Bodily Injury Thematic Review

2015 Bodily Injury Thematic Review

ii Central Bank of Ireland Insurance Directorate 2015

BODILY INJURY THEMATIC REVIEW

1 Introduction 1.1 Overview and Context 4 1.2 Summary of Findings 5 1.3 Observations 5 2 Claims trends 2.1 Private Motor Injury Claims Frequency 6 2.2 Private Motor Injury average claim cost 6 2.3 Liability Lines 6 2.4 Central Bank s Expectations Changing Trends 7 3 Settlement Rates 3.1 Settlement Rates evolution 7 3.2 Central Bank s Expectations Settlement Rates 8 4 Periodic Payment Orders 4.1 Introduction of PPOs 8 4.2 Central Bank s Expectations PPOs 9 5 Pricing Implications 9 2 Central Bank of Ireland Insurance Directorate 2015

Enquiries relating to this document should be addressed to: Analytics Division, Insurance Directorate, Central Bank of Ireland, PO Box 11517, North Wall Quay, Spencer Dock, Dublin 1. Email: insurance@centralbank.ie Central Bank of Ireland Insurance Directorate 2015 3

Bodily Injury Thematic Review 1. Introduction 1.1 Overview and Context The non-life insurance industry has been gradually recognising growing claims costs, stemming from legislative and judicial changes and changing macroeconomic conditions. Increasing court awards, increasing economic activity and increasing miles travelled are some of the main factors behind growing non-life insurance claims in Ireland. These issues predominantly affect bodily injury claims in the private motor, employer liability and public liability lines of business which comprise a significant majority of overall reserves. It is a challenging exercise in normal times to forecast correctly the ultimate cost associated with these claims, which can take a very long time to settle. This uncertainty has been further increased owing to recent developments such as court award and other legislative changes, and the proposed introduction of Periodic Payment Orders ( PPOs ) 1. However, the upward trends in frequency and average cost of claims are clear. The Central Bank therefore carried out a review of bodily injury claims and reserving data this year to assess the extent to which the industry had measured and recognised these trends in their data up to the end of 2014, and to inform its supervisory engagement. The review involved: The establishment of a bodily injury claims database for accident years 2012 to 2014, covering claims data and pricing assumptions for private motor, employer liability and public liability. This was based on data submitted at the request of the Central Bank by the main market participants incorporated in Ireland; The statistical analysis of this database and actuarial findings; and Interviews with a number of market participants focusing on their view of market developments and the implications for reserving and claims management practices. This report presents, in an aggregate format safeguarding the confidentiality of the submissions, the high-level findings and observations of the review. It includes areas for companies Boards of Directors ( Boards ), risk committees and senior management to consider when setting aside reserves for bodily injury claims and setting pricing strategies. The Central Bank will separately follow up with proposed Heads of Actuarial Functions in relation to the approach taken to the review and more detailed findings from the review. The Central Bank is seeking to: Drive a greater awareness of the financial impact of the operating environment on companies reserves and pricing approaches as it was recognised, in part, by market participants at the end of 2014; Facilitate enhanced challenge by companies Boards and risk committees by providing comparative data 2 for key assumptions and instances of expert judgement; and thereby Promote consistent and robust reserving and pricing processes for 2015 and beyond, across the industry. The findings also provide a different perspective for industry stakeholders on the impact of recent developments on the behaviour of industry participants and an opportunity to reflect on whether these are delivering the required outcomes. The Central Bank will separately communicate with companies on company-specific findings. 1 Periodic Payment Orders aim to give much-needed financial security to those who have been catastrophically injured and require longterm care through the provision of an index-linked annual payment to cover care and medical costs as opposed to a lump sum as is currently the case. 2 This bulletin provides broad ranges which are included only to give an approximate understanding of materiality. The purpose of this bulletin is not for the data to be used directly to set reserves. 4 Central Bank of Ireland Insurance Directorate 2015

