Casualty Quarterly, Spring 2018

Cyber Risk—The Great Fire of London Issue of Our Time

By Edmund Douglas

It has been more than 350 years since the Great Fire of London, a watershed event for the area of fire risk management. The event was one of the largest urban fires in history, raging for several days and leaving 80 percent of the city in ashes. It was a catastrophe of catastrophes as “England’s biggest city—containing roughly two-thirds of the wealth of the empire—was ruined.” Rebuilding the city took many years, with one of the offsprings of the process being the world’s first insurance company. Fire brigades were formed, and many laws on the local and national level have since been enacted to reduce the risk of another such catastrophic event.

In our current state of affairs, cyber risk (i.e., digital security and privacy protection risks) bears an uncanny resemblance to fire risk just before the catastrophic event that took place in London in 1666, of course, with the notable exception of personal physical harm that comes with fires. Like fire risk then, which was a significant and complex risk to manage—with the potential to disable critical infrastructure, imperil national security, and threaten the economy—so is the case for cyber risk now. Urbanization, which brought significant economic benefits to the population then, was the driving force behind the increase in fire risk. Today a similar evolution is the increasing use of digital technologies, which has yielded a multitude of benefits affecting the entire world. The digital transformation of economic activities has led to a sharp increase in cyber risks, which was identified among the top global business risks in the 2017 Allianz Risk Barometer survey.

Unfortunately, in London’s case it took a significant catastrophe to summon a serious response to the risk posed by urban fire. Ultimately the response was a multifaceted one that took the form of an integrated approach involving the public, private, and social sectors adopting a package of risk mitigation measures. Insurance coverage for fire risk had a role in, and made important contributions to, the management of the risk. In a similar vein, the Organization for Economic Cooperation and Development’s (OECD) December 2017 report, Enhancing the Role of Insurance in Cyber Risk Management, provides a series of policy recommendations aimed at enhancing the contribution of the cyber insurance market to manage the increasingly prevalent risk posed by digitalization. The report was prepared by the OECD based on questionnaire responses received from (re)insurance companies and brokers globally active in this market, as well as responses from ministries of finance and insurance regulators responsible for overseeing the market.

The report points to how the management of cyber risk could be improved once significant obstacles impeding the development of the cyber insurance market are overcome. Specifically, insurance could contribute to the management of cyber risk through:

• supporting the quantification of cyber exposure;
• providing expertise on risk management and prevention;
• facilitating access to crisis management services; and
• encouraging risk reduction through premium pricing.

In laying out its case, the report provides extensive background on a variety of related topics. Included is an insightful overview of different types of cyber incidents, as well as the types of losses that may result from such incidents. It gives a crash course on the cyber insurance market, including the types of losses that commonly are covered by stand-alone cyber insurance policies and traditional policies, as well as the losses that are more difficult to cover. The report offers useful information on how insurers underwrite cyber insurance coverage and the additional risk mitigation and crisis response services frequently offered with policies and gives an explanatory overview of the main challenges that constrain the capacity of the cyber insurance market from both the supply and demand perspective. It also examines initiatives that are being explored and ideas that have been proposed to address ongoing challenges. The report concludes by providing a pertinent set of recommendations on policy and regulatory measures that could be implemented to improve the development of the cyber insurance market.

Some of the report’s key findings include:

• Governments should include insurance as an essential component of their strategies for addressing digital security risks.
• Greater public–private collaboration is necessary to overcome the sparsity of data on cyber incidents, which is a significant impediment to the management of cyber risk.
• The policy, legal, and regulatory frameworks are important factors in how much information on cyber incidents is made available, and, therefore, governments should promote notification and disclosure requirements that improve the availability of data on cyber incidents and losses.
• The insurance market has an important role to play in providing greater clarity about the coverage available for cyber risk and which policies provide that coverage. Governments need to acknowledge this and ensure that policyholders are provided with as much clarity as possible on available coverage so that no gaps emerge as a result of market practices.
• Although the financial effects of cyber incidents to date have been manageable, there is concern about the potential for significant accumulation losses. Governments should examine options for managing cyber accumulation risk, including the potential role of risk pooling.

