Contingencies Online - November/December 2010

extended reporting for death, disability,
and retirement Liabilities

MOST PROFESSiOnaL LiaBiLiTy POLiCiES include a provision promising the insured individual an extended reporting endorsement (i.e., a tail policy), at no additional charge or at a reduced cost, in the event of his or her death, disability, or retirement (DDR). insurance companies currently are required to establish a liability reserve to reflect the future financial obligation of this benefit.

Vague accounting guidance and the benefit’s complexity have created considerable confusion, much of it stemming from a misunderstanding of what the reserve represents. The DDR reserve accounts for the cost to the insurance company to issue tail coverage in the future at a reduced price or at no additional charge to the insured. It doesn’t include any provision for tail policies, including DDR tail policies, already issued.

Accounting for this benefit can be contrasted against future tails expected to be sold by the insurance company. There’s no carried liability for future purchased tails because the liability isn’t established until the premium is paid and the policy is issued. The promise to provide free tails in the future under DDR provisions, by contrast, does constitute a current obligation for the company.

provide DDR tails at no additional charge, I will focus on this scenario. Establishing a reserve for reduced-cost DDR tails is no different in principle. I use the common term “free tail,” although it should be noted that the DDR tails aren’t free, but prepaid over time. There’s an incremental charge in professional liability coverage rates to fund this benefit. However, this nomenclature helps distinguish between purchased tails and “free” DDR tails.

establishing the ddr Liability

Statement of Statutory Accounting Prin-
ciples (SSAP) Issue Paper No. 65 of the
National Association of Insurance Com-
missioners’ (NAIC) Accounting Practices
and Procedures Manual provides some
guidance in establishing the DDR liabil-
ity. It states, “The amount of the policy
reserve, when combined with premium
appropriate for an ongoing book of busi-
ness, including some charge for extended
reporting endorsement coverage, should
be adequate to pay for all future claims
arising from these coverage features.”
It goes on to list a number of factors
that should be considered in estimating
the reserve, including loss trends, time
value of money, nonrenewal rates, age
and tenure requirements in the con-
tracts, age and tenure demographics of
the insured population, mortality con-
siderations, morbidity considerations,
and pricing differentials (if any) related
to the insured.

The guidance has been interpreted to mean the following:

1. Project the timing under which the current in-force policies can be expected to lapse coverage. Each insured will eventually die, become disabled, retire, or lapse coverage for other reasons (for example, switching to a different carrier, changing careers, or being involuntarily canceled or not renewed);