Understanding the Actuarial World

Outline What Is An Actuary?

What Do Actuaries Do?

Statements of Actuarial Opinion

Reserving

Pricing

What Makes a “Good” Actuary

Summary

Questions

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What is an Actuary?

“Math geeks” -- attracted to actuarial work because of the numbers

Stuck in the back rooms

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Once Upon a Time…

NOW… Consulting has grown, actuarial roles have expanded

Dweebs still around but more “normal,” well-rounded people are working as actuaries and interacting with non-finance personnel

Definition of Actuary

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Actuaries put a price tag on risk. We are leading professionals in finding ways to manage risk, and are experts in:

• Evaluating the likelihood of future events • Reducing the impact of undesirable events • Designing creative ways to reduce the likelihood of undesirable

events Actuaries apply our mathematical expertise, statistical knowledge, economic and financial analyses, and problem-solving skills to a wide range of business problems. Actuaries help companies evaluate the long-term financial implications of their decisions, we develop new ways to manage risk, and we estimate the costs of uncertain future events ranging from tornadoes and hurricanes to changes in life expectancy

We prefer this one!

Professional Organizations

American Academy of Actuaries (AAA)

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Casualty Actuarial Society (CAS)

Society of Actuaries (SOA)

Historical Number of Credentialed Actuaries

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1978 1988 1998 2008 Current

FCAS/ACAS 784 1,437 3,059 4,818 6,100

FCAS = Fellow Casualty Actuarial Society ACAS = Associate Casualty Actuarial Society

1969 1989 1995 Current

FSA/ASA 3,544 11,784 16,942 24,000

FSA = Fellow Society of Actuaries ASA = Associate Society of Actuaries

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What Do Actuaries Do?

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Pricing Rate Level Adequacy Reviews / Rating Plan Analyses / Funding for Self-Insureds / Regulatory Rate Filings / Reinsurance Negotiations

Statements of Actuarial Opinion / Annual and Interim Reserve Analyses / Profitability Analyses / Assistance with Regulatory Examinations / Commutations

Reserving

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Miscellaneous Feasibility Studies & Pro Formas / Reinsurance Advice / Expert Testimony & Litigation Support / RBC Analyses / Pension and Retiree Medical Valuations

GOVERNMENT / PUBLIC POLICY WORK:

Medical Malpractice “Crisis” / Credit Scoring / PPACA /

Social Security and Medicare

SOFTWARE:

Rating / Reserving

Insurers

Reinsurers

Agencies/Brokers

Regulators

Lawyers

Government

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Who Uses Actuaries? Self Insureds

Captives

Start-ups

Health Entities

Life / Pension Entities

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Statements of Actuarial Opinions (and other stuff)

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Actuarial Opinion Requirement Statement of Actuarial Opinion

Actuarial Opinion Summary

Actuarial Report

ITEMS REQUIRED IN STATEMENT OF ACTUARIAL OPINION

Identification

Scope

Opinion

Relevant Comments

Exhibit A: Items and amounts on which the actuary is expressing an opinion

Exhibit B: Disclosures of items affecting the opinion

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Opinions Must State That The Amounts… Meet the requirements of the insurance laws of the

state of domicile

Are computed in accordance with, or are consistent with reserves computed with, accepted actuarial standards and principals

Make a reasonable provision for all unpaid loss and loss expense obligations of the company under terms of its contracts and agreements

Companies that, for example, have $100K of property reserves and $5M of surplus

Opinions are more compliance, will not impact solvency or financial strength

Materiality threshold is high

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The Spectrum: Compliance or Value Added Analysis? COMPLIANCE

Clients look to actuaries for strategic input based on reserve analyses

Very complicated

Material changes in conclusions can impact the financial statements significantly

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The Spectrum: Compliance or Value Added Analysis?

