4
1,000,000
2
0
0
-2
-1,000,000
-4
-2,000,000
-6
-3,000,000
-8
-10
-4,000,000
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Calendar year
Favorable
Source: Aggregated NAIC Annual Statement filings
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29 July 2016
P&C reserve cycle
Adverse
PY Dev
Prior year reserve development ($000)
10
Differentiation between underwriting cycle and reserve
cycle
Underwriting cycle: cyclical behavior observed when measuring profitability of
insurance products by calendar year.
►
Underwriting profit – workers’ compensation
10%
5%
Underwriting profit
0%
-5%
-10%
-15%
-20%
-25%
1996
1997
1998
1999
2000
2001
2002
Source: Aggregated NAIC Annual Statement filings
Page 7
29 July 2016
P&C reserve cycle
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Underwriting cycle illustrated by historical rate changes
►
Similar to underwriting and prior year reserve development, we observe cyclical
behavior
Source: The Council of Insurance Agents & Brokers. Chart Prepared by Barclays Research
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29 July 2016
P&C reserve cycle
Differentiation between underwriting cycle and reserve
cycle
Rate changes are reactive to the profitability of a given insurance product
►
Workers' compensation UW profit and rate change
10%
30%
25%
5%
20%
15%
-5%
10%
-10%
5%
0%
-15%
-5%
-20%
-10%
-25%
-15%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Calendar year
Underwriting profit
Source: Aggregated NAIC Annual Statement filings
Page 9
29 July 2016
P&C reserve cycle
Rate change
2011
2012
2013
2014
2015
Rate change
Underwriting profit
0%
Underwriting cycle vs. reserve cycle: correlation vs.
causation
►
►
Prior year reserve development directly impacts underwriting profit in a given calendar
year and can fuel rate increases/reductions
Unclear whether underwriting cycle can prompt prior year reserve change activity
10%
4,000,000
5%
3,000,000
2,000,000
0%
1,000,000
-5%
0
-10%
-1,000,000
-15%
-2,000,000
-20%
-3,000,000
-25%
-4,000,000
Calendar year
Underwriting profit
►
Correlation = -50%
Source: Aggregated NAIC Annual Statement filings
Page 10
29 July 2016
P&C reserve cycle
PY reserve dev
Prior year reserve development ($000)
Underwriting profit
Workers' compensation UW profit/PY reserve dev
Potential causes of the reserve cycle
Page 11
1 January 2014
Presentation title
Causes of reserve cycle
1.
Market events
►
►
►
Page 12
Late recognition of changes in frequency or severity trend
Unanticipated effects of social, economic and legal trends
Development of unanticipated latent claims
29 July 2016
P&C reserve cycle
Workers’ compensation frequency change – late
recognition
►
Late recognition of frequency increase post recession resulted in reserve actions taken by many WC carriers
Source: NCCI State of the Line 2015 https://www.ncci.com/Articles/Documents/II_AIS-2015-SOTL-Article.pdf
Used with permission from NCCI
Page 13
29 July 2016
P&C reserve cycle
Private passenger auto frequency – higher than
expectation
►
Frequency has continued its upward trend, related to continued economic improvement
Source: Seasonally Adjusted Employed from Bureau of Labor Statistics; Rolling Four-Qtr Avg. Frequency from Insurance Services Office;
Insurance Information Institute. http://www.iii.org/presentation/p-c-insurance-industry-outlook-for-2016-and-beyond-focus-on-texas-markets071416
Page 14
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P&C reserve cycle
Asbestos and environmental loss development –
continued burden on carriers
►
Emerged in early 90s and again in 2000s
►
Insurers always concerned about the “next asbestos”
►
Comes down to underpricing the initial expected loss ratio
Asbestos calendar year net incurred loss and LAE
9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Calendar year
Source: Aggregated NAIC Annual Statement filings
Page 15
29 July 2016
P&C reserve cycle
2007
2008
2009
2010
2011
2012
2013
2014
2015
Potential causes of the reserve cycle
1.
Market events
►
►
►
2.
