Travelers 2007 Annual Report Download - page 35

extending coverage to include domestic acts of terrorism and reauthorizing the Program through 2014.
The three acts are hereinafter collectively referred to as ‘‘the Acts.’’
In order for a loss to be covered under the Program (subject losses), the loss must meet certain
aggregate industry loss minimums and must be the result of an event that is certified as an act of
terrorism by the U.S. Secretary of the Treasury. The aggregate industry loss minimum was $100 million
in 2007 and will remain at $100 million through 2014. The original Program excluded from
participation certain of the following types of insurance: Federal crop insurance, private mortgage
insurance, financial guaranty insurance, medical malpractice insurance, health or life insurance, flood
insurance, and reinsurance. The Terrorism Extension Act exempted from coverage certain additional
types of insurance, including commercial automobile, professional liability (other than directors and
officers’), surety, burglary and theft, and farm-owners multi-peril. In the case of a war declared by
Congress, only workers’ compensation losses are covered by the Acts. The Acts generally require that
all commercial property casualty insurers licensed in the United States participate in the Program.
Under the Program, a participating insurer is entitled to be reimbursed by the Federal Government for
a percentage of subject losses, after an insurer deductible, subject to an annual cap. The Federal
reimbursement percentage was 85% in 2007 and will remain at 85% through 2014.
The deductible is calculated by applying the deductible percentage to the insurer’s direct earned
premiums for covered lines from the calendar year immediately preceding the applicable year. The
deductible under the Program was 15% for 2005, 17.5% for 2006 and 20% for 2007, and will remain at
20% through 2014. The Company’s estimated deductible under the Program is $2.25 billion for 2008.
The annual cap limits the amount of aggregate subject losses for all participating insurers to
$100 billion. Once subject losses have reached the $100 billion aggregate during a program year,
Congress shall determine the sources of funds, if any, available for losses that exceed the $100 billion
cap. The Company had no terrorism-related losses in 2007, 2006 or 2005. Given the unpredictable
frequency and severity of terrorism losses, as well as the limited terrorism coverage in the Company’s
own reinsurance program, future losses from acts of terrorism, particularly those involving nuclear,
biological, chemical or radiological events, could be material to the Company’s operating results,
financial position and/or liquidity in future periods. The Company will continue to manage this type of
catastrophic risk by monitoring and controlling terrorism risk aggregations to the best of its ability.
CLAIMS AND CLAIM ADJUSTMENT EXPENSE RESERVES
Claims and claim adjustment expense reserves (loss reserves) represent management’s estimate of
ultimate unpaid costs of losses and loss adjustment expenses for claims that have been reported and
claims that have been incurred but not yet reported.
The Company continually refines its reserve estimates in a regular ongoing process that includes
review of key assumptions, underlying variables and historical loss experience. The Company reflects
adjustments to reserves in the results of operations in the periods in which the estimates are changed.
In establishing reserves, the Company takes into account estimated recoveries for reinsurance, salvage
and subrogation. The reserves are also reviewed regularly by qualified actuaries employed by the
Company. For additional information on the process of estimating reserves and a discussion of
underlying variables and risk factors, see ‘‘Item 7—Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Critical Accounting Estimates.’’
The process of estimating loss reserves involves a high degree of judgment and is subject to a
number of variables. These variables (discussed by product line in the ‘‘Critical Accounting Estimates’’
section) are affected by both internal and external events, such as changes in claims handling
procedures, inflation, judicial trends and legislative changes, among others. The impact of many of
these items on ultimate costs for claims and claim adjustment expenses is difficult to estimate. Reserve
estimation difficulties also differ significantly by product line due to differences in the underlying
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