Travelers 2007 Annual Report Download - page 142

Fidelity and Surety
Fidelity is generally considered a short tail coverage. It takes a relatively short period of time to
finalize and settle fidelity claims. The volatility of fidelity reserves is generally related to the type of
business of the insured, the size and complexity of the insured’s business operations, amount of policy
limit 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 range of
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 on the 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 third party 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
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