1.2 Summary of Findings Overall our review disaggregates the gradual recognition of the build-up of bodily injury claims charges in the non-life market from 2012 to 2014. This recognition has not been made at the same speed, in particular: In some instances, the impact of variations in reserving practice in private motor resulted in some companies holding approximately half the level of reserves 3 compared to others for each of the accident years from 2012 to 2014; Material differences have been observed within the market across private motor and liability in the estimated average costs of claims 4. Even when large claims are excluded, the lower end of the range is likely to indicate insufficient case reserves. This level of variability is particularly concerning in private motor; Increases in the average cost per claim of approximately 8% in private motor, approximately 27% in employer liability and approximately 8% in public liability have been observed from year end 2012 to year end 2014; Increases have been observed in private motor injury claims frequency 5 from year end 2013 to year end 2014 in the range of 4% to 12%, with an average of 8.3%; The number of claims building up within claims systems is increasing for a number of insurers, as their claims are taking longer to settle fully across private motor and liability lines. The slowdown in settlement rates has been observed in some companies to a varying degree. For some companies higher caseloads per handler have also been observed; and Optimistic assumptions are being made in relation to the potential impact of PPOs by some companies and there is a wide variation in reserving methods applied. Insurance companies have reflected these issues in their 2014 reserves held to varying degrees, with some companies lagging behind peers in recognising the emerging market changes in their approaches to reserving and pricing. While there are valid reasons for some of these differences, companies which have recognised only limited increases in frequency and severity so far need to give careful consideration as to whether the extent of their recognition is appropriate, in particular as the 2015 frequency and severity of claims are set to continue on their upward path. The Central Bank will separately follow up with companies in relation to the adequacy of their bodily injury reserves and their loss ratios forecasts per accident year. 1.3 Observations Boards of insurance companies are responsible for ensuring that reserves and premiums are set so as to cover incurred and future claims. Insurance companies are required to have a robust risk management framework in place to facilitate a deep understanding of the insurance risks underwritten and monitor the performance of their business. This will ensure companies are in a position to recognise changes in the claims environment without delay and forecast the ultimate claims costs adequately. The Central Bank is publishing this report so that management of insurance firms can reflect on aggregate industry figures and trends. This report will also help to put Boards in a stronger position to challenge companies management s measurement of how their business is actually performing and whether the company is setting aside sufficient reserves and pricing adequately for the risks underwritten. In relation to managing insurance risk, the Central Bank views board risk committees as having a significant role in leading risk management and promoting a forward looking measurement of their insurance liabilities. The Central Bank expects risk committees to exercise robust oversight and monitoring of the adequacy of insurance reserves and pricing. Related to the above, the Central Bank will be introducing a new pre-approval controlled function, the Head of Actuarial Function ( HoAF ), under Solvency II. The Central Bank expects HoAFs to be in a position to inform the board in relation to areas of actuarial expertise. The HoAF should take into account the information contained within this report in their role and in their interactions with Boards. In a Solvency II context, companies capital requirements are more responsive to changes in underlying risks. The Central Bank expects Boards to have a deep understanding of the factors at play for setting up reserves and the nature of the key assumptions made within a company s Own Risk and Solvency Assessment ( ORSA ). 3 Specifically, for some companies the bodily injury best estimate ultimate reserve per vehicle year is half that of other companies. 4 This refers to the average cost of incurred claims, that is, the average incurred cost per reported claim. 5 Claims frequency is defined as the ultimate number of injury claims per earned vehicle year, excluding MIBI claims. Central Bank of Ireland Insurance Directorate 2015 5

