Process of Establishing a Surplus Policy for the New Jersey School Boards Insurance Group

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1 1 Process of Establishing a Surplus Policy for the New Jersey School Boards Insurance Group Background In 2010 the Board of Trustees of the New Jersey School Boards Insurance Group (NJSBAIG) developed a surplus policy that would enable them to: Support the risks of existing membership Provide funds for a Safety Grant Award program Support future growth in membership Withstand loss of surplus due to catastrophic, uncontrollable events The project was commissioned by Marty Kalbach, Director of NJSBAIG. SIGMA Actuarial Consulting Group prepared financial statement forecasts as input for development of the surplus policy. The forecasts measured the sensitivity of a pool s financial statements to a variety of risk and operational variables inherent to public schools. Methodology The first step in the analysis was to set a provisional goal for surplus consistent with the standards used by state insurance commissioners to assess the solvency of regulated insurance companies. The measure chosen was Risk Based Capital (RBC), adapted for use with public entity pools. RBC is a technique that considers a variety of risks including: Reserve development Rate adequacy Investment risk Credit risk (receivables from insureds and reinsurers) The provisional goal was set at a level that would satisfy requirements for regulated insurance companies. For purposes of the forecast the provisional surplus goal was increased each year to account for increases in exposures and inflation in claims expenses. Risk Based Capital helps a pool establish a surplus policy that addresses a variety of risks to surplus

2 2 The next step was to forecast the financial statements to determine whether the goal would be achieved over a five year period. Variable claims costs The key input for the forecasts were a range of claims expenses that simulated NJSBAIG s loss experience. The simulations were done separately for each line of coverage. This was important because the variability is greater for lines with low frequency and potentially high severity, like property, than for lines with high frequency and relatively low severity, like workers compensation. The claims expenses were simulated to produce a range of claims based on the historical variability of NJSBAIG s retained losses. The losses were simulated 10,000 times for each line, for each of the five years, to produce an array of potential claims costs. The five years were summed to create the range of total claims costs for the analysis. A forecast should include a range of potential claims Three claims cost scenarios were used in the first phase costs that reflect the unique of the forecasts: risk profile of the pool. Base Case High Variable, and Low Variable The Base Case scenario assumed each year s loss experience will be expected or equal to the annual forecast. Actual losses will vary somewhat from the expected number. The Low Variable and High Variable claim cost scenarios, represented the 10 th and 90 th percentiles of the total five year losses, respectively. These scenarios show how the financial statements, and the surplus, could be affected when the claims vary from the expected level. The other cost and growth assumptions were developed in conjunction with the Director of NJSBAIG. These include investment returns, Safety Grant awards, anticipated growth in exposures or lines of coverage, and other expenses pertinent to the growth of surplus.

3 3 Results of the forecasts In the forecasts using expected and variable claims cost scenarios, the provisional surplus goal was achieved in each year. These forecasts indicated that the Fund Surplus would enable NJSBAIG to help the New Jersey public schools stabilize the cost of risk by. Paying claims that exceed the accident year claims fund Supporting programs like the Safety Grants that encourage safety and, eventually, lower the cost of risk for all members Absorbing new groups of members without additional capital contribution Increasing retentions if market conditions warrant an increase Writing additional lines of coverage Subsidizing premium contributions if predatory competitors threaten the membership Role of Investment Income The forecasts also showed how surplus accumulation is dependent on investment income. Over the five year period, investment income was greater than underwriting income. This was because: Member contributions are kept relatively low to support the school districts operating budgets; leaving little margin for underwriting profit The Safety Grant program was assumed to be funded from underwriting income, so that expense decreased the final underwriting profit This segment of the analysis showed that the member contributions would be stable. The surplus growth depends on investment income, thus surplus should be protected so there are sufficient funds on which to earn investment income.

4 4 Effect of catastrophic expenses The Fund Surplus should support not only the expected variation in claims and operating costs, but also enable NJSBAIG to rebuild the surplus in case of costly unexpected events such as: Multiple large property losses, or Insolvency of a reinsurer, or Adverse loss development, or Class action lawsuits Any of these events could cause large, unexpected decreases in surplus. In the analysis, these were called Stochastic events. A forecast of surplus was done assuming a $40 million decrease in surplus caused by any or a combination of these Stochastic events over a four year period. If a Stochastic event of this magnitude occurred, the surplus would not meet the Adapted RBC goal. After the fourth year, the surplus began to recover, but still did not reach the provision goal. The surplus policy should consider how surplus can be recovered in case of a Stochastic event Based on this result, the board discussed whether assessments and/or increased contributions should be considered to replenish surplus in case of a Stochastic event. It was recognized that it would be difficult to recover that amount of loss in a short period without significant disruption to school boards operating budget. This indicated that Fund Surplus should always be sufficient to support the work necessary to stabilize the cost of risk and to rebuild in a reasonable time frame in case of a large unexpected operating loss.

5 5 Surplus policy The surplus policy was set at a multiple of Adapted RBC that would be consistent with the surplus held by regulated insurance companies. This will allow NJSBAIG to: Continue to keep members contributions stable and competitive Fund the Safety Grant program, thus providing incentive for loss control and eventually decreasing the cost of risk for all members Provide the members solvency protection similar to regulated insurance companies, and Be consistent with state insurance department requirements, thus fulfilling the mission of protecting the personnel, physical, and financial assets of the public schools in New Jersey. Questions about this project should be directed to: Marty Kalbach, Director New Jersey School Boards Insurance Group mkalbach@njsbaig.org ext 3024 or Lloyd Kelley Director of Strategic Consulting SIGMA Actuarial Consulting Group, Inc Lloyd@sigmaactuary.com ext 207