ACTUARIAL STANDARD OF PRACTICE NO. 53

Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention

STANDARD OF PRACTICE

TRANSMITTAL MEMORANDUM

December 2017

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the Actuarial Standards Board and Other Persons Interested in Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 53, Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention

This document contains ASOP No. 53, Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention.

Background

Estimating future costs for prospective property/casualty risk transfer and risk retention has been a fundamental part of actuarial practice since the beginning of the profession. Estimating future costs based on sound actuarial practice is essential to the integrity of the insurance and risk financing system and is key to fulfilling the promises embodied in insurance contracts. The board of directors of the Casualty Actuarial Society (CAS) adopted the Statement of Principles Regarding Property and Casualty Ratemaking (Statement of Principles) in May 1988 (before the ASB was established). This document featured four fundamental principles of ratemaking and also discussed additional considerations. In 2009, the CAS requested that the ASB develop an actuarial standard of practice in the area of property/casualty ratemaking. In its request, the CAS noted that the Statement of Principles contained considerations that might be expanded to become the basis of an ASOP.

Ratemaking has become much more complex and sophisticated since the CAS Statement of Principles was adopted. In crafting this ASOP and responding to comments from its initial exposures, the ASB quickly realized that there are significant differences of opinion within the profession regarding certain aspects of ratemaking, including pricing, price optimization methodologies, and rate filing requirements, that would need to be reconciled before a comprehensive standard of practice on ratemaking could be developed. Therefore, to create a standard of practice for the core aspects of ratemaking that could be issued in a reasonable amount of time, the ASB has chosen to develop this ASOP to pertain solely to the development or review of future cost estimates for prospective property/casualty risk transfer and risk retention. It should be noted, however, that upon completion of this proposed ASOP, the ASB will give consideration to the development of a standard of practice on rate filings in an attempt to address the various issues within rate regulatory discussions today (for example, price optimization, unfair discrimination, and the Principles contained in the current CAS Statement of Principles).

It should be noted that this ASOP incorporates all of the Considerations contained in the CAS Statement of Principles and addresses issues related to the estimation of costs for risk transfer and risk retention not currently addressed in existing ASOPs. This ASOP also references other existing ASOPs that include relevant issues related to the estimation of future costs for prospective risk transfer and risk retention.

First Exposure Draft

In September 2014, the ASB approved a first exposure draft with a comment deadline of January 31, 2015. Twenty-two comment letters were received and considered in making changes that were reflected in the second exposure draft.

Second Exposure Draft

In December 2015, the ASB approved a second exposure draft with a comment deadline of April 30, 2016. Eighteen comment letters were received and considered in making changes that were reflected in the third exposure draft.

Third Exposure Draft

In December 2016, the ASB approved a third exposure draft with a comment deadline of April 30, 2017. Thirteen comment letters were received and considered in making changes that are reflected in this ASOP. As a result of the comment letters, the ASB made changes, including the following: (1) modified the title of the ASOP to Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention; (2) limited the disclosure of assumptions to material assumptions; (3) clarified the guidance for the treatment of unusual events, while changing the designation to be infrequent events; and (4) clarified the guidance for intended measure. For a summary of issues contained in these comment letters, please see appendix 2. In addition, the ASB took editorial suggestions where they improved the document.

The ASB thanks everyone who took the time to contribute comments and suggestions on each of the exposure drafts.

The ASB voted in December 2017 to adopt this standard of practice.

Ratemaking Task Force
Patrick B. Woods, Chairperson
J’ne E. Byckovski	Claudine Modlin
Gregory L. Hayward	Christopher J. Westermeyer

Casualty Committee of the ASB
Kenneth R. Kasner, Chairperson
Caryn C. Carmean	Heather D. Lake
Benjamin W. Clark	Mary Frances Miller
Thomas J. De Falco	Alan K. Putney
Gordon K. Hay	Robert J. Walling III

Actuarial Standards Board
Maryellen J. Coggins, Chairperson
Christopher S. Carlson	Kathleen A. Riley
Beth E. Fitzgerald	Barbara L. Snyder
Darrell D. Knapp	Frank Todisco
Cande J. Olsen	Ross A. Winkelman

The Actuarial Standards Board (ASB) sets standards for appropriate actuarial practice in the United States through the development and promulgation of Actuarial Standards of Practice (ASOPs). These ASOPs describe the procedures an actuary should follow when performing actuarial services and identify what the actuary should disclose when communicating the results of those services.

