Here are a few of the problems I see in complying with the rule concerning
"Unearned Premium Reserve - Single or Fixed Premium Policies with Coverage
Periods in Excess of Thirteen Months" and opining on the amounts:
1) The rule refers to unearned premium reserves for contracts with coverage
period greater than 13 months. Nowhere in the annual statement is the
amount of unearned premium for contracts with term greater than 13 months
shown. As a practical matter, the Scope section of the Actuarial Opinion
lists the items and amounts shown in the Annual statement on which the
opinion is being made. The rule states that this should include the annual
statement page 3 items: Net Unearned Premiums and Ceded Unearned Premiums.
These amounts are for all Contracts regardless of length of coverage period.
Should the Actuarial opinion then state that these amounts make adequate
provision for contracts with coverage period greater than 13 months,
(although the provision for contracts with coverage less than 13 months may
be inadequate)? For example, say the amount shown on page 3 for net
unearned premium is 100 million, and the calculated amount for long duration
contracts is 99 million per the rule concerning policies with coverage
period in excess of thirteen months. Would this net unearned premium
provision be adequate or would it be necessary to also determine adequacy of
the remaining 1 million to meet the future liabilities for contracts with
coverage period less than 13 months (and according to what rules?). It
would seem more appropriate to opine on the total unearned premium reserve
for any line of business which has any premium with coverage period greater
than 12 months (the amount shown in the Underwriting and Investment
Exhibit - Part 2A column 5.
2) The rule also requires opining on Direct Unearned Premium as reported on
the State Page. The same issues as stated in 1) apply, and I also question
whether this is referring to the Consolidated State Page or the amount for
each individual State Page (this becomes a much larger task).
3) I generally question the logic of the 3 tests stated in the rule. It is
my understanding that the intent of the unearned premium is to fund future
payment of yet to incur losses and to fund return of premium to policyholder
in the event of policy cancellation and to defer recognition of earnings to
match the extinguishing of exposure. The tests, as I understand them, don’t
seem to address funding of future policyholder refund for cancellation.
More specifically :
· For test number 1, what is meant by the best estimates of the amount
refundable to the policyholder at the reporting date. This could
possibly mean 3 things: 1) Is this the amount of "outstanding" refund as of
the
reporting date, for contracts that have been canceled but return premium not
yet paid? 2) Is it the best estimate of probable future cancellation
premium until the expiration of the contracts of the given policy year? 3)
is it the total amount of cancellation premium if all contracts are
canceled?
· For test number 2, what is mean by gross premium and gross losses?
Are the premium gross of reinsurance or gross of cancellations? Could they
be gross of reinsurance but net of cancel premiums to date? Could they be
gross of reinsurance but net of all past refunds and future anticipated
cancellation
refund premium?
· When estimating gross losses, should it be assumed that none of the
outstanding contracts will be canceled? Development using past payment
history (a standard actuarial procedure) by policy year, will not properly
handle this. This method implicitly assumes that some of the losses to be
paid in the future will be reduced due to the contract being canceled before
a loss could occur. It seems that an estimate should be made of all future
losses and future expenses and future cancellation refund premium.
4) The Annual Statement Instructions states that the opinion paragraph of
Actuarial Opinion should include a sentence that states "In my opinion, the
amounts carried in the scope paragraph on account of the items identified:
are computed in accordance with accepted loss reserving standards and
principles." The CAS statement of principles regarding Property and Casualty
Loss Reserves does not pertain to unearned premium reserves and does not
address provisions for yet to incur claims (or yet to incur cancel premium).
Standard methods used for loss reserving are not applicable to estimation
of future yet to incur losses and cancellation without some modifications.
Whether these modifications are generally accepted is not clear to me. To my
knowledge the actuarial community is silent on this issue. For example, a
paid loss development method (by occurrence year) is an accepted loss
reserving procedure to estimate future loss payments on losses that have
already occurred. Modifying this paid loss development method to be by
policy year would estimate future loss payments on both incurred and yet to
incur losses. But this, in my opinion would not provide necessary
provisions for cancellations. This could be done by using a paid
cancellation refund development by policy year to estimate future refund
payments. Another example: A standard loss reserving method commonly used
when loss history is sparse or erratic is the Bornhuetter/Ferguson or
expected loss method. This method when modified to be used to estimate
future yet to incur losses could use unearned premium to estimate future
losses (and, if so, would, in my opinion, not need an additional provision
for cancellation: if the contract
were canceled the refund would be paid, but no future losses). This
estimate of future losses might then be used in test number 2 of the "rule
of determining unearned premium " to affect the required provision for
unearned premium. This circular method may or may not be considered
acceptable.
5) Issues regarding self insured retentions and deductibles: It is common
for an auto warranty program to have a self insured retention (or similar
first loss funding mechanism). The insurance company collects a
substantially less premium for these types of programs because it is only
liable for amount not covered within the self insured retention or
deductibles. The "rule" states that the actuarial opinion should disclose
the amount of reduction in the unearned premium reserve and loss reserves
for each of the following : …. c) credit for deductibles and self insured
retentions. If the premium does not include provisions for ground up
losses and ground up losses are not paid and then reimbursed from self
insured retention fund is there a reduction in the unearned premium? if so,
how is it calculated.
An Example:
Possibly a another simple example would further illustrate some of my
issues. Say $10 million in premium was written on contracts with coverage
period greater than 13 months for a given policy year. As of the the
valuation date, 3 million in premium had been returned due to cancellations
(premium net of cancellation as of 12-31-97 = 7 million) and 1 million in
losses and expenses had been incurred. At this time, it is estimated that
an additional 2 million in premium will be returned in the future on this
policy year block of business (premium net of cancellation as of expiry of
the policy year block= 5 million) and an additional 4 million in losses and
expenses will be incurred. What is the appropriate provision for unearned
premium as of 12-31-97?
(assume no reinsurance applies to this business).
To me, it would seem that since ultimately it is expected that 5 million in
premium will be earned and 5 million in losses and expenses will be
incurred, the appropriate UEP at 12-31-97 would be 6 million. This would
leave enough for future cancellation refunds (2 million) and future losses
(4 million). Life to date earnings as of 12-31-97 for this block would then
be 1 million (NWP=7 milIion and UEP=6 million) which would match to the 1
million in incurred losses.
But according to test #2 of the rule (under one possible interpretation):
UEP = gross premium (10 million) times the ratio of future gross losses &
expenses to projected total gross losses and expenses. (UEP=10 million
times 4 million/5 million= 8 million) which would amount to negative
life-to-date earnings for this block.
I don't know how I will comply with this rule if I cant understand the logic
of the three tests. I'm I the only one that doesn't understand?
Sincerely,
Ray DeJaco
P.S.- Thanks to all who took the time to read this rather long message. I
really think it is an important issue to the CAS now that comment is
required in the Actuarial Opinion.
Visit the CAS Web Site at http://www.casact.org
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