Late recognition of changes in frequency or severity trend
Unanticipated effects of social, economic and legal trends
Development of unanticipated latent claims
Actuarial methods and assumptions
►
►
Page 16
Actuarial tendencies can feed into cyclical behavior
Lag in response to market events
29 July 2016
P&C reserve cycle
Actuarial methods and assumptions as
drivers of reserve development
►
►
►
Actuaries have a tendency to select favorable
assumptions in profitable periods, unfavorable
assumptions in unprofitable periods
Actuaries have a tendency to react to favorable news
more quickly than adverse news
Lag in adjusting assumptions to most recent activity
►
►
►
Can result in playing “catch up”
Important to stay ahead of deteriorating situation
Impact of critical assumptions on initial expected loss ratio
Page 17
29 July 2016
P&C reserve cycle
Current position in reserve cycle by line of
business
Page 18
1 January 2014
Presentation title
Reserve cycle impact by line of business
►
►
►
Casualty line cycles correlated
Common underlying drivers: economic, social, legal trends
Diversification by line of business only partially mitigates impact of market effects
Prior year reserve development by line of business
Res dev on prior AY / PY reserves
15%
10%
5%
0%
-5%
-10%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Calendar year
WC
Med prof
Source: Aggregated NAIC Annual Statement filings
Page 19
29 July 2016
P&C reserve cycle
Other + prod liab
Comml auto liab
Prv auto liab
Medical professional – reserve releases continue
►
►
Favorable development exhibited since 2004; however, reserves appear to be
weakening since 2010
Reserve releases more significant on claims made business in late 2000s
Prior year reserve development by line of business
Res dev on prior AY / PY reserves*
10%
5%
0%
-5%
-10%
-15%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Calendar Year
Med prof occurrence
Med prof claims made
*Denominator does not include A&O reserves when separating CM/Occ; MCIC Vermont excluded from 2014 calendar year
Source: Aggregated NAIC Annual Statement filings
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29 July 2016
P&C reserve cycle
2013
2014
2015
Private and commercial auto – a challenging phase for
auto lines
Auto carriers challenged by recent period of prior year adverse development
Higher than expected frequency likely driving uptick
►
►
Prior year reserve development by line of business
10%
Res dev on prior AY / PY reserves
8%
6%
4%
2%
0%
-2%
-4%
-6%
-8%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Calendar year
Comml auto liab
Source: Aggregated NAIC Annual Statement filings
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P&C reserve cycle
Prv auto liab
2009
2010
2011
2012
2013
2014
2015
Other liability – adverse development in 2015, continued
impact of asbestos liabilities
2015 exhibited adverse prior year development, driven by large commercial writers
Materially impacted by continued asbestos liability development
►
►
Prior year reserve development by line of business
Res dev on prior AY / PY reserves*
15%
10%
5%
0%
-5%
-10%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Calendar year
Other liability occurrence
*Denominator does not include A&O reserves when separating CM/Occ
Source: Aggregated NAIC Annual Statement filings
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29 July 2016
P&C reserve cycle
Other liability claims made
2010
2011
2012
2013
2014
2015
Products liability – continued impact of asbestos
liabilities
Materially impacted by continued asbestos liability development
►
Prior year reserve development by line of business
Res dev on prior AY / PY reserves*
40%
30%
20%
10%
0%
-10%
-20%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Calendar year
Products liability occurrence
*Denominator does not include A&O reserves when separating CM/Occ
Source: Aggregated NAIC Annual Statement filings
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P&C reserve cycle
Products liability claims made
2011
2012
2013
2014
2015
Workers’ compensation – three straight years of reserve
releases
►
►
Favorable prior year development observed in last three calendar years after adverse
prior year development of the previous four calendar years
Higher than expected indemnity claim frequency after recession
Prior year reserve development by line of business
Res dev on prior AY / PY reserves
5%
4%
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Calendar year
WC
Source: Aggregated NAIC Annual Statement filings
Page 24
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P&C reserve cycle
Future cycles could be shorter and less
drastic
Page 25
1 January 2014
Presentation title
Reserve levels have stabilized since early 2000s
With exception of commercial auto, most lines of business have stabilized compared to
challenging early 2000s
►
Prior year reserve development by line of business
Res dev on prior AY / PY reserves
15%
10%
5%
0%
-5%
-10%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Calendar year
WC
Med prof
Source: Aggregated NAIC Annual Statement filings
Page 26
29 July 2016
P&C reserve cycle
Other + prod liab
Comml auto liab
Prv auto liab
2013
2014
2015