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose

This actuarial standard of practice (ASOP) provides guidance to actuaries when performing actuarial services with respect to developing or reviewing future cost estimates for prospective property/casualty risk transfer and risk retention. This includes future cost estimates for insurance, reinsurance, self-insurance, loss portfolio transfers, or any other mechanisms for risk transfer or risk retention.

1.2 Scope

This standard applies to actuaries when performing actuarial services with respect to developing or reviewing future cost estimates (commonly known as actuarial indications) for prospective property/casualty risk transfer and risk retention. For example, this standard applies when actuaries are developing future cost estimates underlying product prices, estimating funding requirements for self-insured programs and captives, and developing reinsurance prices.

As estimates are often made for separate elements of the cost of risk transfer and risk retention (for example, loss and loss adjustment expenses, operational and administrative expenses, the cost of reinsurance, and the cost of capital) and subsequently summed to a total cost estimate, this standard applies to the separate elements as well as the total. If the actuary’s role relates to any of the elements of the future cost estimate, the guidance in this standard applies only to the actuarial services related to those elements. If the actuary’s actuarial services involve reviewing future cost estimates developed by another party, the actuary should use the guidance in section 3 to the extent practicable. This standard also applies to developing or reviewing the future cost estimates by class within a risk classification system.

Actuarial services involved in developing or reviewing estimates of future costs may include actuarial communications, expert testimony, regulatory activities, legislative activities, or statements concerning public policy to the extent these activities involve providing an opinion on property/casualty future cost estimates.

If the actuary departs from the guidance set forth in this standard in order to comply with applicable law (statutes, regulations, and other legally binding authority), or for any other reason the actuary deems appropriate, the actuary should refer to section 4.

1.3 Cross References

When this standard refers to the provisions of other documents, the reference includes the referenced documents as they may be amended or restated in the future, and any successor to them, by whatever name called. If any amended or restated document differs materially from the originally referenced document, the actuary should consider the guidance in the referenced standard as amended or restated to the extent it is applicable and appropriate.

1.4 Effective Date

This standard is effective for work performed on or after August 1, 2018.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Coverage

The terms and conditions of a plan or contract, or the requirements of applicable law, that create an obligation to pay benefits, expenses, or claims associated with contingent events.

2.2 Exposure Base

A basic unit that is used to measure the future cost of risk transfer and risk retention. This unit can vary by element of cost.

2.3 Method

A systematic procedure for developing, reviewing, or revising future cost estimates or elements thereof.

2.4 Model

A simplified representation of relationships among real world variables, entities, or events using statistical, financial, economic, mathematical, or scientific concepts and equations.

2.5 Risk Retention

A risk-management and risk-control strategy for the assessment, management, or financing of retained risk associated with the specific coverage. Examples of risk retention include self-insurance and certain types of single parent captives.

2.6 Risk Transfer

A risk-management and risk-control strategy, involving legally binding agreements, that shifts responsibility from one party to another or indemnifies one party by another party for the financial obligations associated with the coverage. Examples of risk transfer include insurance, reinsurance, and loss portfolio transfers.

Section 3. Analysis of Issues and Recommended Practices

3.1 Future Cost Estimate

The actuary should determine the elements that are appropriate to include in the future cost estimate. Such elements should relate to the applicable coverage and include loss and loss adjustment expenses, operational and administrative expenses, the cost of reinsurance, and the cost of capital.

3.2 Intended Measure

The actuary should determine the intended measure of the future cost estimate based on the purpose or use of the estimate. The intended measure may vary for each element of the future cost estimate as needed and appropriate. Intended measures will be affected by the desires or needs of the principal, legal requirements, and the regulatory environments in which the future cost estimate will be used.

Examples of intended measures include the mean, the mean plus risk margin, the high or low estimate within a range of reasonably possible outcomes, and a specified percentile of the distribution of reasonably possible outcomes. There are instances in which other measures may be appropriate based upon the purpose or use of the estimate.

3.3 Organization of Data

The actuary should determine what data are available and appropriate for estimating future costs. Based on what data are available and appropriate, the actuary should determine how the data will be organized to develop or review the future cost estimate or any element of the future cost estimate.