Many of these conclusions may not be surprising, particularly to those well-versed in the topic. Nevertheless, the overarching theme that easily may be missed is that the burden of enhancing the development of the cyber insurance market does not need to fall solely on the private sector. Collaboration between the private and public sectors is the optimal path. Even so, there are significant obstacles that need to be overcome, which the report discusses in great detail.

It took a significant catastrophe for London to develop effective measures involving both the private and public sectors to manage the risk of urban fire. How and when we respond to the increasingly prevalent risk posed by the digital revolution remains to be seen.

Edmund Douglas is chairperson of the Academy’s Cyber Risk Task Force

COPLFR Releases P/C Loss Reserves Practice Note

The Committee on Property and Liability Financial Reporting (COPLFR) released its annually updated Statements of Actuarial Opinion on P/C Loss Reserves practice note, the purpose of which is to provide information to actuaries on current or emerging practices in which their peers are engaged related to issuing NAIC P/C statements of actuarial opinion (SAOs) and actuarial opinion summaries (AOSs).

It is intended to assist actuaries by describing practices that COPLFR believes are commonly employed in issuing SAOs and AOSs on loss and loss adjustment expense reserves in compliance with the P/C Annual Statement Instructions for 2017 issued by the NAIC. Actuaries may also find this information useful in preparing SAOs for other audiences or regulators.

COPLFR Issues Exposure Draft of Retained Risk Practice Note

The Committee on Property and Liability Financial Reporting (COPLFR) released an exposure draft of a new practice note, Retained Property Casualty Insurance-Related Risk: Interaction of Actuarial Analysis and Accounting. Comments are due by March 30; read the Academy alert.

The practice note defines ways that entities use to retain risk, often described in other literature as methods of financing an entity’s exposure to risk. Because the type of entity often determines the particular approach or applicable accounting treatment, the various types of entities and the associated variation in the retained risk characteristics are described. The common exposures that these various entities may retain also are described, and the practice note also discusses the relevant accounting guidance that could apply to the various entities and exposures, the interaction of the accounting guidance with the relevant actuarial concepts, and the variation by type of entity.

“COPLFR saw a need for practitioners to be able to access a single source document that provides an overview of the accounting principles that apply and identifies what practitioners view as the right resources to access,” said Past Academy President Mary Frances Miller, a member of COPLFR.

Lisa Slotznick, a member of the Academy’s Board and a past COPLFR chairperson, added that actuaries working for insurers that provide commercial insurance with retained risk components also encounter the situations described in the practice note and, therefore, may also find it a helpful resource.

Academy Weighs In on Proposal for ‘Qualified Actuary’

The Academy provided comments in response to the NAIC’s exposure draft of the proposed Revised Qualified Actuary Definition for the Property/Casualty (P/C) Actuarial Opinion Instructions.

“The Academy strongly supports the exposure draft’s revised definition that refers to the Member of the American Academy of Actuaries (MAAA) as the sole credential the NAIC recognizes as identifying qualification to sign statutory statements of actuarial opinion (SAOs) in the P/C Actuarial Opinion Instructions,” wrote former Academy President Mary D. Miller. “We support this approach, as we have before, for several reasons that make this approach the most appropriate way for the NAIC to focus its qualifications specifically on actuaries who are knowledgeable and dedicated to practice in the U.S.”

The letter also offered comments on a qualified actuary being able to perform tasks identified in the NAIC 2017 U.S. P/C Appointed Actuary Job Analysis.

Senior Fellow Ryan Testifies at Maryland General Assembly Auto Insurance Hearing

Academy Senior Property and Casualty Fellow Kevin Ryan testified Feb. 8 before the Maryland House Economic Matters Committee, commenting on legislation that would prohibit the use of occupation, education, gender, and marital status as factors in determining private passenger automobile insurance rates. Ryan’s remarks focused on the actuarial implications of such actions, including application of actuarial principles and standards of practice, including, specifically, risk classification.

Actuaries Climate Index Remains High for Latest Quarter

Quarterly data for the Actuaries Climate Index (ACI) released in January for the period of spring 2017 reveal the five-year moving average of climate extremes across the United States and Canada remains near the high recorded in the previous quarter, winter 2016–17. The seasonal ACI value was 1.66, compared with 1.94 in the previous quarter, marking the seventh consecutive season with an elevated value of above 1.5.