The Central Bank has an increasing focus on data analytics and the interrogation of data pertaining to companies operations to help identify trends and developments at an early stage. This will help to guide and steer its supervisory actions. This is very much reflected in the new organisational structure within the Insurance Directorate with the establishment of a new Analytics, Advisory and Actuarial Services Division. This division will sit alongside the Insurance Supervision Division within the Insurance Directorate. The Central Bank is currently evaluating the nature and scope of various thematic reviews to assist in its supervision of this sector. 2. Changing Trends 2.1 Private Motor Injury Claims frequency Claim frequency is a key determinant of the overall cost of claims and reserves booked. Companies have observed increases in private motor injury claims frequency ranging from 4% to 12% from 2013 to 2014, with an average increase of 8.3%. These increases are in line with increases in motor fuel sales and road traffic fatalities in the same period. Changes in claims frequency make a material difference. For example, as a sensitivity test for claims frequency only, were an increase in frequency of 10% to occur in 2015 (similar to that experienced by some companies from 2013 to 2014) this would increase best estimate ultimate reserves by approximately 8% - 13% (holding all other factors constant). This trend would need to be taken into account in pricing. There are wide variations in the projected claims frequency used by companies for pricing and reserving purposes. For example, the average injury claims frequency across 2012 to 2014 varies from 0.58% to 0.87%, with an average of 0.72% in 2012, 0.71% in 2013 and 0.77% in 2014. 2.2 Private Motor Injury average claim cost The determination of the ultimate cost of claims involves reliance on expert judgement, both on the part of claims handlers in determining case estimates and on the part of actuaries in setting reserves. While this subjectivity is unavoidable, companies should have clear policies in place in relation to areas such as the credit taken for contributory negligence in setting case estimates and assumptions relating to legal costs. Cross subsidies between legal costs or other costs for different claim types should be avoided. There is a wide variation in the average costs 6 assumed by companies, from approximately 19,000 to 40,000 in 2014. The impact of this variation can be significant. While some of these variations will again be driven by different risk selection, the level of observed variation is likely to give rise to adverse reserve development in 2015 and beyond for insurers with lower estimates. Differences of this magnitude are unsustainable within the industry and could lead to inappropriate pricing decisions being taken. The average cost for each accident year is approximately 23,400 for 2012, rising to 25,200 for 2014, so that the average incurred cost per claim has risen over time of 1,800 per claim across the market, or 8% from 2012 to 2014. There is some evidence of a continuation of this trend into 2015. 2.3 Liability Lines The employer liability average cost per claim 7 in recent years has risen significantly for most companies by approximately 4,300 per claim or 27% from 2012 to 2014. The public liability average cost per claim has increased by approximately 1,500 per claim or 8% from 2012 to 2014. The cost of injury claims per 100 premium paid has also shown an increasing trend, with a percentage increase in absolute terms of 5% for employer liability and 8% for public liability from 2012 to 2014. 6 This is the average incurred cost per claim in the first development year for private motor bodily injury only i.e. all commercial motor claims are excluded and all property damage claims are excluded. 7 This is the average cost per claim in the first development year. It should be noted that for the liability lines, the claims data used included both injury and property damage. For both classes, the majority of claims reserves are for bodily injury claims (with a higher percentage of damage claims in public liability generally). 6 Central Bank of Ireland Insurance Directorate 2015