The actuary should consider the level of data aggregation that the actuary believes is appropriate for the types of cost estimation analyses to be undertaken. Examples of aggregation methods include aggregating by accident period, calendar period, policy period, and report period. The nature of the coverage, the element of the future cost being estimated, and the type of analysis will influence the actuary’s selection of the level of data aggregation.

The actuary also should consider segmenting the data if the actuary believes it will improve the cost estimation analysis, subject to credibility considerations (see section 3.11). Examples of data segmentation include segmenting the data by coverage, risk class, or risk characteristic. Segmenting the data to more refined levels may be appropriate for estimating future costs within a risk classification system.

3.4 Data Quality

The actuary should refer to ASOP No. 23, Data Quality, for guidance in the consideration of the choice and use of data for estimating future costs.

3.5 Methods, Models, and Assumptions

The actuary should select appropriate methods or models consistent with the intended measure for each element of the future cost. The actuary should use reasonable assumptions (including parameters) appropriate to each method or model. Assumptions may be implicit or explicit and may involve interpreting available experience, projecting future experience, or adjusting for changes in conditions affecting the available experience. The actuary should use methods or models, along with reasonable assumptions, that, in the actuary’s professional judgment, have no known significant bias in the aggregate relative to the intended measure. When using models, the actuary should refer to ASOP No. 38, Using Models Outside the Actuary’s Area of Expertise (Property and Casualty).

3.6  Exposure Base

If selecting a new exposure base or changing an existing exposure base, the actuary should select an exposure base that bears a strong relationship to the cost of risk transfer or risk retention and is practical. Characteristics of a practical exposure base may include that the exposure base is objectively measurable and easily verifiable.

Some mechanisms for implementing risk transfer and risk retention may use multiple exposure bases, with different exposure bases applying to different aspects of coverage provided (for example, sales revenue for general liability, amount of insurance for commercial property). In undertaking analyses for these mechanisms, it may be appropriate to select one exposure base, referred to as the composite exposure base, to act as a proxy for the more refined coverage-by- coverage exposure bases.

3.7 Risk Classification System

Risk classification systems can be an integral part of the development of future cost estimates for prospective property/casualty risk transfer and risk retention. The actuary should refer to ASOP No. 12, Risk Classification (for All Practice Areas), for guidance in designing, reviewing, or changing a risk classification system.

3.8 Use of Historical Data

The actuary should determine the extent to which historical data (premium, exposure, loss, and loss adjustment) are available and appropriate for estimating future costs. For example, the data should be consistent with insurance policy provisions or risk-management and risk-control strategies of the applicable insurance, reinsurance, self-insurance, loss portfolio transfers, or any other mechanisms for risk transfer or risk retention.

3.8.1 Use of Historical Exposure and Premium Data

If the actuary is using historical exposure and premium data, the actuary should consider adjusting the data to reflect a consistent measurement of the historical exposures and rate level, if applicable. These considerations include adjusting historical data to a common exposure level and adjusting premium data for historical changes in the way premium charges are calculated, including both changes to manual rates and the impact of any individual risk rating plans, if applicable. If the actuary is adjusting historical exposure and premium data, the actuary should consider changes during and after the historical period and should select an appropriate method for adjustments that is consistent with the nature of the available data, the intended measure, and the purpose of the analysis.

3.8.2 Use of Historical Loss and Loss Adjustment Expenses

The actuary should determine the extent to which historical loss and loss adjustment expenses are available and appropriate as a basis for estimating future costs. In estimating future costs related to loss and loss adjustment expenses, the actuary should consider adjusting historical data using methods or models, along with reasonable assumptions, that, in the actuary’s professional judgment, reflect the ultimate value of the loss and loss adjustment expenses. The actuary also should consider the following:

a. the coverage being evaluated;

b. the type of analysis (such as overall future cost level analysis or risk classification analysis); and

c. the differences between the future period and the historical conditions under which the historical claims occurred, the claims were adjusted, and the claim reserves were set.

The actuary should consider whether the analysis of loss adjustment expense data requires different methods, models, or assumptions than the analysis of loss data. Additionally, the actuary should consider whether different coverages within a line of business may require different methods, models, or assumptions.

3.8.3 Trends

The actuary should consider past and prospective changes in claim costs, claim frequencies, exposures, and premiums. The actuary should refer to ASOP No. 13, Trending Procedures in Property/Casualty Insurance, for guidance in the selection of trends for estimating future values of costs associated with the elements that make up the future cost estimate.

