The Hartford 2008 Annual Report Download - page 86

Table of Contents
In both Small Commercial and Middle Market, workers’ compensation is the Company’s single biggest line of business and
the line of business with the longest pattern of loss emergence. Reserve estimates for workers’ compensation are particularly
sensitive to assumptions about medical inflation and the changing use of medical care procedures. In addition, changes in
state legislative and regulatory environments impact the Company’s estimates. These changes increase the uncertainty in the
application of development patterns. In addition, over the past several accident years, the Company has experienced
favorable claim frequency on workers’ compensation claims. The Company’s reserve estimates assume that reported losses
for recent accident years will continue to emerge favorably and that severity will not be adversely impacted by the lower
volume of reported claims.
In the Specialty Commercial segment, many lines of insurance, such as excess insurance and large deductible workers’
compensation insurance, are “long-tail” lines of insurance. For long-tail lines, the period of time between the incidence of
the insured loss and either the reporting of the claim to the insurer, the settlement of the claim, or the payment of the claim
can be substantial, and in some cases, several years. As a result of this extended period of time for losses to emerge, reserve
estimates for these lines are more uncertain (i.e., more variable) than reserve estimates for shorter-tail lines of insurance.
Estimating required reserve levels for large deductible workers’ compensation insurance is further complicated by the
uncertainty of whether losses that are attributable to the deductible amount will be paid by the insured; if such losses are not
paid by the insured due to financial difficulties, the Company would be contractually liable. Another example of reserve
variability relates to reserves for directors and officers insurance. There is potential volatility in the required level of reserves
due to the continued uncertainty regarding the number and severity of class action suits, including uncertainty regarding the
Company’s exposure to losses arising from the collapse of the sub-prime mortgage market. Additionally, the Company’s
exposure to losses under directors and officers insurance policies is primarily in excess layers, making estimates of loss
more complex. The current financial market turmoil has increased the number of shareholder class action lawsuits against
our insureds or their directors and officers and this trend could continue for some period of time.
Impact of changes in key assumptions on reserve volatility
As stated above, the Company’s practice is to estimate reserves using a variety of methods, assumptions and data elements.
Within its reserve estimation process for reserves other than asbestos and environmental, the Company does not derive
statistical loss distributions or confidence levels around its reserve estimate and, as a result, does not have reserve range
estimates to disclose.
The reserve estimation process includes explicit assumptions about a number of factors in the internal and external
environment. Across most lines of business, the most important assumptions are future loss development factors applied to
paid or reported losses to date. For most lines, the reported loss development factor is most important. In workers’
compensation, paid loss development factors are also important. The trend in loss costs is also a key assumption, particularly
in the most recent accident years, where loss development factors are less credible.
The following discussion includes disclosure of possible variation from current estimates of loss reserves due to a change in
certain key assumptions. Each of the impacts described below is estimated individually, without consideration for any
correlation among key assumptions or among lines of business. Therefore, it would be inappropriate to take each of the
amounts described below and add them together in an attempt to estimate volatility for the Company’s reserves in total. The
estimated variation in reserves due to changes in key assumptions is a reasonable estimate of possible variation that may
occur in the future, likely over a period of several calendar years. It is important to note that the variation discussed is not
meant to be a worst-case scenario, and therefore, it is possible that future variation may be more than the amounts discussed
below.
Recorded reserves for auto liability, net of reinsurance, are $2.3 billion across all lines, $1.6 billion of which is in Personal
Lines. Personal auto liability reserves are shorter-tailed than other lines of business (such as workers’ compensation) and,
therefore, less volatile. However, the size of the reserve base means that future changes in estimates could be material to the
Company’s results of operations in any given period. The key assumption for Personal Lines auto liability is the annual loss
cost trend, particularly the severity trend component of loss costs. A review of Insurance Services Office (“ISO”) data
suggests that annual growth in industry severity since 1999 has varied from +1% to +6%. The ISO data shows recent
severity changes to be in the middle of this range. A 2.5 point change in assumed annual severity is within historical
variation for the industry and for the Company. A 2.5 point change in assumed annual severity for the two most recent
accident years would change the estimated net reserve need by $90, in either direction. Assumed annual severity for accident
years prior to the two most recent accident years is likely to have minimal variability.
Recorded reserves for workers’ compensation, net of reinsurance, are $6.3 billion in total for Ongoing Operations. Paid loss
development patterns are a key assumption for this line of business, particularly for more mature accident years.
Historically, paid loss development patterns have been impacted by, among other things, medical cost inflation. The
Company has reviewed the historical variation in reported loss development patterns. If the reported loss development
patterns change by 4%, the estimated net reserve need would change by $400, in either direction. A 4% change in reported
loss development patterns is within historical variation, as measured by the variation around the average development
factors as reported in statutory accident year reports.
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009