Travelers 2006 Annual Report Download - page 142

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and attachment point of coverage. The uncertainty surrounding reserves for small, commercial insureds is
typically less than the uncertainty for large commercial or financial institutions. The high frequency, low
severity nature of small commercial fidelity losses provides for stability in loss estimates whereas, the low
frequency, high severity nature of losses for large insureds results in a wider rangeof ultimate loss
outcomes. Actuarial techniques that rely on a stable pattern of loss development are generally not
applicable to low frequency, high severity policies.
Surety has certain components that are generally considered short tail coverages with short reporting
lags, although large individual construction and commercial surety contracts can result in a long settlement
tail, based onthe length and complexity of the construction project or commercial transaction being
insured. (Large construction projects can take many years to complete.) The frequency of losses in surety
correlates with economic cycles as the primary cause of surety loss is the inability to perform financially.
The volatility of surety losses is generally related to the type of business performed by the insured, the type
of bonded obligation, the amount of limit exposed to loss and the amount of assets available to the insurer
to mitigate losses, such as unbilled contract funds, collateral, first and thirdparty indemnity, and other
security positions of an insured’s assets. Certain classes of surety claims are very high severity, low
frequency in nature. These can include large construction contractors involved with one or multiple large,
complex projects as well as certain large commercial surety exposures. Other claim factors affecting reserve
variability of surety include litigation related to amounts owed by and due the insured (e.g., salvage and
subrogation efforts) and the results of financial restructuring of an insured.
Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the
required fidelity and surety reserves (beyond those included in the general discussion section) include:
Fidelity risk factors
Type of business of insured
Policy limit and attachment points
Third-party claims
Coverage litigation
Complexity of claims
Growth in insureds’ operations
Surety risk factors
Economic trends, including the general level of construction activity
Concentration of reserves in a relatively few large claims
Type of business insured
Type of obligation insured
Cumulative limits of liability for insured
Assets available to mitigate loss
Defective workmanship/latent defects
Financial strategy of insured
Changes in statutory obligations
Geographic spread of business
Fidelity and Surety book of business risk factors
Changes in policy provisions (e.g., deductibles, limits, endorsements)
Changes in underwriting standards
Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a
change in one or more risk factors could have on reserves for fidelity and surety, a 1% increase (decrease)
in incremental paid loss development for each future calendar year could result in a 1.2% increase
(decrease) in loss reserves.