3.8.4 Additional Adjustments to Historical Data

The actuary should consider whether additional adjustments to the historical data are needed to reflect the environment expected to exist in the period for which the future costs are being estimated. If the actuary makes adjustments, these adjustments should be made so that the historical data are stated and used on a consistent basis. Examples of changes that may suggest the need for adjustments include the following:

a. judicial, legislative, or regulatory changes;

b. mix of business changes;

c. policy contract changes;

d. claim practice or reserving changes;

e. operational changes;

f.  accounting changes; and

g. reinsurance changes.

3.9 Expenses

Some types of expenses may require different treatment for future cost estimates than other types of expenses. The actuary should refer to ASOP No. 29, Expense Provisions in Property/Casualty Insurance Ratemaking, and ASOP No. 13 for guidance in estimating future expenses.

3.10 New Coverages or Exposures

If the actuary is estimating the future cost for a new coverage or exposure, and the historical loss and loss adjustment expenses are either unavailable, limited, or not fully representative of the new coverage or exposure, the actuary should consider the following in selecting data and developing methods, models, or assumptions for use in estimating the future costs:

a. data from coverages or exposures that are similar to the new coverage or exposure;

b. data on the phenomenon or events that are contemplated by the new coverage or exposure;

c. differences between coverages or exposures with available relevant data and the new coverage or exposure; and

d. appropriate adjustments to the available relevant data to reflect expected differences identified in section 3.10(c).

3.11 Credibility

The actuary should refer to ASOP No. 25, Credibility Procedures, for guidance in considering the credibility given to a particular set of data and the selection of the relevant experience used to supplement the data, which is often referred to as the complement of credibility.

3.12 Treatment of Catastrophes

The actuary should refer to ASOP No. 38 and ASOP No. 39, Treatment of Catastrophe Losses in Property/Casualty Insurance Ratemaking, for guidance in the consideration of catastrophes.

3.13 Treatment of Infrequent Events

The actuary should consider whether it is necessary to use methods that adjust for either the presence or absence of infrequent large losses in the historical data set. For example, some data sets may require using a longer experience period to calculate an appropriate provision for large losses. Similarly, when estimating expected losses in higher layers that contain infrequent losses, different methods may be appropriate. In some cases, the methods used to deal with catastrophe losses may be applicable and the actuary should refer to ASOP No. 39.

3.14 Reinsurance

When the cost of reinsurance is reflected in future cost estimates, the actuary should select appropriate methods or models, along with reasonable assumptions, for estimating the cost associated with reinsurance arrangements expected to apply during the period for which the future costs are being estimated. If the cost of reinsurance is treated as an expense, the actuary should refer to ASOP No. 29 for additional guidance.

3.15 Profit and Contingency Provisions and the Cost of Capital

The actuary should refer to ASOP No. 30, Treatment of Profit and Contingency Provisions and the Cost of Capital in Property/Casualty Insurance Ratemaking, for guidance in the consideration of the profit and contingency provisions and the cost of capital.

3.16 Additional Funding Sources

In some mechanisms for risk transfer, income may come from other sources, such as assessments paid by policyholders or other parties including insurers, a group of insurance purchasers, or taxpayers. The actuary should consider additional sources of funding and their allocation and timing when estimating future costs.

Section 4. Communications and Disclosures

4.1  Actuarial Communications

When issuing actuarial communications under this standard, the actuary should refer to ASOP Nos. 12, 13, 23, 25, 29, 30, 38, 39, and 41, Actuarial Communications. In addition, the actuary should disclose the following in an appropriate actuarial communication:

a. the elements included in the future cost estimates (see section 3.1);

b. the intended measure used in developing or reviewing the future cost estimates (see section 3.2);

c. the methods or models used in developing or reviewing the future cost estimates (see section 3.5); and

d. the material assumptions made by the actuary and used in developing or reviewing the future cost estimates (see section 3.5).

