Loss Reserves are generally the largest liability listed on an insurance company’s balance sheet. Loss Reserves are the amounts set aside to pay for claims that have already occurred for which the company is obligated to pay, whether they have been reported to the company or not. Reserves are also established for unpaid loss adjustment expenses. For most insurance companies state insurance regulators require an opinion be rendered by a qualified actuary as to the reasonableness of the Loss and Loss Expense Reserves.
In the past, a high percentage of property/casualty insurance company insolvencies have been due to the inadequacy of their reserves. In order to verify the reasonableness of these reserves, each state now requires that there be an attestation by a qualified professional actuary, formally called the “Statement of Actuarial Opinion” (SAO) and frequently referred to as an “opinion”.
Is it an “unqualified” opinion?
One of the most important aspects of the SAO is whether the opining actuary has issued an “unqualified” or “clean” opinion. A clean opinion states that the loss and expense reserves:
- Meet the requirements of the domiciliary state,
- Are consistent with reserves computed with accepted loss reserving standards and principles, and,
- Makes a reasonable provision in the aggregate for all unpaid loss and loss adjustment expense obligations of the Company under the terms of its contracts and agreements.
The first two items are rarely an issue; it is the third point that usually prompts the question. In a sense, an “unqualified” opinion means that, in the actuary’s opinion, the booked loss and loss expense reserves are reasonably sufficient, and there are no reasons to qualify or make restrictions about that opinion.
The alternatives to an “unqualified” opinion generally indicate the presence of an unfavorable condition with one exception. These alternatives are outlined below:
- A Qualified Opinion happens when the reserves for a certain item or items are in question; either they cannot be reasonably estimated, or the actuary is unable to render an opinion on those specific items. Note, if there is a loss for which the actuary has no means of determining the ultimate value, but the perceived value is not material, the opinion can still be “clean.”
- A Deficient or Inadequate Provision is rendered when the reserve amount is less than the minimum amount believed by the actuary to be reasonable. In this case, the actuary will issue a SAO specifying that the carried reserve amount does not make a reasonable provision for the liabilities associated with the specified reserves. This type of SAO is the most unfavorable.
- A Redundant or Excessive Provision is very rare and occurs when the carried reserve amount is greater than the maximum amount believed by the actuary to be reasonable. In this situation, the actuary believes the company is very strongly reserved and this type of SAO is very favorable.
In some cases, the opining actuary will be unable to issue an opinion.
- The No Opinion outcome is a rare rendering. The actuary’s ability to give an opinion is dependent upon data, analyses, assumptions, and related information deemed sufficient to support a conclusion. If the actuary cannot reach a conclusion due to deficiencies or limitations with this information, he/she may issue a statement of “no opinion” which should include a statement as to why no opinion could be given.
Important Sections of the SAO
The opinion part of the SAO may be the most important section. However, the SAO includes other important sections.
The “Relevant Comments” section starts with a discussion of the “Risk of Material Adverse Deviation” and answers three important questions:
- Is there a risk of a material deviation (i.e. change) from the loss and loss expense reserves booked?
- How large does a possible deviation need to be to be considered “material?”
- What is the source of such a deviation(s)?
An indication that there are one or more items that are a potential source of risk of material deviation may or may not be a cause for concern. The absence of a risk of material adverse deviation does not imply that additional factors will not be identified in the future as having a significant influence on the company’s reserves; it is a statement concerning a point in time.
While the interest in Asbestos Exposures and Environmental Exposures has waned in recent years, these can still represent a significant exposure to the company. These are addressed in the section bearing that as a title.
Most companies do not write policies with durations over thirteen months, but the section titled Disclosure of Unearned Premium Reserves for Long Duration Contracts will provide information to that effect.
The Reinsurance Collectability section provides information pertaining to the likelihood of the company’s ability to collect on its reinsurance. While the actuary’s comments do not imply an opinion as to the financial stability of any of the reinsurers, it should include information from management regarding any collectability problems the company has encountered with its reinsurers. Publicly available information, as well as the reinsurers’ ratings provided by a rating agency, are used by the actuary to reach their conclusion.
The National Association of Insurance Commissioners (NAIC) has a series of mathematical formulae, known as the “NAIC IRIS Tests,” that are applied to various Annual Statement entries. Of the thirteen formulae the last three namely Tests 11, 12 and 13, concern the booked loss and loss expense reserves. The actuary is required to look at these tests and comment on any that fall outside the range of acceptance: i.e. they “fail” the test. If the company fails any of these tests, the actuary will provide a narrative as the level of importance of this failure.
(More detailed information is available at https://content.naic.org/sites/default/files/publication-uir-zb-iris-ratios-manual.pdf)
The final pages of the SAO include the signature page. The opining actuary may also include supporting exhibits providing selected values of interest.
In summary, the SAO should answer the following:
- Is the opinion qualified or unqualified (i.e. “Clean”)?
- How financially large does a deviation need to be in order to be a material risk to the finances of the company, and are there any such risks?
- Did the company fail any IRIS Tests? And if so, why?
If you have any further questions on this topic, please feel free to contact your Huggins Actuarial Services consulting actuary.
Grover M. Edie, MBA, FCAS, MAAA, CPCU, ARP, CERA, ARM
Huggins Actuarial Services, Inc.