December 20, 2006 | |
Mr. Jim B. Rosenberg | |
RE: | The Commerce Group, Inc. |
Dear Mr. Rosenberg: | |
This letter responds to the verbal comments Ms. Dana Hartz provided to me in association with the October 4, 2006 written response to the SEC comments regarding The Commerce Group, Inc.'s ("CGI") Management's Discussion and Analysis. | |
In response to the comments included in the above-referenced submission, please note below the "SEC COMMENT / OUR RESPONSE" format. In addition, we have attached, as Exhibit 1, our prospective disclosure for our critical accounting policy for unpaid losses and loss adjustment expenses. We propose to include this information in future filings with appropriate changes for then-current circumstances. | |
SEC VERBAL COMMENT: | |
The verbal comments dealt with the proposed sensitivity analysis disclosures. Ms. Hartz mentioned that it would appear CGI's key loss reserve assumptions are paid loss factors and that our sensitivity analysis should depict reasonably likely changes in our key assumptions and the impact those changes would have on our results. She asked that we update our sensitivity analyses for both total reserves and CAR-based reserves. | |
OUR RESPONSE: | |
As was discussed, due to the fact that we only utilize historical paid loss information, we are not able to provide information on changes such as severity or frequency, as these factors are implicitly included within the historical paid loss information. As such, we propose to more clearly state that our reserves are established using historical paid loss information and provide sensitivity analyses using only our historical paid information for both total reserves and CAR reserves. | |
We will prospectively refine our sensitivity analysis discussion to read substantially as follows. | |
As we base our estimate of loss and LAE reserves primarily on historical payment experience, the following sensitivity analysis assumes that our historical payment experience was impacted by the stated percentages. The factors which could cause the payment experience to change are not analyzed individually as these factors are imbedded in the historical information. Based upon historical results over the last five years, we show a redundancy for all five years, with a minimum redundancy of 7.3% and a maximum redundancy of 9.4% from the initially established reserves. See page 22 for an analysis of our historical loss and LAE reserve development. | |
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December 20, 2006 | ||||||
The following sensitivity analysis presents the pro forma effect of a 7.3 and 9.4 percentage point redundancy change in our loss and LAE reserves (prior to the effect of ceded reinsurance recoverable) at December 31, 2005: | ||||||
Hypothetical Change in Loss | Loss and LAE | Pro forma | Pro forma Percentage | |||
No change | 834,699 | - | - | |||
7.3% decrease | 773,766 | 39,606 | 3.0% | |||
10% decrease | 756,237 | 51,000 | 3.9% | |||
(1) | Net of income taxes at an assumed rate of 35%. |
The hypothetical changes noted above are based on historical experience. Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on the preceding table. |
We believe that any additional payments due as a result of the inherent uncertainty of establishing loss and LAE reserves as noted in the sensitivity analysis above would be adequately met by our normal operating cash flow. |
The business we assume from CAR is a significant component of our loss and LAE reserves. Our assumed CAR loss and LAE reserves amounted to approximately 16% of our loss and LAE reserves at December 31, 2005 (prior to the effect of ceded reinsurance recoverable). CAR provides information to pool participants on a quarterly basis. CAR provides consolidated results, which consists of all companies' ceded business into the pool, as well as information specific to our company. CAR provides information by line of business on policy year and accident year bases. This information consists of premiums written, unearned premium, earned premium, paid losses, case reserves, IBNR reserves, incurred losses, incurred loss adjustment expenses and underwriting expenses. The starting point for CAR's determination of its loss and LAE reserves is the separate loss and LAE reserves that CAR member companies provide to CAR. CAR then aggregates this information, which is reviewed by CAR's loss reserve committee, comprised of actuaries from member companies. This CAR actuarial committee establishes the total loss and LAE reserves for a given period. Our share of these loss and LAE reserves is derived by multiplying our participation ratio by the total CAR loss and LAE reserves. Management utilizes the information provided by CAR to book the initial amount related to the pool. The consolidated financial results produced by CAR are audited by independent public accountants and we rely on this audit for the incorporation of their reported results into our financial statements. CAR assesses the integrity of premium and claim data submissions by member companies by periodically auditing those member companies. Our actuary also reviews the CAR actuarial committee's work along with total CAR and company loss results for reasonableness. |