“Sea levels have overtaken high temperatures as the biggest single factor behind the record averages in climate extremes measured by the ACI,” Academy Senior Property and Casualty Fellow Kevin Ryan said in a statement. “Sea level measurements in the Atlantic and Gulf Coast regions were particularly important in keeping the moving index value at its current high level.”

The five-year ACI moving average for spring 2017 was 1.14, the same value as reported in the previous quarter, which was a record. Sea level, one of the six components of the index, has been highest in recent years in the Southeast Atlantic region (Virginia to Louisiana) and in the Southern Plains coastal region (Texas).

Sea levels in the Central East Atlantic (Maryland to Maine) and Northeast Atlantic (Canada’s Maritime Provinces) regions also contributed to the increased significance of the component.

The ACI is based on analysis of seasonal data from neutral, scientific sources for the six different index components collected since 1961. It measures changes in extremes of high and low temperatures, high winds, heavy precipitation, and drought, as well as changes in sea level, expressed in units of standard deviations from the mean for the 30-year reference period of 1961 to 1990 for the United States and Canada combined.

The ACI—sponsored by the Academy along with the Canadian Institute of Actuaries, the Casualty Actuarial Society, and the Society of Actuaries—is designed to provide objective data about changes in the frequency of extreme climate events and sea levels in recent decades.

COPLFR Shares Academy Research Findings on Schedule P Reporting Practices

The Committee on Property and Liability Financial Reporting (COPLFR) sent a letter informing the NAIC’s Casualty Actuarial and Statistical Task Force of the results of Academy research into Schedule P reporting practices. The Academy’s survey looked at currency conversion and changes in intercompany quotashare pooling due to acquisition or divestiture.

Related to foreign currency, 89 percent reported having no material amounts in Schedule P in non-US currency. For those that responded with regard to amounts in non-U.S. currency, questions were asked on two groupings, Canadian currency and all other currencies. With respect to Canadian currency, 60 percent converted into U.S. dollars prior to preparing Schedule P, thus indicating that Schedule P amounts for those companies is all in U.S.-dollar denominated currency. The remaining 40 percent do not convert the Canadian dollar denominated amounts into U.S. currency for preparing Schedule P. With respect to non-Canadian currencies, 100 percent of the respondents indicated that they converted the foreign currency into U.S. dollars.

Legislative/Judicial/Regulatory Update

Following is an update of key federal and state property/casualty legislation.

Federal Legislative and Regulatory Activities

Flood insurance remains a key issue for Congress in 2018. Despite Hurricanes Harvey, Irma, and Maria in 2017, congressional efforts on long-term reauthorization and revision of the National Flood Insurance Program (NFIP) have been stymied. The U.S. House of Representatives, however, in November passed H.R. 2874, The 21st Century Flood Reform Act, which would reauthorize the NFIP for five years, increase the role of private insurers in the flood insurance market, and improve tools and data used to develop accurate estimates of flood risk. The U.S. Senate has yet to consider its version of NFIP reauthorization. In lieu of longer-term reauthorizations, the NFIP has received five short-term reauthorizations since its authority expired on Sept. 30, 2017.

Other federal activity:

• President Trump signed a bill Feb. 9 temporarily funding the government through March 23, providing a two-year extension of discretionary spending caps and suspending the limit on government borrowing (known as the debt ceiling) until March 1, 2019. The bill extends NFIP authority through March 23. Read the Academy alert.
• Tax-reform legislation adopted by Congress and signed into law by the president in December (PL 115-97) includes a provision to modify the proration rule for P/C insurers by increasing the amount insurers can reduce deductible reserves from 15 percent to 25 percent and links the percentage to changes in the corporate tax rate to maintain an effective tax rate of 5.25 percent. The law also includes a provision that requires reserve discounting for P/C insurers based on a higher interest rate determined under a corporate bond yield curve and repeals the election to use the company’s own loss payment patterns.
• The U.S. Government Accountability Office released a report on budgetary and actuarial reviews of the Mutual Mortgage Insurance Fund by the Federal Housing Administration on Dec. 11. Read the Academy alert.