Impact of Sarbanes-Oxley requirements
►
►
►
Implemented in 2002 as part of fallout from
Enron/WorldCom
Establishment of Public Company Accounting Oversight
Board (PCAOB)
Protection from accounting fraud, improved accuracy and
detail of disclosures
►
►
►
Justification of assumption changes
Disclosure by accident year
CEO/CFO sign off on financial statements with personal
liability on the line
Page 27
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P&C reserve cycle
Management understanding of reserve
process has improved
►
Reserve committees in place at many companies
►
Due to increased disclosures, increased scrutiny of
actuarial assumptions
►
Transparency of process
►
Page 28
Independent actuaries and state examiners increase visibility of
results
29 July 2016
P&C reserve cycle
Reduction in likelihood of unreasonable
players in marketplace
►
One or two competitors taking unreasonable actions can
impact all writers in a market
►
Underpricing new business, low initial expected loss ratio
assumptions may cause market to follow
►
Sarbanes-Oxley reduces likelihood of competitors acting
unreasonably
►
Entry of hedge funds into insurance market increases
competition, and rates are more likely to remain stable
Page 29
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P&C reserve cycle
Communication of actuaries in times of
increased transparency
Page 30
1 January 2014
Presentation title
Actuaries must list key assumptions in
layman’s terms
►
In order to get buy-in from management, an actuary must
communicate results in a clear and direct fashion
►
Avoid use of actuarial jargon when communicating with
management
►
Balance transparency of actuarial processes while also
staying high-level
►
Add market context to results
Page 31
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P&C reserve cycle
An actuary must convey both confidence in
estimate, as well as inherent uncertainty
►
Hallmark of actuarial work: our estimates are always
changing as new information becomes available
►
Separation of process uncertainty vs. parameter
uncertainty
►
►
►
Strength of justification of actuarial assumptions will limit process
uncertainty
Transparency around parameter uncertainty important
Transparency and strong communication skills allow
actuaries to maintain and improve standing among
management
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P&C reserve cycle
An actuary must convey both confidence in
estimate, as well as inherent uncertainty
►
“what if” scenarios prepare management for alternative
outcomes
►
Scenarios should be based on alternative set of
assumptions
►
Simulation techniques can be used to develop range
around central estimate
Page 33
29 July 2016
P&C reserve cycle
In light of a change in estimate, actuaries will
need to assuage management concern
►
An actuary needs to remain objective and use actuarial
techniques, skills and experience in producing unbiased
estimates.
►
Management needs to know what conditions caused the
change in estimate.
►
►
How could these changes in conditions have been anticipated?
How have the actuary’s assumptions changed in light of
the change in estimate?
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P&C reserve cycle
Communicating reserve releases
►
Reserve releases sometimes considered easier to communicate, as it
means improvement to the bottom line
►
Management may ask the question: were we over-pricing in prior
years? Important to stress uncertainty of actuarial methods
►
Underwriters – may expand terms and conditions
►
Claims department – reluctant to set high case reserves
►
Actuaries – may tend toward optimistic LDFs and trend selections
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P&C reserve cycle
Communicating reserve strengthening
►
Adverse development deteriorates bottom-line result
►
Prepare management ahead of time for “bad news”
►
Underwriters – likely to consider tougher terms and conditions
►
Claims department – more likely to set high case reserves
►
Actuaries – may tend toward conservative LDFs and trend selections
Page 36
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P&C reserve cycle
Strategies for reporting of results
►
Data visualization software can provide insights into results
►
►
Can assist members of management who may prefer visuals rather than numerical
results
Consider length of time management has to review reserving results
►
Page 37
Management must be given enough time to digest and understand results
29 July 2016
P&C reserve cycle
Reserve cycle consideration for an actuarial
analyst
►
Challenges
►
►
►
Benefits
►
►
►
►
►
►
Difficult to consider context of reserve cycle with few years of experience
Conversations around reserves strength over time can be limited to executives
Valuable to consider historical context in day-to-day work
Observations prompt questions
Cyclical activity can be seen in loss triangles
Observations prompt questions not otherwise thought of
“If we don’t learn from history, we are doomed to repeat it”
As an analyst, it never hurts to ask a question to your
supervisor
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P&C reserve cycle
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