4.2  Disclosures

The actuary should also include the following in an actuarial communication, if and when applicable:

a. if appropriate data are available for the analysis, the actuary should disclose the data organization (level of data aggregation and, if considered, segmentation) used for each element (see section 3.3);

b. if the actuary selects a new exposure base or changes an existing exposure base, the actuary should disclose the new or revised exposure base (see section 3.6);

c. if the actuary uses historical data, the actuary should disclose any adjustments made to the historical data to account for expected differences between the historical data and future experience (see sections 3.8 and 3.10). For adjustments made to address issues of data quality, refer to ASOP No. 23;

d. if the actuary estimates future costs for a coverage or exposure when the historical data are unavailable, limited, or not fully representative, the actuary should disclose the data used and any appropriate adjustments made to the data (see sections 3.8.4 and 3.10);

e. when the cost of reinsurance is reflected in future cost estimates, the actuary should disclose the methods or models, along with the material assumptions, used in estimating the costs of reinsurance (see section 3.14);

f. if the actuary considers additional sources of funding, the actuary should disclose how the funding was reflected in estimating the future cost (see section 3.16);

g. the disclosure in ASOP No. 41, section 4.2, if any material assumption or method was prescribed by applicable law;

h. the disclosure in ASOP No. 41, section 4.3, if the actuary states reliance on other sources and thereby disclaims responsibility for any material assumption or method selected by a party other than the actuary; and

i. the disclosure in ASOP No. 41, section 4.4, if, in the actuary’s professional judgment, the actuary has otherwise deviated materially from the guidance of this ASOP.

Appendix 1

Note: This appendix is provided for informational purposes and is not part of the standard of practice.

Background

Cost estimation, ratemaking, and risk retention have been a fundamental part of actuarial practice since the beginning of the profession. A critical piece of these professional activities is the estimation of future costs.

Ratemaking principles and standards of practice are important to protect the soundness of the system, permit economic incentives to operate, and thereby encourage widespread availability of coverage. The board of directors of the Casualty Actuarial Society (CAS) adopted the Statement of Principles Regarding Property and Casualty Ratemaking in May 1988. The Statement of Principles has served as a foundational source of information regarding future cost estimation and ratemaking, providing both principles and considerations. Several actuarial standards of practice (ASOPs) issued by the Actuarial Standards Board are also important in future cost estimation, including the following:

• ASOP No. 12, Risk Classification (for All Practice Areas);
• ASOP No. 13, Trending Procedures in Property/Casualty Insurance;
• ASOP No. 23, Data Quality;
• ASOP No. 25, Credibility Procedures;
• ASOP No. 29, Expense Provisions in Property/Casualty Insurance Ratemaking;
• ASOP No. 30, Treatment of Profit and Contingency Provisions and the Cost of Capital in Property/Casualty Insurance Ratemaking;
• ASOP No. 38, Using Models Outside the Actuary’s Area of Expertise (Property and Casualty)
• ASOP No. 39, Treatment of Catastrophe Losses in Property/Casualty Insurance Ratemaking; and
• ASOP No. 41, Actuarial Communications.

Current Practices

Over the years, a multitude of methods and models for the estimation of future costs have been designed, put into use, and modified as a result of experience. Materials and publications of the CAS such as the Syllabus of Basic Education (formerly the Syllabus of Examinations), Variance, Proceedings (discontinued in 2014), Foundations of Casualty Actuarial Science, Ratemaking and Ratemaking/Product Management Seminar archives, and others provide discussions of current practices. While these may provide useful educational guidance to practicing actuaries, none is an actuarial standard of practice.

Throughout our history as a profession, actuarial future cost estimates have not always been the sole basis for rates and prices in risk-transfer or risk-retention transactions. For example, other important influences may include regulatory requirements and business objectives. Such other influences may support or compete with actuarial future cost estimates in deciding upon final rates and prices.

The increased availability of data and advances in technology, tools, techniques, and learnings from other disciplines have resulted in continued evolution of methods and models for the estimation of future costs. Innovation and use of new data and technologies will continue.

Appendix 2

Comments on the Third Exposure Draft and Responses

The third exposure draft of this ASOP, Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Funding (previously Property/Casualty Ratemaking), was issued in December 2016 with a comment deadline of April 30, 2017. Thirteen comment letters were received, some of which were submitted on behalf of multiple commentators, such as firms or committees. For purposes of this appendix, the term “commentator” may refer to more than one person associated with a particular comment letter. The Ratemaking Task Force carefully considered all comments received, reviewed the exposure draft, and proposed changes. The Casualty Committee and the ASB reviewed the proposed changes and made modifications where appropriate.

Summarized below are the significant issues and questions contained in the comment letters and responses.

The term “reviewers” in appendix 2 includes the Ratemaking Task Force, the Casualty Committee, and the ASB. Unless otherwise noted, the section numbers and titles used in appendix 2 refer to those in the third exposure draft.

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