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2006 Casualty Loss Reserve SeminarSeptember 12, 2006
Understanding Collateral Requirements in Relation to Self-
Insurance
Introduction
• Why collateral is required
• How collateral is determined
• Collateral stacking – what and why
• How insurance program structure affects operations
and collateral
• Types of collateral
• Other Key considerations before selecting the
insurance program structure and collateral
• Questions
How Collateral Requirement Determined?
For Financial Reporting Year (Balance Sheet)
• Estimate of Ultimate Loss – Paid to Date
What Impacts This Calculation?
• Actual Loss Results to Date
• Loss Development Methodology
• Development Factors Used
How Collateral Requirement Determined?
For Budget Year (Fiscal Plan)
• Loss Forecast
What Impacts This Calculation?
• Historical Loss Experience
• Loss Forecast Methodology
• Development Factors Used
Collateral Stacking
• What is collateral “stacking”?
- Collateral stacking is the accumulation of
required collateral across multiple effective
periods.
• Why is collateral “stacked”?
- Paid loss emergence patterns
- Accrued loss emergence and “IBNR” losses
Collateral Stacking (cont.)
• Example 1 – No growth and no inflation scenario
• Example 2 – No growth and 4% inflation scenario
• Example 3 – 3% growth and 4% inflation scenario
Collateral Stacking
0
1
2
3
4
5
6
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Example #1
No Growth/No InflationYear 10
Year 9
Year 8
Year 7
Year 6
Year 5
Year 4
Year 3
Year 2
Year 1
Collateral Stacking
0
1
2
3
4
5
6
Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Y ear 8 Y ear 9 Y ear 10
Example #1
No Growth/No Inflation
Previous Collateral Additional Collateral
Collateral Stacking
0
1
2
3
4
5
6
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Example #2
No Growth/4% InflationYear 10
Year 9
Year 8
Year 7
Year 6
Year 5
Year 4
Year 3
Year 2
Year 1
Collateral Stacking
0
1
2
3
4
5
6
Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Y ear 8 Y ear 9 Y ear 10
Example #2
No Growth/4% Inflation
Previous Collateral Additional Collateral
Collateral Stacking
0
1
2
3
4
5
6
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Example #3
3% Growth/4% InflationYear 10
Year 9
Year 8
Year 7
Year 6
Year 5
Year 4
Year 3
Year 2
Year 1
Collateral Stacking
0
1
2
3
4
5
6
Y ear 1 Y ear 2 Y ear 3 Y ear 4 Y ear 5 Y ear 6 Y ear 7 Y ear 8 Y ear 9 Y ear 10
Example #3
3% Growth/4% Inflation
Previous Collateral Additional Collateral
Collateral Stacking
Comparing the 3 Examples
0
1
2
3
4
5
6
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
No Growth/No Inflation No Growth/4% Inflation 3% Growth/4% Inflation
Collateral Stacking
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
5% Loss Growth 0% Loss Growth 5% Loss Dec line
Insurance Program Structures Impact
• Common Insurance Program Structures
- Guaranteed cost
- Deductible
- Self-insured retention
- Retrospectively rated contracts
- Captive insurance company
Insurance Program Structures Impact (cont.)
• Balance Sheet and Income Statement Impact
• Working Capital Impact
• Credit Capacity Impact
• Compliance considerations
Insurance Program Structures Impact (cont.)
Guaranteed Cost Deductible
Self-Insured Retention
Inc. Loss
Retro. Captive
Balance Sheet Low High High High High
Income Statement High High High High High
Working Capital (Cash)
High Low Low High High
Working Capital (Credit)
Low High High Low High
Compliance Low Low High Low High
Insurance Program Collateral Impact
Letter of Credit Cash
Surety Bond
Trust Account
Promissory Note
Working Capital (Cash)
Low High Low Low Low
Working Capital (Credit)
High Low Low Low Low
Deductible
Considerations
• Cash Position
• Effective Tax Rate
• Ability to Retain Risk
• Capacity and Cost of Collateral
• Financial Strength
Questions?
Tom Fuller
Liberty Mutual
Sr. Risk Management Consultant
314-843-0600 x214
Marn Rivelle
KPMG LLP
Senior Manager, Actuarial Services
213-533-3340