State P/C Legislation

There were many developments in state legislatures regarding insurance legislation, including:

Automobile Insurance

• Two auto insurance bills were introduced in the Maryland House in January. H.B. 656 would prohibit insurers from using an individual’s occupation or education level as factors in determining auto insurance rates. Similarly, H.B. 657 would prohibit setting rates on the basis of an individual’s marital status or gender. (Academy Senior P/C Fellow Kevin Ryan testified on this bill on Feb. 9; see his testimony here.)
• H.B. 1045, introduced in the Maryland House in February, would prohibit insurers from considering a vehicle used in a peer-to-peer car sharing program as a rental vehicle.
• S.B. 1075, passed in the Arizona Senate in February and now under consideration in the House, would increase limits on auto insurance damages beginning June 1, 2019.
• H.B. 5517, introduced in the Michigan House in February, would repeal the state’s no-fault automobile insurance law.
• H.B. 533, passed in the Florida Senate in March and now under consideration by Gov. Rick Scott, would authorize insurers to refuse to insure individuals who have failed to purchase motor vehicle services from a membership organization that, since Jan. 1, 2018, has more than 1 million members in the state and is affiliated with an admitted P/C insurer.
• A bill (H.B. 5419) introduced in the Michigan House in January would prohibit insurers from basing rates for automobile insurance on any factors except for an insured individual’s driving safety records, annual miles driven, or number of years of driving experience.

Autonomous Vehicles

• Oregon Gov. Kate Brown signed into law a bill (H.B. 4063) in March that would establish a task force to study the potential effects of autonomous vehicles and to propose legislation on the deployment of such vehicles on highways.

Flood Insurance and Climate Change

• H.B. 1350, introduced in the Maryland House in February, would require new construction and reconstruction to implement siting and design criteria that address sea level rise and coastal flood impact on state and local projects.
• Two bills introduced in the Hawaii Senate in January would address risks from climate change and flooding. S.B. 2327 would require P/C insurers that cover losses resulting from environmental events to establish a mandatory reserve to fund the payment of claims associated with global warming and erosion in shoreline areas of the state. S.B. 2334, passed in March and now under consideration in the House, would require the state and its counties to incorporate predictions of climate change hazards, including seal level rise, into their multi-hazard mitigation plans.
• H.B. 2182, introduced in the Missouri House in January, would require all counties and municipalities in the state to participate in and comply with the NFIP and to designate a state-certified floodplain manager to mitigate flooding risks. The bill would also require the state emergency management agency to develop regulations to determine allowable levels of floodplain development in the state.
• S.B. 292, introduced in the New Jersey Senate, would require insurers selling flood insurance to provide policyholders who have filed claims for damages to their insured properties with copies of all reports and documents relating to the properties and damages at issue.

Medical Professional Liability

• A.B. 1568, introduced in the New Jersey Assembly, would prevent insurers from increasing the premium of any medical malpractice liability insurance policy based on a claim of medical negligence or malpractice unless the claim results in a medical malpractice claim settlement, judgment, or arbitration award against the insured.

Workers’ Compensation

• Two workers’ compensation bills were introduced in Illinois in February. H.B. 4432, introduced in the House, would provide that a workers’ compensation insurance rate is excessive if it is likely to produce an unreasonably high long-run profit or if expenses are unreasonably high in relation to the services rendered. S.B. 2973, introduced in the Senate, would create a state-sponsored workers’ compensation insurance fund.
• Wisconsin Gov. Scott Walker signed a bill (S.B. 781) into law in February that allows temporary help employees and loaned and leased employees the right to recover worker's compensation benefits from their employer.

Misc. P/C

• H.B. 979, introduced in the Maryland House in February, would require insurers to pay a premium tax on premiums paid by individual or blanket policyholders who purchase travel insurance.
• H. 719, passed in the Vermont House in February and now under consideration in the Senate, would align state law with the NAIC’s Property & Casualty Model Law.
• H.B. 2058, introduced in the West Virginia House in January, would prohibit the use of credit scores in casualty insurance rate filings.

Court Proceedings

• The U.S. Supreme Court declined to hear an appeal to a ruling by the U.S. Court of Appeals for the Eighth Circuit upholding a Nebraska law affirming the lower court’s ruling and upholding the Nebraska Hospital Medical Liability Act.
• A ruling by the Supreme Court of New Mexico clarifies that individuals who discover medical malpractice injuries in the final year of the state’s three-year statutory period will still have a full 12 months to file claims.

