Construction Defects

Casualty Loss Reserve Seminar

September 24, 2002

Panelist:

Carolyn Yau, ACAS

2

Overview

Background Actuarial Issues Methodologies Current Issues

3

Background

Montrose Decision Continuous trigger theory applied to pollution case

Stonewall Insurance Company vs. City of Palos Verdes Estates Carriers respond to claims on prorata basis

Frequency rises Severity falls

Insureds coverage is generally maximized Reinsurers less exposed Indemnity apportioned based on time on risk Expense apportioned based on number of carriers

4

Example: $3 Million Claim

Pre Montrose

0

500000

1000000

1500000

2000000

2500000

3000000

19

90

19

91

19

92

19

93

19

94

Primary Coverage Reinsurance Coverage

Post Montrose

0

500000

1000000

1500000

2000000

2500000

3000000

1990

1991

1992

1993

1994

Primary Coverage Reinsurance Coverage

5

Actuarial Issues

Uncertain determination of accident date Varies by company and frequently within a company

Uncertain determination of future development pattern

Appears to be lengthening Influx of claim activity along recent accident year diagonals

Uncertain determination of tail factor selection One assumption to use is no more development after 13 years for

California Not sure if it will hold

6

Methodology: Obtain Program Knowledge

What is exposure mix (general contractor, designer/builders, subcontractors)

Is exposure residential or commercial construction Which states have construction defect exposure Is exposure information available What is the definition of a construction defect claim How is accident date determined What reinsurance agreements are in place

7

Methodology: Data Organization

California vs. Non California (or other specific states)

General Contractors vs. Subcontractors Accident year vs. report year data Separate ALAE

8

Methodology: Analysis

Accident Year Methods Report Year Methods Exposure Based Methods

9

Methodology: Accident Year Analysis

Traditional Loss Development Method is not appropriate

Montrose Adjustment Method Aids in selection of development factors and tail selection

Transactional Count / Incremental Paid Loss Method

Count times Severity Approach Key is estimating the ultimate reported counts

10

Methodology: Report Year Analysis

Estimate Development on Known Claims and Pure IBNR separately

Pure IBNR Count times Severity Approach Estimate reporting pattern of the remaining

claimsFitted DistributionEmpirical Distribution

11

Methodology: Exposure Analysis

Ideal method if data is available Develop list of policy holders

Compare policy holders with list of claimants to determine remaining exposure

Determine future reported claims by extrapolation or market share analysis

Earned GL premium for contractors is also useful

12

Issues in Construction DefectsOne Year Ago

Frequencies 1994 – 1999 rising 2000 flat

Severities 1994 – 1999 stable 2000 flat to declining

ALAE to loss ratios Rising over time Recommend monitoring separately from loss as still evolving

13

Issues in Construction DefectsToday

Mold Claims (Texas) Schools and public buildings Statute of limitations is shorter

Additional Insured ALAE (Southern California) Presley Homes, Inc. v. American States Insurance Company (2001) As general contractors reach their polity limits or go bankrupt, they

are looking for coverage under the subcontractor policies where they are listed as an “additional insured”

Sharing of defense costs among insurers

14

Issues in Construction Defects

Other States Areas of rapid increase in population

Baby boomers retiring – NV, FL, TX, AZ, CO Seen increase in activity but legal landscape is different Statute of limitations shorter Minimal use of continuous trigger theory Claim frequency is rising