VALUE ADDED

Reserving

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What Exposures Can Be Projected to Ultimate? Loss and/or Expense (ALAE) Paid and/or Reported Claim Counts Severities Premium ALAE / Loss Ratio Active Life Reserves Disabled Life Reserves

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Paid Loss Development Method Paid Loss Months of Development

Accident Year 12 24 36 48

2005 464,200 582,880 592,820 592,820

2006 485,270 520,935 523,874

2007 202,840 319,380

2008 175,236

Development Factors

Accident Year 12-24 24-36 36-48 48-ult

2005 1.256 1.017 1.000

2006 1.073 1.006

2007 1.575

2008

Average 1.301 1.011 1.000

Weighted Avg. 1.235 1.012 1.000

Prior LDF Sel. 1.250 1.010 1.000 1.000

Selected 1.250 1.015 1.000

Cumulative 1.269 1.015 1.000 1.000

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Paid LDF Method IBNR Calculation

Accident Year Paid Loss &

DCCE Development

Factors Indicated Ultimate

Loss & DCCE Case Reserves IBNR

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

2005 592,820 1.000 592,820 - -

2006 523,874 1.000 523,874 - -

2007 319,380 1.015 324,171 2,000 2,791

2008 175,236 1.269 222,374 35,000 12,138

Total 1,611,310 1,663,239 37,000 14,929

FOOTNOTE: (1),(2) From prior slide (3) = (1) x (2) (4) = From company (5) = (3) – (4) – (1)

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Case Reserve Development Method

Valuation Date 12/31 Case Reserves as of End of

Year

Total Paid after End of Year on Case Reserves at End of

Year Implied IBNR

Implied Development

Factor

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

2005 31,300 41,500 10,200 1.33

2006 7,600 8,140 540 1.07

2007 22,500 27,852 5,352 1.24

2008 37,000

Total (through 2007) 61,400 16,092 1.26

(5) Selected case reserve development factor 1.25

(6) Indicated future development on case 9,250

May be appropriate for smaller, property-driven exposures

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Reported Loss Development Method

Maturity (in years)

Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

1991 142 176 222 259 292 334 374 411 445 494 567 613 658 703 708 734 762

1992 634 749 853 953 1,079 1,200 1,304 1,399 1,509 1,591 1,684 1,738 1,834 1,884 1,919 1,936

1993 668 772 899 1,025 1,173 1,299 1,382 1,511 1,627 1,761 1,865 2,001 2,114 2,174 2,239

1994 510 629 831 830 940 1,074 1,167 1,281 1,408 1,505 1,595 1,703 1,763 1,783

1995 223 272 297 336 380 397 446 487 515 541 546 559 573

1996 287 349 427 502 574 663 779 886 996 1,096 1,142 1,192

1997 515 582 663 753 833 883 954 992 1,023 1,045 1,070

Development Factors

Year 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10-11 11-12 12-13 13-14 14-15 15-16 16-17

1991 1.239 1.261 1.167 1.127 1.144 1.120 1.099 1.083 1.110 1.148 1.081 1.073 1.068 1.007 1.037 1.038

1992 1.181 1.139 1.117 1.132 1.112 1.087 1.073 1.079 1.054 1.058 1.032 1.055 1.027 1.019 1.009

1993 1.156 1.165 1.140 1.144 1.107 1.064 1.093 1.077 1.082 1.059 1.073 1.056 1.028 1.030

1994 1.233 1.321 0.999 1.133 1.143 1.087 1.098 1.099 1.069 1.060 1.068 1.035 1.011

1995 1.220 1.092 1.131 1.131 1.045 1.123 1.092 1.057 1.050 1.009 1.024 1.025

1996 1.216 1.223 1.176 1.143 1.155 1.175 1.137 1.124 1.100 1.042 1.044

1997 1.130 1.139 1.136 1.106 1.060 1.080 1.040 1.031 1.022 1.024

Weighted Avg. 1.239 1.261 1.166 1.127 1.143 1.119 1.098 1.082 1.110 1.147 1.055 1.049 1.027 1.022 1.016 1.038

Selected 1.239 1.261 1.166 1.127 1.143 1.119 1.098 1.082 1.110 1.147 1.055 1.049 1.027 1.022 1.016 1.038

Cumulative 4.899 3.952 3.133 2.686 2.382 2.082 1.860 1.692 1.563 1.408 1.227 1.163 1.108 1.078 1.055 1.038

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Reported LDF Method IBNR Calculation

Accident Year Reported Loss Development

Factors Indicated Ultimate

Loss & DCCE IBNR

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

1993 509 1.055 537 28

1994 630 1.078 679 49

1995 564 1.108 625 61

1996 409 1.163 476 67

1997 546 1.227 670 124

2000 583 1.692 987 404

2002 388 2.082 808 420

Total 3,629 4,782 1,153

FOOTNOTE: (1),(2) From prior slide (3) = (1) x (2) (4) = (3) – (1)

