Reserving for Unusual Catastrophes 4 2002

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CAS Emerging Issues Seminar
April 15, 2002
Reserving for Unusual Catastrophes
Dan Thomas, PricewaterhouseCoopers
Claire Louis, PricewaterhouseCoopers

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Outline
• Individual company reserve estimate methodology
• Ongoing issues

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Individual Company Reserve Estimate Methodology
• Potential actuarial methods
• Methods used
• Underwriting methodology with assumptions
• Specific line of business considerations

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Potential Actuarial Methods
• CAT development factors
– Actual development history
– Problems applying to 9/11 losses
• Market share allocation

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Methods Used
• Insurers and reinsurers initially used exposure-based loss
estimation method
• Loss estimation generally directed by underwriting with
the assistance of claims and actuarial
• Companies did not anticipate a 9/11-type loss event
• Company exposure identification and management process
reflected this: Most companies did not have such a process
in place prior to 9/11.

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Underwriting Methodology with Assumptions
• Intelligence gathering
• Intelligence vetting
• Exposure investigation
• Exposure estimation
• Loss reporting and analysis
• Loss reserving

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• Intelligence gathering – identifying the exposure
– Market sources
– Underwriting records
– Knowledge of ceding company book of business,
underwriting practices and underlying insured
operations
– Predictive models
– Sufficiently iterative

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• Intelligence vetting – assessing the exposure information
– Source reliability
– System data integrity
– Human error
– Ceding company advices

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• Exposure identification
– Primary exposure areas
– Product lines
– Contract types
– Detailed contract or policy analysis
– Contract wordings

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• Exposure estimation
– Industry loss estimates
– Market share
– Large measure of uncertainty regarding extent of
exposure
– Reassess as new market information is received

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• Loss reporting and analysis
– Expert retention
– Industry steering committees
– Coordinating counsel
– Contract terms and conditions
– Discrepancies in insurer policy and reinsurance contract
terms and conditions
• Occurrence
• Terrorism risk exclusion (some non-U.S. reinsurers)

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• Loss reserving
– General philosophy
– Provisions for uncertainty: portfolio versus transaction-
based – IBNER (ACRs) v. bulk v. IBNR
– LAE
– Volatility of ceding company or insured loss estimates
– Intra-company consistency in reserving approach

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Specific Line of Business Considerations
• Property coverages
– Business interruption
– Extra expense

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• Business Interruption
– Background
– Threshold requirements
• Loss arising from a covered peril
– Causation
– Lost profits
• Interruption of insured’s business operations
– “Necessary suspension of operations”: Sufficient
level of interruption
– Physical damage may not be required for coverage to
attach

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– Coverage issues
• Replacement structure different from original
structure
• Cost of rebuilding
• Period of restoration or recovery
– Time to restore versus time to improve
– Post-restoration period losses
– Projected profits during period of restoration

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Pre-9/11 Post-9/11
Airlines Poor; losses expected for
3Q and for entire 2001;
drop in business travel;
GDP decline and traffic
highly correlated; severe
economic hardship
Grim; 40-50% decline in
revenue for remainder of
the year and 15-20% drop
for first half of 2002.
Lodging Poor; 7-9% decline
through August 2001;
expect continued
volatility
Grim; 20-40% short-term
decline due to travel
restrictions, fear to travel,
worsening of the general
U.S. economy; rising fuel
costs

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• Business Interruption - Civil or military authority coverage
– Impairment of access to insured premises
– Physical loss or damage to property other than the
insured premises
– Caused by or results from covered peril
– Some policies eliminate physical damage requirement
– Some policies exclude civil or military authority
coverage
– Sub-limits

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• Business Interruption - Civil or military authority coverage
– Claims presented by airlines, airports, airport
concessions, entertainment-related organizations,
hotels, travel and tour companies, and transportation
authorities (NY/NJ Port Authority)
– Ingress-egress

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• Business Interruption - other coverages
– Contingent business interruption

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• Extra Expense
– Necessary expenses that exceed normal operating costs
to continue or minimize suspension of business
operations
• Incurred during period of restoration
• Physical loss or damage required
• Sub-limits

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• Extra Expense - Categories
– Expenses incurred when insured shifts operation to
other pre-existing locations
– Cost of renting temporary office space
– Terror prevention expenses; new WTC
– Advertising expenses: Cost of changing Web site, sales
literature, and marketing
– Clean-up costs

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• Workers’ Compensation
– Background / definitions
– Post-traumatic stress syndrome (PTSD)
• Delayed response to stressor event: At least one
month
– Occupational disease

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• Worker’s Compensation - PTSD
– Five days post-event: 44% of Americans reported
substantial stress (Rand Institute)
– Early October 2001: 25% of Americans reported being
worried or having difficulty sleeping (Pew Research
Center)
– Some project a 20% rate of PTSD in work force within
1,000 feet of WTC at time of attack
– Risks of PTSD rise with age and history of trauma,
decline with higher educational level and higher quality
social and economic supports

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– Statutes or case law for many states excludes
compensation for purely mental injury (mental-mental)
– In most states, less than 1% of total claims are purely
mental (Worker’s Compensation Research Institute)
– Many states require accompanying physical injury
(physical-mental)
– New York does not require physical injury

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– Other PTSD compensation standards:
• Unusual and extraordinary stress
• Sudden, unexpected, extraordinary event
• Proximity to event
• Work conditions caused the injury
– Employers offering psychological counseling
– Few PTSD claims reported to insurers to date
• Reporting lag not unexpected given nature of PTSD
(delayed response to stressor event)

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• Worker’s compensation – occupational disease
– Background / definitions
• NYS Worker’s Compensation Law
– 29 specific illnesses if contracted by persons
working with certain toxic substances, including
silicosis and other dust diseases, asbestosis,
anthrax, lead, mercury and radium poisoning

