SOP 97-3 and Other Balance Sheet Reserves

1
SOP 97-3 and Other Balance Sheet Reserves

• CLRS 2004
• Las Vegas, Nevada
• September 13, 2004
• Claus S. Metzner, FSA, FCAS, MAAA, Aktuar SAV
• Actuary, Milliman, Inc.

2
Other Balance Sheet Reserves

• Reserves
• Premium Revenue Recognition Reserve
• Retro Rated Premium Reserve
• Reserves for Contingent Commissions
• Premium Deficiency Reserves
• Policyholder Dividend Reserves
• Will be discussing these reserves/assets from the
  insurer perspective and the insured perspective
• Impacts if Reserve not Set Appropriately
• Remember
• Materiality is, as always, a consideration
• Consider consistency between loss reserving
  assumptions and assumptions underlying Other
  reserves

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Other Balance Sheet Reserves

• Premium Revenue Recognition Reserve
• Arises from delays in premium reporting
• Estimated premium is higher/lower than final
  premium since exposures (payroll, sales)
  initially estimated
• Impacts Insurer
• Mismatch of revenue/expense
• B-F loss ratio implications
• Combined Ratio too low/high
• Balance Sheet Asset (general situation) is
  missing
• Capital understated due to missing asset
• Impacts Insured
• Mismatch of revenue/expense
• Balance sheet liability (general situation) is
  missing
• Capital overstated

4
Other Balance Sheet Reserves

• Retro Rated Premium Reserve
• Arises from loss reporting/loss settlement
  pattern
• Interim adjustments lead to premium recorded to
  date that is higher/lower than final contractual
  premium since losses are not yet fully settled
• Impacts Insurer
• Mismatch of revenue/expense
• B-F loss ratio implications
• Combined Ratio too low/too high
• Impacts Insured
• Mismatch of revenue/expense
• Balance sheet liability is missing

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Other Balance Sheet Reserves

• Contingent Commission Reserve
• Arises from Agency contracts
• May be based on revenue targets
• May be based on profit targets
• May be a combination of various targets
• Impacts Insurer
• Mismatch of revenue/expense
• Combined Ratio too low/too high
• Capital misstated
• (note specific contract terms should be reviewed
  and the contingent commission program could be
  modeled in relation to the underlying loss ratio
  performance)
• Impacts Agency
• Mismatch of revenue/expense
• Capital misstated

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Other Balance Sheet Reserves

• Premium Deficiency Reserve
• Projection of Loss arising from obligations
  entered into but where premium has not yet been
  earned
• Considerations
• By Line?
• By Business Unit?
• By Company?
• Source of Data
• Calendar/Accident Year
• Policy Year
• Impacts Insurer
• Capital misstated
• (note loss ratio performance, adjusted for the
  premium revenue recognition reserve, is critical
  a good paper on this evaluation, is Ralph
  Blanchards article in the 2000 Fall CAS Forum)

7
Other Balance Sheet Reserves

• Dividend to Policyholder Reserve
• Need to consider the impact of
• Premium Revenue Recognition Reserve
• Reflection in Variable Dividends of Loss Ratio
  changes due to
• Premium Revenue Recognition Reserve
• knowledge gained from Premium Deficiency
  Reserve evaluation
• Impacts Insurer
• Capital misstated

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Other Balance Sheet Reserves

• Summary
• Other Balance Sheet Reserves are important
• To the Insurer and to the Insured
• May need to be considered within the scope SOP
  97-3 for non-insurers (materiality?)
• Other Balance Sheet Reserves are probably
  impacted by Loss and Loss Adjustment Reserve
  Evaluations need to assure consistency