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					Industry Reserve Adequacy and Other
   Hot Topics: Financial Analyst’s
            Perspectives


      1999 Casualty Loss Reserve Seminar

             Scottsdale, Arizona
                              Presenters

   Sarah Hibler - Vice President & Senior Analyst,
    Moody‟s Investors Service

   Jay Votta - Principal, Deloitte & Touche LLP

   Bill Wilt - Vice President & Senior Analyst,
    Moody‟s Investors Service



1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   2
                     Discussion Topics


   Overview of Reserve Adequacy
    – Results of Moody’s Top 50 Analysis
   Use of Reserves in Credit and Equity Analysis
    – Reserves play critical role in gauging financial
      health
   Reserving Issues in Mergers & Acquisitions
    – Reserves key consideration in structuring deals


1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   3
                       Goals of Session

   Discuss macro-level trends in loss reserves
   Provide insight into how „outsiders‟ analyze loss
    reserves
   Demonstrate importance of reserves in different
    contexts:
    – Credit Analysis
    – Equity Analysis
    – M&A Activity


1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   4
                       Top 50 Analysis
   Moody‟s Analyzed Top 50 P/C Groups
    – Approx. 2/3 industry reserves and surplus
   Used annual statement data and internal reserve
    model
    – Excluded A&E, reinsurance, miscellaneous lines
   Tested results against independent analyses where
    available
    – Despite limitations, A/S data can provide credible
      starting point



1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   5
                       Top 50 Analysis

Benefits of Analysis
    – Critical component of capital adequacy and credit
      analysis
    – Provides greater insight in discussions with companies
    – Independent verification of results
    – Insight into developing trends: quality of earnings,
      current rate adequacy
    – Separate supportable facts from unsubstantiated rumors
      in market


1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   6
                            Top 50 Analysis

Conclusions
    – Industrywide $12.6 B redundancy at 12/98
            » Represents abut 4% of Reserves and 4.5% of Surplus
                 PPA, WC provide redundancies; CMP, OL show
                  deficiencies
    – Trends in Reserve Margins are Major Story
            » Margins thinning quickly
    – Differences Between Personal and Commercial Insurers
            » Whoever heard of a negative loss trend?



1999 CLRS        Industry Reserve Adequacy - Financial Analyst's Perspectives   7
   Top 50 Analysis - Personal Lines Writer’s
              Current Position




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   8
Top 50 Analysis - Retrospective View of PPA




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   9
                              Top 50 Analysis


   Findings - Personal Insurers
    – All showed reserve redundancies
    – The story then?
            » Favorable loss trends early-to-mid 1990s
            » Actuaries/management slow to recognize in rates
    – The story now?
            » Most carriers reducing rates, dividends
            » Loss cost trends ticking upward again




1999 CLRS         Industry Reserve Adequacy - Financial Analyst's Perspectives   10
   Top 50 Analysis - Commercial Writer’s
             Current Position




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   11
    Top 50 Analysis - Retrospective View of
         Reviewed Commercial Lines




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   12
                              Top 50 Analysis


   Findings - Commercial Insurers
    – More even mix of deficiencies and redundancies
            » WC similarities to PPA
            » legislation and rate reform benefits coupled with loss trends
            » Competition intensifying, loss ratio climbing steadily
    – Significant rate pressures all other commercial lines
            » Most commercial lines show uniformly increasing loss ratio
   Diversified Insurers
    – Redundancies outweigh deficiencies
            » Favorable PPA and WC experience outweighs other lines

1999 CLRS         Industry Reserve Adequacy - Financial Analyst's Perspectives   13
                             Top 50 Analysis

Conclusions
    – Industry adequately reserved -- for now
    – How actuaries can help:
            » Expand statement of opinion
            » Include detailed footnotes in Schedule P
            » Expand content of actuarial reports and distribution of reports
   Reserves Used in Variety of Ways by Many
    Constituencies…Think Beyond Statement of
    Opinion

1999 CLRS         Industry Reserve Adequacy - Financial Analyst's Perspectives   14
             Industry Reserve Adequacy --
            Beyond the Statement of Opinion


   Moody’s Approach to Insurance Analysis

   Credit vs. Equity Analysis




1999 CLRS      Industry Reserve Adequacy - Financial Analyst's Perspectives   15
 Moody’s Approach to Insurance Analysis




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   16
 Moody’s Approach to Insurance Analysis




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   17
 Moody’s Approach to Insurance Analysis
            Analytical Approach - Benchmark




   The lowest “Secure” rating has the annual
  default probability of a “500 Year” event
1999 CLRS    Industry Reserve Adequacy - Financial Analyst's Perspectives   18
 Moody’s Approach to Insurance Analysis


   Traditional Financial Indicators
    – Financial Leverage (Debt/Total Capital)
    – Double Leverage (Inv in Subs+Goodwill)/Equity
    – Fixed Charge Coverage and Cash Flow Coverage
   In Context of Underlying Business Volatility
   In Context of Business Cycle
   Does Legal/Regulatory Structure Inhibit
    Cash/Capital Flows Across the Group?