State Regulatory Update

• The Utah Department of Insurance adopted a rule in January that requires insurers to have an actuary certify that auto, homeowners, and workers’ compensation insurance rates are not excessive, inadequate, or discriminatory.
• The California Department of Insurance issued a notice to P/C insurers on Jan. 29 notifying them of their duty to cover damages from recent mudslides in the state. Although homeowners’ insurance policies generally do not cover mudslides, the notice emphasizes that if a covered peril is determined to be caused by a wildfire (“efficient proximate cause”), damages as the result of mudslides and similar damages, hold insurers liable for those damages under the California Insurance Code.
• California Insurance Commissioner Dave Jones issued a statement in January directing the Department of Insurance to conduct a regulatory review of P/C insurers’ rates following the enactment of federal tax reform late last year that included a reduction in the corporate income tax to 21 percent from 35 percent.
• The New York Department of Financial Services adopted a rule prohibiting insurers from using an individual’s occupation or education level to determine auto insurance rates.

Webinar Looks at RMAD and Reserve Ranges

More than 400 members attended the Academy’s webinar, “P/C Loss Reserve Opinion Writing: RMAD and Reserve Ranges,” which looked at risk of material adverse deviation (RMAD), reserve ranges, and how they fit together for the purposes of issuing statements of actuarial opinion.

The webinar, hosted by COPLFR, was a follow-up to presentations on those subjects at December’s Seminar on P/C Effective Loss Reserve Opinions.

Moderated by COPLFR Chairperson Kathy Odomirok, the panelists were COPLFR member and Past Academy President Mary Frances Miller, and Dawn Fowle, a member of the Opinion Seminar Subcommittee.

Actuarial Standard of Practice (ASOP) No. 36, Statements of Actuarial Opinion Regarding Property/Casualty Loss and Loss Adjustment Expense Reserves, discusses significant risks and uncertainties, with paragraph 4.2(e) requiring disclosure: “If the actuary reasonably believes that there are significant risks and uncertainties that could result in material adverse deviation, an explanatory paragraph should be included in the statement of actuarial opinion.” The ASOP only covers situations in which such risks are believed to exist.

The Annual Statement Instructions require disclosure of whether or not there are significant risks and uncertainties that could result in material adverse deviation and the amount of the materiality standard on Exhibit B also, the presenters noted.

Slides and audio are available free to Academy members.

Sold-Out P/C Opinion Seminar Held in Chicago

About 80 actuaries attended the Seminar on Effective P/C Loss Reserve Opinions in Chicago. The two-day seminar provided participants with information about the latest regulations and standards and included reviews of actuarial qualification standards and interactive case studies.

Presenters included Committee on Property and Liability Financial Reporting Chairperson Kathy Odomirok, Lisa Slotznick, Mary Frances Miller, Dawn Fowle, John Gleba, Chuck Emma, and Hyeji Kang.

Academy Presents on Casualty Issues at NAIC

Academy Senior Property and Casualty Fellow Kevin Ryan presented an update on the activities of the Casualty Practice Council (CPC) and the Committee on Property and Liability Financial Reporting to the NAIC’s Casualty Actuarial and Statistical Task Force at the NAIC Fall 2017 National Meeting in Honolulu in December. The update included a report on the CPC’s near-term projects such as a travel insurance monograph and a catastrophe modeling white paper.

In the News

• Insurance Journal published a story relaying key findings from the Flood Insurance Work Group’s 2017 public policy monograph, The National Flood Insurance Program: Challenges and Solutions.
• Several media outlets, including the Weather Network, Insurance ERM, E&E News, Beach News (N.C.), and The Globe and Mail (Canada) reported on the newly released spring 2017 results from the Academy’s jointly sponsored Actuaries Climate Index, which provides a quarterly gauge of changes in extreme weather events and sea levels.
• Lexology and JD Supra cited the Academy’s comment letter to the NAIC’s Statutory Accounting Principles Working Group expressing concerns over proposed changes to SSAP No. 62R: Property and Casualty Reinsurance.
• An editorial in the Journal Gazette (Ind.) cited the cover story, “Autonomous Vehicles—Next Steps in the Hands-Free Revolution,” from the January/February 2018 issue of Contingencies.

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