The quarterly reports that CAR provides to us are one quarter in arrears when we calculate this component of our financial statement loss and LAE reserves, and therefore, it is necessary for us to make an estimate of the most recent quarter results for CAR. In calculating this estimate we compare the CAR loss and LAE reserve data with historical premium written and earned amounts from CAR. We then utilize the estimated written and earned premiums from CAR for the most recent quarter to calculate losses, LAE and underwriting expenses that would relate to that quarter, and then incorporate that information into our financial results. |
CAR results are less predictable and therefore more susceptible to change than our loss reserves because they are comprised of individual ceded business from all CAR member companies, as adjusted in the aggregate by the CAR actuarial committee, which may or may not use similar reserving methodologies and ceding philosophies as we use. |
Based on the historical data of the five most recent accident years, CAR had redundancies and deficiencies within its accident years. The deficiencies had a low of 2.5% and a high of 3.7% of the initial reserve, while the redundancies had a low of 2.5% and a high of 16.7% of the initial reserve. These are the percentages utilized in our sensitivity analysis for loss and LAE reserves related to CAR at December 31, 2005: |
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December 20, 2006 | ||||||
Hypothetical Change in Loss | Loss and LAE | Pro forma | Pro forma Percentage | |||
3.7% increase | $135,874 | $(3,151) | (0.2)% | |||
2.5% increase | 134,302 | (2,129) | (0.2)% | |||
No change | 131,026 | - | - | |||
2.5% decrease | 127,750 | 2,129 | 0.2% | |||
16.7% decrease | 109,145 | 14,223 | 1.1% | |||
(1) | Net of income taxes at an assumed rate of 35%. |
The hypothetical changes noted above are based on historical experience. Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on the preceding table. | |||
Although we appreciate the opportunity to respond to the Staff's verbal comments, the prospective changes, which we have outlined in this letter, to the critical accounting policies section of our MD&A shall not constitute an admission that such section of our Form 10-K for the fiscal year ended December 31, 2005 or any prior year does not comply in all material respects with the requirements of Form 10-K and related guidance promulgated by the Commission. | |||
In addition, as requested, we acknowledge that: | |||
* | the company is responsible for the adequacy and accuracy of the disclosure in the filing; | ||
* | staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and | ||
* | the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. | ||
Should you have any additional questions or wish to discuss any of the responses detailed above, please do not hesitate to contact me at 508.949.4129. | |||
Sincerely, | |||
/s/ Randall V. Becker | |||
Randall V. Becker | |||
RVB:nc | |||
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Exhibit 1 |
Critical Accounting Policies - Prospective Disclosure |
Unpaid Losses and Loss Adjustment Expenses.The liability for loss and loss adjustment expenses represents our best estimate of the ultimate net cost of all loss and loss adjustment expenses incurred after reinsurance and amounts estimated to be recoverable through salvage and subrogation.The estimate for the ultimate net cost of all losses incurred through the balance sheet date includes the adjusted case estimates for losses, incurred but not reported (IBNR) losses, salvage and subrogation recoverable and a reserve for LAE.In arriving at our best estimate, we begin with the aggregate of individual case reserves and then make adjustments to these amounts on a line of business basis.These adjustments to the aggregate case reserves by line of business are made based on analyses performed by us.The entire liability for unpaid losses and LAE is also s eparately reviewed quarterly and annually by our actuarial department.Liability estimates are continually analyzed and updated, and therefore, the ultimate liability may be more or less than the current estimate.The effects of changes in the estimates are included in the results of operations in the period in which the estimates are revised. |
The claim cycle begins when a claim is reported to us and claims personnel establish a"case reserve" for the estimated amount of our exposure without regard to injury causality, third party liability or potential recoveries.The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding the claim and the policy provisions relating to the loss.This estimate reflects the informed judgment of such personnel based on the experience and knowledge of the claims personnel adjusting the claim.During the loss adjustment period, these case basis estimates are revised as deemed necessary by our claims department personnel based on subsequent developments and periodic reviews of the claim. |
