Issues Relating to Discounting2007 CASE Spring MeetingMarch 14, 2007Nashville, TennesseeWilliam R. Wilkins, FCAS MAAASenior Vice President and Chief ActuaryFirst Acceptance Corporation
What is Reserve Discounting? • Actuarial Standard of Practice No. 20 Defines Discounted Reserve as “The present value, calculated at selected interest rate(s), of the payment of outstanding losses and/or loss adjustment expenses in the anticipated future settlement amounts.”
Why Discount Reserves? • Mandated by the IRS for Income Taxes • Makes Combined Ratio better profitability tool • Investment Income is reflected in Product Pricing • It increased Surplus underlying the balance sheets.
Concerns arising from the Discount Rate • How should the value be determined? • Risk Free Rate? • Market Rates? • A specific investment portfolio? • Interest Rate Risk adjusted? • One rate for all years or multiple rates? • Should there be a range for each year?
Concerns arising from the Payout Pattern • Payout Pattern • Should single or range of payout patterns be used? • Actual vs. Expected • Effects of • Salvage & Subrogation • Reinsurance • Claims Handling
Concerns arising from the Original Estimate • While Financials are booked to a point estimate, there is generally a range around that estimate. That is due to uncertainty throughout the estimation process. • Discounting lowers the held reserve. That is an explicit increase in risk. • Conversely a lower reserve raises the surplus, however practice would be to increase writings for that higher surplus level, not leaving the money for the uncertainty.
So if you wish to discount • You need fairly predictable payouts. • Relatively stable reserve levels • Interest Rates should be on the conservative side • Growth in writings need to be tempered against possible development • Read and comply with ASOP #20
Articles on discounting • ASOP #20 Adopted April 1992 • Stephen Lowe, Randall Holmberg & Wayne Upton, 1989 CLSR 4E: “Discounting Loss Reserves” • David Wasserman and Allan Kaufman, “Empirical Measure of Reserve Level Uncertainty Relative to Discounting and Financial Solvency for a Monoline Medical Professional Liability Insurer”, Casualty Actuarial Society Discussion Paper Program, Spring 1984 • Stephen D’arcy , “Revisions in Reserving Techniques necessary to discount Property-Liability Loss Reserves”, Casualty Actuarial Forum Fall 1987 • CAS Committee on Theory of Risk , “Risk Theoretic Issues in the Discounting of Loss Reserves”, Casualty Actuarial Forum Fall 1987