Travelers 2004 Annual Report Download - page 107

uncertain. In addition, the greater the reporting lag the greater the proportion of IBNR claims to the total claim
liability for the product line. Writing new products with material reporting lags can result in adding several years
worth of IBNR claim exposure before the reporting lag exposure becomes clearly observable, thereby increasing
the risk associated with pricing and reserving such products. The most extreme example of claim liabilities with
long reporting lags are asbestos claims. A more recent but less extreme example is automobile leasing residual
value coverage.
For some lines, the impact of large individual claims can be material to the analysis. These lines are
generally referred to as being low frequency/high severity, while lines without this “large claim” sensitivity are
referred to as “high frequency/low severity”. Estimates of claim liabilities for low frequency/high severity lines
can be sensitive to a few key assumptions. As a result, the role of judgment is much greater for these reserve
estimates. In contrast, high frequency/low severity lines tend to have much greater spread of estimation risk, such
that the impact of individual claims are relatively minor and the range of reasonable reserve estimates is narrower
and more stable.
Claim complexity can also greatly affect the estimation process by impacting the number of assumptions
needed to produce the estimate, the potential stability of the underlying data and claim process and the ability to
gain an understanding of the data. Product lines with greater claim complexity, such as for certain surety and
construction exposures, have inherently greater estimation uncertainty.
Actuaries have to exercise a considerable degree of judgment in the evaluation of all these factors in their
analysis of reserves. The human element in the application of actuarial judgment is unavoidable when faced with
material uncertainty. Different experts will choose different assumptions when faced with such uncertainty,
based on their individual backgrounds, professional experiences and areas of focus. Hence, the estimate selected
by the various actuaries may differ materially from each other.
Lastly, significant structural changes to the available data, product mix or organization can also materially
impact the reserve estimation process. During the past year, the merger of TPC and SPC resulted in the exposure
of each other’s actuaries and claim departments to different products, data histories, analysis methodologies,
claim settlement experts, and more robust data when viewed on a combined basis. This has impacted the range of
estimates produced by the Company’s actuaries, as they have reacted to new data, approaches, and sources of
expertise to draw upon. It has also resulted in additional levels of uncertainty, as past trends (that were a function
of past products, past claim handling procedures, past claim departments, and past legal and other experts) may
not repeat themselves, as those items affecting the trends change or evolve due to the merger. This has also
increased the potential for material variation in estimates, as experts can have differing views as to the impact of
these frequently evolutionary changes. Events such as mergers increase the inherent uncertainty of reserve
estimates for a period of time, until stable trends reestablish themselves within the new organization.
Risk factors
The major causes of material uncertainty (“risk factors”) generally will vary for each product line, as well as
for each separately analyzed component of the product line. In some cases, such risk factors are explicit
assumptions of the estimation method and in others, they are implicit. For example, a method may explicitly
assume that a certain percentage of claims will close each year, but will implicitly assume that the legal
interpretation of existing contract language will remain unchanged. Actual results will likely vary from
expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being
estimated currently.
Some risk factors will affect more than one product line. Examples include changes in claim department
practices, changes in settlement patterns, regulatory and legislative actions, court actions, timeliness of claim
reporting, state mix of claimants, and degree of claimant fraud. The extent of the impact of a risk factor will also
vary by components within a product line. Individual risk factors are also subject to interactions with other risk
factors within product line components.
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