The range across the market in the average cost 8 of employer liability claims in 2014 is 20,000 to 35,000 and for public liability claims is 15,000 to 30,000. While this variation reflects differences in underwriting and mix of business which are particularly material for the liability lines, the level of variation is nonetheless useful for individual companies to consider. 2.4 Central Bank s Expectations Changing Trends Boards should be in a position to: Ensure that robust controls are in place to monitor the history of actual vs. expected results, which should be appropriately segmented. Companies should carry out a detailed and timely actual vs. expected analysis for all material assumptions underlying reserving, showing with the benefit of hindsight what appropriate assumptions chosen by the Signing Actuary or HoAF would have been at previous year ends. This should form a significant area of emphasis for HoAFs; Justify their assumptions. The justification should be specific rather than general, should reflect developments in business mix and economic activity indicators and should make reference to the changing trends in the claims environment and any effect they may have on the appropriateness of historical data; Identify high level trends in claims and check whether they are broadly in line with those noted above; Consider whether management information is able to identify these trends and in particular whether more granular management information would be better able to identify the trends; Identify the underlying drivers of these trends. Across the industry, a number of factors have been identified, such as increases to the monetary limits for claims settled in lower courts, the potential introduction of PPOs, changes to the composition of the judiciary etc.; Confirm that the Solvency II best estimate reserves reflect a sufficiently wide underlying distribution of possible outcomes, taking into account the trends above. The Solvency II Delegated Acts 9 require that the best estimate take into account expected future developments, such as demographic, legal, medical, technological, social, environmental and economic developments including inflation, and also take into account all uncertainties in the cash flows. Justification should be provided for the range of possible outcomes considered for the calculation of the best estimate; Reflect these issues in the choice of reserving assumptions and methodologies. Consider whether the company has reacted sufficiently quickly to the emerging changes. Again, this consideration should rely on specific evidence of how the changes have been taken into account; and Take these trends into account in the premium provision booked on the Solvency II balance sheet. This reserve should also take into account emerging trends in average cost which may have a greater impact on the unexpired period of risk. 3. Settlement Rates 3.1 Settlement Rates evolution There is an observed slowdown in settlement rates 10 for some insurers, to varying degrees in various classes. In private motor, some companies have seen an average fall in the settlement rate from approximately 13% to 10% in absolute terms. In employer liability, some companies have seen an average fall in the settlement rate from approximately 5% to 2% in absolute terms. It should be noted that not all companies have observed this trend and it is also not uniform across classes (in particular, it is not observed in public liability). This effect is also reflected in caseloads per claims handler with some companies having high numbers of claims per handler at year end 2014. A higher number of claims per handler may exacerbate the impact from the external environment. This slowdown means that claims are staying on companies books for longer periods, which can result in higher legal costs and potentially higher settlement costs. 8 Defined as the average incurred cost per claim in the first development year. 9 Commission Delegated Regulation (EU) 2015/35, Articles 29 and 30. 10 The settlement rate is defined as the amount paid divided by the projected ultimate cost, for each development year. For example, 10% paid in 2012 for accidents occurring in 2012, 30% paid in 2013 for accidents occurring in 2012 etc. Central Bank of Ireland Insurance Directorate 2015 7

The Central Bank calls on companies to manage properly the associated operational risks and to take the effect into account in reserving appropriately. The evolution in settlement rates indicates the need for companies to monitor the use of the various routes to settlement within the company. 3.2 Central Bank s Expectations Settlement Rates The Central Bank expects companies to challenge themselves as to whether the settlement rate of claims is slowing and whether this has been appropriately taken into account in reserves. In particular, Boards should be in a position to: Identify the main drivers of the slowdown if observed; Assess whether idiosyncratic effects are involved or if the slowdown is due mainly to external factors; Monitor settlement rates in a suitably segmented way (e.g. claim counts, Paid to Ultimate ratios). Consider whether improved management information could be produced in this regard e.g. could settlement statistics by settlement channel (e.g. direct, Injuries Board, Courts) should be monitored; Take the slowdown into account in claims management. Caseloads per handler should be monitored at a suitably segmented level on a regular basis in order to identify any emerging issues. Where caseloads are rising, there should be an action plan in place to deal with caseloads and any associated claims leakage; Monitor the impact of any initiatives put in place to counteract the slowdown e.g. is the impact uniform across claims sizes? If smaller, less complex claims are impacted to a higher degree, this may cause average costs to rise by duration. This should be taken into account in reserving; Reflect these issues in the choices made for reserving assumptions and methodologies; Consider whether the company has reacted sufficiently quickly to the emerging changes; and Take these trends into account in the unexpired risk reserve assessment for the technical provisions booked on the Solvency II balance sheet. This reserve should take into account changes in settlement rates which may impact on average costs for the unexpired period of risk. 4. Periodic Payment Orders 4.1 Introduction of Periodic Payment Orders The Civil Liability (Amendment) Draft Bill issued on 27 May 2015 contained provisions for the introduction of PPOs. The extent of the uptake of PPOs and their impact on companies costs are unknown. The eventual impact will depend on the uptake of PPOs, the index used to increase periodic payments, the types of claims which PPOs are applied to and the reaction of reinsurers. Across the market, companies are currently making a wide range of different assumptions. This leads to estimates of the potential impact of PPOs on 2014 reserves in the range of 0.8% to 4.3% of booked reserves 11. In the long term, the cumulative impact will be much more material. We set out below our expectations in relation to companies approach to PPOs, in order to promote greater consistency in the market in relation to this issue. In the absence of any data specific to Ireland, the Central Bank views the recent UK experience as the best source of available data, although there are some differences between the UK regime and the proposed Irish regime. The Central Bank expects companies to use the UK experience as a basis for quantifying the possible impact of PPOs on their reserves. While it is difficult to estimate the impact, the Central Bank believes that the following assumptions are reasonable: In order to calculate the day one impact on reserves for open claims, it would be reasonable 11 This is the gross estimated additional cost of PPOs divided by the total gross booked reserve, as at year end 2014. 8 Central Bank of Ireland Insurance Directorate 2015

