Travelers 2008 Annual Report Download - page 149

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
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 1.4%
increase (decrease) in loss reserves.
Historically, the one-year change in the reserve estimate for this product line over the last nine
years has varied from 10% to 138% (averaging 21%) for the Company, and from 11% to 24%
(averaging 6%) for the industry overall. The Company’s year-to-year changes are driven by, and are
based on, observed events during the year. Because the high end of the Company’s range was due to
acquired business in 2004, the Company believes that the industry’s range of historical outcomes is
illustrative of reasonably possible one-year changes in reserve estimates for this product line. Fidelity
and surety reserves represent approximately 3% of the Company’s total loss reserves.
In general, developments on single large claims (both adverse and favorable) are a primary source
of changes in reserve estimates for this product line.
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