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• Worker’s compensation – occupational disease
– Exposure to asbestos and other airborne pollutants from
WTC recovery and clean-up
– Health complaints reported by 4,000 emergency
response personnel working on WTC clean-up
– Respiratory ailments, neurological problems, cancer
– One-year statute of limitations begins when employee
is disabled and begins to lose wages
– Potentially long latency period and reporting lag

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• Liability – potential coverages impacted
– General liability
• Airlines or airports for negligent security
• Building owners for negligent security and fire
protection systems
– Professional liability – architects and engineers
• Negligent building design

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• Liability
– Industry losses difficult to estimate
– Limitation of Silverstein and airline liability for
damages under federal Air Safety and System
Stabilization Act
– Probability of subrogation
– Victims’ Compensation Fund
– Single venue for all lawsuits

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• Disability
– Employers required to provide under NYS law
– Provides income protection for non-employment-
related injuries or sicknesses
– Does not pay for cost of medical care
– Manhattan workers, visitors, general public
– Mental and nerve-related claims, including PTSD
– Lung ailments, cancers
– Latency period

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• Health
– Non-work-related injuries
– Manhattan residents: Many children
– Manhattan visitors
– “WTC cough”, chronic sinus infections, acute lung
trauma

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Ongoing Issues
• Summary of paid / incurred to date
• Company reserve revisions
• Potential WTC reserving issues
• Future terrorism-related reserving issues
• 9/11 Insurance and non-insurance dispute update
• Reserving “checklist”

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Ongoing Issues
Summary of paid / incurred to date
• Types of payments
• Gross / net gap
Company reserve revisions
• Number of revisions
• Reasons for revisions

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Ongoing Issues
• Potential WTC reserving issues
– Property
– Worker’s compensation / disability / health
• PTSD
• Respiratory and neurological ailments; cancers
– Liability
• General, products

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Ongoing Issues
• Future terrorism-related reserving issues
– U.S. and global risks
– Chemical, biological, radiological attacks
• Could affect large numbers of people
• Potentially affected coverages
– Property / business interruption
– Worker’s compensation
– General liability, professional liability, products
liability
» Could give rise to mass tort and class actions

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Ongoing Issues
• Insurance response to terrorism exposures
– Shut-down from a bio-hoax
• Business interruption
– Anthrax clean-up
• Property
– Pollution or contamination exclusion
– Bio-attack in workplace
• Workers’ compensation

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Ongoing Issues
• Insurance response to terrorism exposures – Cont’d.
– Anthrax testing; cost of precautionary antibiotics
related to suspected anthrax exposure
• Worker’s compensation
– Protection of employees and customers against
potential terrorist attacks
• To date, lawsuits filed against U.S. Postal Service,
physician, and hospital
• General liability
– Pollution exclusion

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Ongoing Issues
• 9/11 Insurance Dispute Update
– Silverstein
• Total of 19 insurers, Swiss Re and others
• Policies did not reference Willis policy: Source of
dispute on number of occurrences
• 3rd September 2002 trial date
– Silverstein: ACE, XL
• Referenced Willis policy: one occurrence, not two
• Defines occurrence as “all losses or damages that
are attributable directly or indirectly to one cause or
to one series of similar causes”
• Settled based on one occurrence

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Ongoing Issues
• 9/11 Insurance Dispute Update – Cont’d.
– Westfield
• Lawsuit with Zurich dismissed
• Dispute will be decided through arbitration
• Zurich policy supplements Silverstein cover
– Port Authority
• No lawsuit; ongoing negotiations with insurers
• Primary issue is number of occurrences

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Ongoing Issues
• 9/11 Insurance Dispute Update – Cont’d.
– Reinsurers are challenging ceding company property &
business interruption claim payments, resulting in
delays in reinsurer payments
– Increase in reinsurer/ceding company disputes
• “Follow the fortunes” does not always mean “follow
the settlement”

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Ongoing Issues
• Non-Insurance Dispute-Related Issues
– 90-day deadline to give notice of claim; some notices
received after 90 days may be accepted
– One year deadline to file suit
– 1,300 people have given notice may sue NYC for $7.8
billion for fear of cancer and ailments related to WTC
cleanup and recovery
– Under NYS law, fire fighters not entitled to worker’s
compensation

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Ongoing Issues
• Non-Insurance Dispute-Related Issues – Cont’d.
– Property owners near WTC have also given notice they
may file suit against NYC
– As of 1/2002 (following expiration of 90-day deadline),
the Port Authority had received 87 notices of claim
– Suit filed on behalf of relatives of six airline passengers
who died on 9/11: American Airlines, United Airlines,
security firms at Logan, Newark, and Portland, ME,
airports

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Ongoing Issues
• Reserving “checklist”
– Liability estimation
– Solvency considerations
– Ongoing business considerations

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Ongoing Issues
Checklist – Liability Estimation
• Statement of Opinion considerations
– Reinsurance Collectibility
– Applicability of financial reinsurance
– Impact on RBC or IRIS tests
– Type of opinion
– Changes in reserving methods and assumptions
– List of major risk factors
– Potential for material adverse deviation
– Materiality

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Ongoing Issues
Checklist – Liability Estimation
• Other considerations
– Booked reserve issues
– Personnel and methods used
– Uncollectible reinsurance
– Loss versus LAE
– Procedural changes in company

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Ongoing Issues
Checklist -- Solvency Considerations
• Cash flow
• Asset management
• Present to the outside world
• Reserve range uncertainty

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Ongoing Issues
Checklist -- Ongoing Business Considerations
• Reinsurance scenarios
• Policy and underwriting changes
• Changes in direction of company

Reserving for Unusual Catastrophes 4 2002

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