to assume a propensity for a claim to settle as a PPO in the range of 30% to 60%. Average lump sums and periodic payments for the UK are available for reference 12 ; and For the longer term impact on balance sheets, an impact in the range of 30% to 50% of motor reserves covering PPO liabilities has been estimated for the UK and this appears to be the best benchmark available for Ireland. 4.2 Central Bank s Expectations - Periodic Payment Orders In terms of approach, the Central Bank expects companies to take the following steps: Central estimate: Companies should produce a central estimate of day one reserving impact of PPOs on their company. The Central Bank expects this to be carried out in two ways, using a top down approach and a bottom-up approach identifying open claims with the potential to settle as PPOs; and Scenario testing: Scenario tests on the possible impact of PPOs should be considered. These scenario tests should consider the impact of varying assumptions such as: The propensity for PPOs: In the UK, the propensity has been in the range 30% to 35% approximately for motor in recent years. The propensity in Ireland could be significantly higher than this, given that, in the proposed Irish regime, PPOs would be imposed by judges. A range of propensities should be checked, as this is a key assumption in determining the eventual impact; Higher indemnity cost for individual claims: A stress test of the assumed higher cost per individual claim should be carried out; and Claims exposed to PPOs: A stress test should be performed assuming that PPOs apply to claims at various large claim bands and apply to a relatively broad definition of catastrophic claims. 5. Pricing Implications 5.1 Pricing Implications The trends discussed above have significant implications for pricing. Appropriate projection of emerging claim trends is particularly important from a pricing perspective. It is important that companies take these trends into account in setting pricing assumptions for future periods of risk. Companies need to ensure that pricing is sufficiently dynamic so that emerging trends can be taken into account sufficiently quickly. The nature of the insurance cycle is such that there will always be an element of cross-subsidy between different risk periods. Notwithstanding this, it is important to ensure that companies pricing strategies are sufficiently robust to manage the business appropriately through the cycle and that, at an industry level, excessive peaks and troughs are avoided. In this regard, the Central Bank would like to draw companies attention to the newly introduced requirement for the HoAF under Solvency II to provide an opinion to the board on the overall underwriting policy. Underwriting aims to ensure that the risk being accepted by the company is being appropriately priced for and is in line with the company s risk appetite. Within the bodily injury review, pricing assumptions made as at year end 2014 were compared between peers. The assumed average cost per private motor claim for 2015 was broadly in line with that observed in 2014. The assumed claims frequency showed a similar range across the market to that discussed above. The Central Bank has observed examples of good practice in this area, in which companies regularly monitor frequency trends at a reasonably segmented level, formally document their findings and any actions arising and communicate these as needed e.g. to the risk management function and pricing teams. Boards should ensure that the following are in place: A regular (e.g. quarterly at a minimum) monitoring system which will highlight emerging trends in frequency and costs over time. This should consider any changes in claims handling, underwriting and pricing and the results of this monitoring should be taken into account in reserving and risk management; A retrospective actual vs. expected analysis of all material pricing assumptions underlying 12 See Periodical Payment Orders - Working Party GIRO 2013 Report dated 24 January 2014, produced by the Institute and Faculty of Actuaries. Central Bank of Ireland Insurance Directorate 2015 9

the periodic pricing adequacy calculations used to make pricing decisions. This should be an area of emphasis for HoAFs; and Pricing assumptions taking trends into account for future periods of risk. Companies should ensure that pricing is sufficiently dynamic so that emerging trends can be taken into account sufficiently quickly. 10 Central Bank of Ireland Insurance Directorate 2015