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Reasonability Checks Loss Ratios Frequencies Severities Average Case Reserves

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Changes That Impact Actuaries’ Analyses Rate & Rating Plans Underwriting Guidelines TPAs Personnel Reserving Philosophy Territory Business Profile Agencies Premium Growth Government Regulations (e.g. PPACA)

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Baseball and Actuaries Sabermetrics is the analysis of baseball

through objective evidence, especially baseball statistics

The term is derived from the acronym SABR – Society for American Baseball Research – coined by Bill James

John Dewan, FSA, worked with Bill James, and formed STATS, Inc., in his basement sold it to Fox News for $45M in 1999

Formed Baseball Info Solutions in 2002

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Reported Loss Development Method

Age

Year 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43

Bonds 142 176 222 259 292 334 374 411 445 494 567 613 658 703 708 734 762

Aaron Mays McCovey

634 749 853 953 1,079 1,200 1,304 1,399 1,509 1,591 1,684 1,738 1,834 1,884 1,919 1,936

Robinson Palmeiro Jackson Williams

668 772 899 1,025 1,173 1,299 1,382 1,511 1,627 1,761 1,865 2,001 2,114 2,174 2,239

Ruth Schmidt Thomas

510 629 831 830 940 1,074 1,167 1,281 1,408 1,505 1,595 1,703 1,763 1,783

Killebrew 223 272 297 336 380 397 446 487 515 541 546 559 573

Sosa McGwire

287 349 427 502 574 663 779 886 996 1,096 1,142 1,192

Mantle Foxx

515 582 663 753 833 883 954 992 1,023 1,045 1,070

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Reported LDF Method Home Run Calculation

Player Number of HR’s Development

Factors Projected Career HR

Total

Projected Remaining

HR’s

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

Gary Sheffield 509 1.055 537 28

Ken Griffey, Jr. 630 1.078 679 49

Jim Thome 564 1.108 625 61

Jason Giambi 409 1.163 476 67

Manny Ramirez 546 1.227 670 124

Alex Rodriguez 583 1.692 987 404

Andruw Jones 388 2.082 808 420

Total 3,629 4,782 1,153

FOOTNOTE: (1),(2) From prior slide (3) = (1) x (2) (4) = (3) – (1)

Pricing

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Rate Work Rate work often done by rating bureaus They file on behalf of member companies

Insurance Services Office

National Council on Compensation Insurance

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Rate Indications: A High-Level View of Loss Ratio Method An insurer wants to set rates for policies to be written

in CY 2014 The insurer’s actuary estimates that during the past

three years there were: Losses and Allocated Loss Adjustment Expense (ALAE) =

$700K Premium (assuming current rates) = $1M

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Are Current Rates Adequate? Historical Loss and ALAE (L&ALAE) Ratio $700K / $1M = 70% of premium

After insurer pays budgeted expenses and profit, it only has 100% - 40% - 5% = 55% of premium to pay losses This is the Permissible Loss Ratio

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Are Current Rates Adequate? To compensate for this shortfall, the insurer

needs to raise rates to the extent that the Historical L&ALAE Ratio exceeds the Permissible Loss Ratio 70% / 55% - 1 = 27.3% Indicated Change

Check that raising rates 27.3% is adequate: Revised Historical L&ALAE Ratio = $700K / ($1M x

1.273) = 55% so the Historical Loss Ratio matches the Permissible Loss Ratio

No one has the ability to know the future, or to estimate historical losses perfectly

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Can It Be That Easy?

Trend Changes in business profile Competitive influences All the issues with reserving Price optimization software

behind the scenes And more

THIS SIMPLE ANALYSIS IGNORES: WHY?

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Macro vs. Micro

Macroeconomic Ratework Microeconomic Ratework

A change in base rate that impacts all insureds the same.

A change to rating factors that fine tunes the rating plan and impacts insureds differently.

New Rates

Old Rates

New Rates

Old Rates

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What Makes a Good Actuary??

Listen to management or clients

Understand the business of insurance

Good communication

skills Not stupid

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Summary

Actuaries bring an important set of tools to insurance problems

Actuaries are the accepted experts in loss reserving and rate filings

Actuaries provide services to all areas in and around the insurance industry

Basic actuarial reserving and ratemaking methodologies are straightforward

Good actuaries understand the underlying characteristics of the business and adjust their actuarial methodologies and assumptions accordingly

Any questions?