Reserving for Catastrophes

Reserving for Catastrophes

Kay Cleary

Catastrophe Risk Management Seminar October 7, 2002

10/7/2002 Reserving for Catastrophes 2

Current Catastrophe Reserve Funding (Problem)

After tax

Timing of establishment of a loss reserve

Recognition of catastrophe premiums


Other Countries

Equalization reserves

Catastrophe reserve


Two Components of Catastrophe Reserve (Solution)

NAIC mechanism

Internal Revenue Code change


Internal Revenue Code Change

Deduction from taxable income for loss reserves

HR785


NAIC Catastrophe Reserve

Definitions

Design overview

Accounting treatment


Definitions

Qualifying lines of business

Qualifying catastrophe events

Qualifying losses

Reserve cap

Catastrophe reserve cap factors

Reserve drawdowns/thresholds

Catastrophe year


Qualifying Lines of BusinessFire & allied linesFarmowners multiple-perilHomeowners multiple-perilCommercial multiple-peril (non-liability portion)EarthquakePrivate passenger & commercial auto physical damageInland marine Non-proportional reinsurance for the qualified lines of business.


Qualifying Catastrophe Events

Wind & hail

Earthquake and fire following

Winter catastrophes such as snow, ice, freezing

Fire

Tsunami

Flood

Volcanic eruption (including lahar)


Design Overview

Pre-event reserves

Voluntary

Company specific


Reserve Additions

Portion of net written premium

Sum of $$ for qualifying lines

Contribution subtracted from taxable income

Individual company vs. group


Reserve Cap Factors

$40B industry-wide reserve

Data

Methodology


Data

Both historical experience and modeling

AM Best – 1967 through 1999

Judgment


Methodology1. Industry direct incurred loss ratios2. Mean and standard deviation of loss ratio for

each line3. Cap each loss ratio at mean plus one standard

deviation4. Recalculate means and standard deviations using

capped loss ratios5. Threshold loss ratio for each line of adjusted

mean plus two adjusted standard deviations


Methodology, continued

6. Calculate loss ratios excess of threshold by line and by year

7. Calculate loss dollars excess of threshold by line for all years, using 1999 direct written premium

8. Prorate loss dollars from historical experience to be 2/3 of $40 B

9. Modeled losses by line, prorated to 1/3


Methodology, continued

10. Add historical losses and modeled losses for each line.

11. To get initial factors, divide summed losses by 1999 net written premium.

12. Auto physical damage set to 1%

13. Recalculate

14. Round to 5%


Adjustments

See Appendix C


Reserve Cap Factors

Fire 25%

Allied lines 85%

Farmowners 10%

Homeowners 60%

CMP 30% (non-liab)

Inland marine20%

Earthquake 1630%

Auto PD 1%

Reinsurance 45%


Example - Accumulation

(1) (2) (3) (4)

Line Prem Factor (2) x (3)

Home 100,000 .60 60,000

Auto liab 150,000 na 0

Auto PD 80,000 .01 800

Total 330,000 60,800


When are $$ in Reserve Used?

Declaration of a catastrophe

Allowable drawdown amounts & qualifying losses

Federally taxed when taken out


Declaration of a Catastrophe

Property Claims Service

President

Chief executive official of a state, territory or possession of the United States or the District of Columbia


Qualifying Losses

Gross qualifying losses Used in calculations of allowable amounts

Net qualifying losses Maximum amount that can be draw down

Track by catastrophe year


Amount of Drawdown Allowed

Amount is larger of:Excess of gross qualifying loss above 30% prior year’s surplus

OR

Excess of gross qualifying loss above 100% prior year’s reserve cap

Up to net qualifying loss


Example - Drawdown

Gross qualifying losses 1,350

Salvage, subro & other recoveries 800

Net qualifying losses 550

30% of prior ye surplus 1,853

Prior year reserve cap 584


Excess of gross qualifying loss above 30% prior year’s surplus

(1350 minus 1583) = negative

OR

Excess of gross qualifying loss above 100% prior year’s reserve cap

(1350 minus 584) = 766

Amount is Larger of:

766


Up to Net Qualifying Loss

Larger amount = 766

Net qualifying loss = 550

Allowable drawdown is

550


Other Drawdowns Allowed

Amounts in excess of cap

Insolvency


Accounting Treatment

Single separate reserve

Additions to annual statement blanksBalance sheet

Statement of income

Notes to financial statements


State Catastrophe Programs

Florida Hurricane Catastrophe Fund

California Earthquake Authority


Considerations during Development

Voluntary or mandatory

Lines of business

Perils

Net written premiums

Factors by state as well as by line


Additional NAIC Activities

Review and update

Accounting and blanks

RBC treatment

Demonstrating financial responsibility framework


Accounting and Blanks

Need effective date

Need to reconcile voluntary reserve with mandatory reporting


RBC Treatment

Additional liability;“paid for” from surplus

Increased reserving risk charge?

Catastrophe risk in RBC formula


Demonstrating Financial Responsibility Framework

Proposed when reserve became voluntary

How company will manage net PML

NAIC status

Considerations


Reserve as Part of Catastrophe Management Program

Funds immediately availableStability in resultsNo credit riskVisible to regulators, investors, policyholdersBetter tracking of catastrophe premium

Potential future tax liability

No transfer of risk


Questions ???

[email protected]

850-413-5254

[email protected]

217-524-5376

Reserving for Catastrophes

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