Travelers 2006 Annual Report Download - page 89

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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 revisedestimates 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. Dueto this highdegree 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 o f 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.
Charge Related to the Financial Condition of a Specific Construction Contractor. 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, its banks, 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 restructuringplanthroughout 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 theeffects 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
fromsupporting the contractor’s restructuring plan to adopting a workout plan as ameans tominimize
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
paid amounts, net receivables, liquidated damages, overhead costs, additional completion costs, including
costs associated with replacing the contractor, receivable discounts, current and future claims from owners
and subcontractors against the contractor, and the value of collateral, among others.