1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   19
 Moody’s Approach to Insurance Analysis
     A Practical Reserve Example




      Your typical property/casualty insurer
1999 CLRS    Industry Reserve Adequacy - Financial Analyst's Perspectives   20
 Moody’s Approach to Insurance Analysis
     A Practical Reserve Example




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   21
              Credit vs. Equity Analysis
            What Creditors/Policyholders Want

   Absolute Repayment
   Minimize likelihood of loss of principal;
    benchmark is risk-free rate
   Which translates into:
    –   Conservative corporate governance
    –   Prudent capital and financial management
    –   Capital cushion
    –   Strong earnings and cash flows


1999 CLRS     Industry Reserve Adequacy - Financial Analyst's Perspectives   22
              Credit vs. Equity Analysis
                   What Shareholders Want

   Relative Return
   Maximize total return, with acceptable level of
    risk; benchmark is a market index.
   Which translates into:
    –   Assertive corporate governance
    –   High capital efficiency, as measured by ROE
    –   Active capital and financial management
    –   Growth in top and bottom lines
    –   Strong earnings and cash flows

1999 CLRS     Industry Reserve Adequacy - Financial Analyst's Perspectives   23
            Credit vs. Equity Analysis
             Contrasting Analytical Styles

   Basic Motivations
    – Equity and credit analysts both want to be right
    – Credit analysts have pressure from issuers to be more
      liberal and investors to be more conservative
    – Equity analysts can face substantial implied pressure
      from issuers
   Inherent Bias
    – Credit analysts tend to focus on the downside risk
    – Equity analysts tend to focus on the upside opportunity

1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   24
                 Credit vs. Equity Analysis
            Contrasting Analytical Styles - Example




           Trustworthy‟s creditors/policyholders have NO upside

1999 CLRS        Industry Reserve Adequacy - Financial Analyst's Perspectives   25
    Industry Reserve Adequacy - Beyond The
              Statement of Opinion

   Reserving Issues in Mergers and Acquisitions

    – Actuarial Due Diligence Process


    – Sampling of Solutions to Reserve Uncertainty




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   26
               Reserving Issues in M&A
            Actuarial Due Diligence Process

   Reserve Position
   Restatement of Reported Results
   GAAP Adjustments
   Pro Forma Analysis
   Appraisal Value



1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   27
            Actuarial Due Diligence Process
                    Reserve Position

   “Windshield” Analysis
   Limited Review
     – Business Units
     – Access
     – Time
   Comprehensive Analysis


1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   28
                             Actuarial Due Diligence Process
                             Restatement of Reported Results




    Source: Consolidated Industry Loss Ratios

1999 CLRS               Industry Reserve Adequacy - Financial Analyst's Perspectives   29
             Actuarial Due Diligence Process
                   GAAP Adjustments
   Assets
   DAC
   Premium Deficiencies
   Policyholder Dividends
   Contingent Commissions
   Salvage & Subrogation
   Federal Income Taxes
   Other
   Present Value of Future Profits (PVFP)
1999 CLRS    Industry Reserve Adequacy - Financial Analyst's Perspectives   30
                 Actuarial Due Diligence Process
                       Pro Forma Analysis
Assumptions:
    –       Premium Growth
    –       Earnings Pattern
    –       Loss Ratio
    –       Expense Ratio
    –       Payout Patterns
    –       Investment Portfolio Mix
    –       Investment Yield
    –       Risk Adjusted Discount Rate
    –       Time Horizon

1999 CLRS        Industry Reserve Adequacy - Financial Analyst's Perspectives   31
                 Actuarial Due Diligence Process
                       Pro Forma Analysis

 Output:
      –     Income
      –     Dividends
      –     Surplus
      –     Cash Flow From Operations
      –     “Value”
      –     Key Ratios, e.g. RBC




1999 CLRS        Industry Reserve Adequacy - Financial Analyst's Perspectives   32
Reserving Issues in M&A


Sampling of Solutions to
  Reserve Uncertainty
                 Sampling of Solutions
   Purchase Accounting
   Retrospective Adjustments
   Reinsurance
   Carve Outs
   Other




1999 CLRS   Industry Reserve Adequacy - Financial Analyst's Perspectives   34
                          Purchase Accounting
   Reserves are increased by seller prior to
    transaction date
    – Purchase accounting does not allow acquirer to book
      additional reserves

    – Advantages
            » fattens the pig before it goes to market


    – Disadvantages
            » depresses surplus

1999 CLRS         Industry Reserve Adequacy - Financial Analyst's Perspectives   35
                Retrospective Adjustments
   Future adjustment of sales price based on
    retrospective reserve estimates
    –   Cash settlements
    –   Portion of sales price held as a note payable
    –   Contingent interest dividend paid to stockholders
    –   Advantages
         » Low transaction cost
    – Disadvantages
         » Uncertainty



1999 CLRS      Industry Reserve Adequacy - Financial Analyst's Perspectives   36
                                    Reinsurance
   Stop loss cover provides protection against
    adverse reserve development
    – Purchased by seller
            » internal
            » external
    – Purchased by acquirer

    – Advantages
            » alleviates uncertainty associated with reserve development
    – Disadvantages
            » cost
1999 CLRS         Industry Reserve Adequacy - Financial Analyst's Perspectives   37
                               Carve Outs
   Segregation of “undesirable” business segments
    and exclusion from transaction
    –   Prior to transaction
    –   Post transaction
    –   Strategic motives
    –   Advantages
         » may be only way to attract buyers
    – Disadvantages
         » seller may retain unwanted business
         » Regulatory scrutiny

1999 CLRS      Industry Reserve Adequacy - Financial Analyst's Perspectives   38

				
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