Travelers 2005 Annual Report Download - page 92

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obtained concerning contractors with reported claims, the Company considered whether or not losses were
incurred but not yet reported on one or more additional projects for each contractor examined.
Also on April 1, 2004, the Company could begin to use this detailed information to compare SPC’s
assumptions, judgments and actuarial methods that were und erlying th e acquired reserves with its own
assumptions, judgments and actuarial methods. Similarities and differences were found to exist.
Similarities included, but were not limited to, recognizing claim reserves when it was determined that
contractors and commercial surety insureds were in default and thereby unable to meet their obligations,
estimating initial IBNR provisions, and periodically re-evaluating, at least quarterly, the adequacy of the
reserves established based on actual claims recorded and revised estimates of IBNR. Differences included
judgments and methods related to determining IBNR development factors and expected salvage, among
others.
That these differences exist is not unusual for surety reserve estimates. Surety is a line of business for
which there are low frequency, high severity, very complex claims for certain exposures, particularly those
related to large construction contractors and commercial surety insureds. Determining the date of loss in
these circumstances requires a high degree of judgment. In addition, the claim reserve estimates even for
reported claims are also highly judgmental. These two factors, among others, combine to make IBNR
reserve estimations for surety extremely difficult. Due to this high degree of uncertainty, the informed
judgments of different actuaries could and do vary materially. As discussed above, in a merger, these
differences are likely to be even more pronounced.
The claim reviews and actuarial analyses were both completed near the end of the second quarter of
2004. Based upon the results of these reviews and analyses, the Company increased its estimate of the
acquired surety reserves by $300 million, net of $170 million of reinsurance, and recognized this change in
estimate as an income statement charge in the second quarter.
Other Reserving Actions. Prior to the merger and beginning in the third quarter of 2003, SPC
disclosed that a large construction contractor for which it had written several surety bonds was
experiencing financial difficulty. Based upon an analysis of the financial condition of the construction
contractor that was performed in the third quarter of 2003, a restructuring plan was adopted by the
construction contractor, itsbanks, and SPC, among others, as a means to minimize estimated losses. SPC
monitored the progress of the construction contractor toward meeting the requirements of the
restructuring plan throughout subsequent quarters. SPC also estimated and disclosed its estimated
ultimate net losses related to this exposure, beginning in the third quarter of 2003 and updated each
quarter thereafter, including the effects of advances made or expected to be made to the construction
contractor, applicable collateral, co-surety participations and reinsurance. The size and complexity of these
particular construction contracts, coupled with the deteriorating credit quality of the construction
contractor and the inherent uncertainty as to whether it would meet the obligations of the restructuring
plan, resulted in a high degree of judgment in estimating potential losses.
A comprehensive analysis that began in the first quarter of 2004 was completed during the last half of
the second quarter. Based upon this analysis, the Company concluded that the contractor would not be
able to meet the targets set forth in its business and restructuring plans. Therefore, the Company moved
from supporting the contractor’s restructuring plan to adopting a workout plan as a means to minimize
estimated losses. Under the workout plan, the Company would no longer provide additional surety bonds
for new projects of the construction contractor. Also as part of the workout plan, the Company was able to
implement additional accounting and engineering procedures for each open project, which included using
specialists to implement additional forecasting, cash management, and reporting procedures, on both a
project-by-project and consolidated level. Based upon this second quarter change to a workout plan and
the detailed financial analysis that was able to be performed, the Company increased its estimate of the
ultimate net loss by $252 million, including $9 million of reinsurance. This estimate took into consideration