wcm 2009 - warranty profitability - an actuarial approach
DESCRIPTION
TRANSCRIPT
2009
“Warranty Profitability –An Actuarial Approach”
Doug Nishimura, ARMMike Paczolt, ACAS, MAAA
MillimanMarch 12, 2009
Agenda
3
Background
Actuarial Considerations
Alternative Risk Financing
Questions
About Milliman
• Internationally Recognized Global Firm
• Independent – Not broker or insurance carrier
• Over 2,100 Employees
• Office in most major cities
• Multi-Disciplined Practice
4
Our Experience
5
Past and Current Clients
National Retailers
Major Insurance Companies
Major Electronics Internet Provider
Major Electronics Manufacturer
Household Service Provider
Major Electrical Service Provider
Plumbing Manufacturer (Warranty and Products Liability)
5
Our Expertise
• Brown Goods - Typically small household electrical appliances• Televisions• Stereos• DVD Players• Cameras• Telephones• Computers• Video Game Consoles
• White Goods - Comprised of major household appliances• Freezers• Refrigerators• Dishwashers• Microwaves• Washers• Dryers
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Actuarial Considerations
• Data Needed• Loss Distributions• Adverse Selection• Goodwill – Out of Warranty Costs• Seasonality• Pipeline Claims• Earnings Pattern• Unearned Premium Reserve vs. Loss Reserve• Other Common Pitfalls
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Data Needed
• Raw data by claim• Transaction dates
• Occurrence• Report• Record• Paid
• Claim Amount• Product Sales• Product Information• Coverage Periods
8
Warranty Loss Distribution
9
Mechanical Breakdown
(Weibull Distribution)
Consumer Behavior
Total Loss Distribution
Seasonality
Goodwill
Product Mix
Pipeline Claims
Trends
Non-Defective Returns
Obsolescence
Length of Coverage
9
Loss Distribution -Mechanical Breakdown
Weibull Distribution
1010
Loss Distribution -Consumer Behavior
Can be difficult to quantify!
Cause Effect
Consumer Awareness Bump in development throughout warranty life
Length of Warranty Bump in development at end of warranty coverage
Obsolescence No development as product ages
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Loss Development –Actuary’s Solution
24 Months of Coverage
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326/50 = 6.533
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(Time from sales quarter)
Adverse Selection
• Tendency of people with significant loss potential to obtain insurance coverage
• Need to be aware of adverse selection in pricing• Can reduce adverse selection at point of sale
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Goodwill
• Continued payments after warranty coverage has expired (Out of Warranty Costs)
• Very common• 2 reasons goodwill exists:
• Keep consumers happy• Unable to track warranty policy inception
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Quarter Quarters of DevelopmentEnding 6/3 9/6 12/9 15/12 18/15 21/18 24/21 27/24 30/27 33/30 36/33 39/36 42/39
6/30/2005 2.334 1.271 1.092 1.363 1.158 1.034 1.071 1.028 1.064 1.001 1.000 1.004 1.0009/30/2005 1.905 1.260 1.545 1.334 1.080 1.003 1.095 1.128 1.005 1.001 1.000 1.00112/31/2005 1.965 1.689 1.427 1.248 1.122 1.040 1.100 1.099 1.005 1.014 1.0013/31/2006 3.453 1.690 1.156 1.134 1.199 1.135 1.021 1.033 1.042 1.0016/30/2006 2.398 1.264 1.178 1.340 1.110 1.080 1.010 1.085 1.0229/30/2006 1.703 1.305 1.536 1.352 1.092 1.064 1.145 1.04912/31/2006 2.043 1.793 1.415 1.263 1.119 1.143 1.0583/31/2007 3.678 1.646 1.207 1.142 1.235 1.1156/30/2007 2.340 1.349 1.090 1.367 1.1329/30/2007 1.898 1.224 1.610 1.29912/31/2007 2.162 1.747 1.4063/31/2008 3.254 1.7186/30/2008 2.364
Seasonality• Warranty estimates are usually based on monthly or quarterly data• Geography of exposure may cause complexity• Must recognize seasonality
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KEY:
Spring Summer
Fall Winter15
Pipeline Claims
• Lag between occurrence, report, recorded and paid.
• The triangles must be adjusted for this lag
• Reported in warranty period paid after policy expiration
• Development appears less for recent calendar quarters
• Complete development for apples to apples basis
16
Occurred Reported Recorded Paid
16
Earnings Pattern
• Must be based on an incurred (not paid or reported) basis• Earnings pattern calculated after lag adjustment• Match premium and losses• Mismatch can show unprofitable policies as profitable
Losses Premium Loss Ratio
1st Quarter 50 100 50%
2nd Quarter 10 100 10%
3rd Quarter 40 100 40%
4th Quarter 200 100 200%
300 400 75%
Losses Premium Loss Ratio
1st Quarter 50 67 75%
2nd Quarter 10 13 75%
3rd Quarter 40 53 75%
4th Quarter 200 267 75%
300 400 75%
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Unearned Premium Reserve vs. Loss Reserve
• Loss reserve = incurred claims but not yet paid• Typical insurance has a long lag occurrence to payment• Warranty claim is for when claim is reported not sold• Warranty claims are paid quickly after the loss occurs (days)• Warranty liability is almost entirely an unearned premium reserve
for an insurance company
18
Unearned Premium ReserveProduct Sold
Loss Reserve
Loss Occurs
Loss Paid
18
Other Common Pitfalls
• Tail development is unique to warranty (bump in tail)• Repeat breakdowns• Non-defective returns• Long Duration Contracts• Trend• Product Mix• Underlying Warranty
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Alternative Risk Financing
Typical Insurance
Self-Insurance
Cash-flow advantages
More control over losses
Tax Advantages
Do not Subsidize Profit, Commission
Legal Expenses Covered
Retain less Risk
Less complex to insured
TPA Included
20
Captives
• Subsidiary Corp. to insure its own risks
• Recognize premium earlier to reduce income for tax advantage
• Tax deductible for 1st party coverages, only if >30% of premium are 3rd party coverages (general rule)
• No tax advantage for warranty itself
• Should consult with Tax Professional
<70%>30%
Captive Premium
1st Party
3rd Party
1st Party Coverages
• Workers’ Compensation
• General Liability
• Auto Liability
3rd Party Coverages
• Warranty• Credit Card• Employee
Benefits
21
Contact Information
Doug Nishimura, ARMTel: [email protected]
Mike Paczolt, ACAS, MAAATel: [email protected]
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