In accordance with industry practice, we also maintain reserves for estimated IBNR, salvage and subrogation recoverable and LAE.These reserves are determined based on historical information.Imbedded within the historical information are changes in the volume of policies written, claims frequency, severity and payment patterns, the mix of business and claims processing.IBNR reserves are established for claims that have been incurred prior to year end but have not been reported to us until after year end.Our IBNR reserve is derived by analyzing the amount of losses that have been incurred subsequent to a given calendar year end.We aggregate losses incurred for each of the three years after a given calendar year end and determine the percentage of losses to earned premium for that calendar year.We calculate the IBNR reserve by multiplyi ng the appropriate historical percentage of losses by the earned premium for the current year and each of the prior two calendar years.Our calculations are based on historical losses incurred by line of business and coverage type and are modified where appropriate for changes in premium rates. We monitor the percentages for historical patterns and adjust our IBNR reserves as appropriate. |
Salvage and subrogation reserves are established in a similar manner to IBNR except that we track actual historical salvage and subrogation receipts as a percentage of loss incurred.In addition, we establish LAE reserves by tracking historical expenses as a percentage of incurred losses. |
Our financial management personnel calculate our financial statement loss and LAE reserves independently from those amounts calculated by our actuaries.Our financial management personnel estimate our financial statement loss and LAE reserves primarily by reviewing historical loss and LAE data, focusing mainly on payment data.This method of using historical loss payments over discrete periods of time to estimate future losses assumes that the ratio of losses paid in one period to losses paid in an earlier period will remain consistent.This method necessarily assumes that factors that have affected paid losses in the past, such as inflation or the effects of litigation, will remain consistent in the future.Although we review trends for inflation, severity and the effects of litigation, these factors have not caused us to materially modify our loss and LAE reserves. Historical paid loss development methods do not use case reserves to estimate ultimate losses and can be more reliable than the other methods that look to case reserves (such as actuarial methods that use incurred losses) in situations where there are significant changes in how case reserves are established by a company's claims adjusters.However, historical paid loss development methods are more leveraged (meaning that small changes in payments have a larger impact on estimates of ultimate losses) than actuarial methods that use incurred losses because cumulative loss payments take much longer to equal the expected ultimate losses than cumulative incurred amounts.In addition, and for similar reasons, historical paid loss development methods are often slow to react to situations when new or different factors arise than those that have affected paid losses in the past.Because of the nature of our business and the consistent manner in clai ms settlement, we believe the use of historical payment patterns provides us the most appropriate method for establishing our reserve. |
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We also review and compare the most recent loss frequency, severity, and payment data to historical trends in an attempt to determine if patterns are remaining consistent or not.We believe they remain consistent.We record our best estimate of the ultimate losses and LAE that we will incur to settle all claims and IBNR at each reporting date, but the actual amount of such losses and LAE cannot be known until all claims are settled. Our financial statement loss and LAE reserves net of reinsurance (prior to the effect of ceded insurance recoverable), based on our best estimate, were established at $834,699 for December 31, 2005. | ||||||
This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.There is no reasonably precise method, however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves is affected by many factors, as noted above. | ||||||
We utilize an actuarial calculation as a test of reasonableness of our financial statement loss and LAE reserves which were calculated by financial management. Our actuaries calculate their estimate of our liability for loss and LAE reserves using generally accepted actuarial reserving techniques. The reserving techniques employed by our actuaries include incurred loss development and paid loss development for all reviewed lines. For voluntary personal automobile liability, two additional methods were used - claim count times average severity and exposures times ultimate pure premium. In estimating allocated LAE ("ALAE") reserves, we used two methods - paid ALAE development and ratio of paid ALAE to paid loss development. For unallocated LAE ("ULAE") reserve, three methods were used - paid ULAE development, paid ULAE to paid loss ratio development and calendar year paid ULAE to paid loss and ALAE. An average of these methods is calculated, which is called the indicated ultimate loss. The indicated loss is then subjected to actuarial judgment which considers other factors, such as the resulting ultimate loss ratio, loss trends, changes to business and the relative value of each of the different methods. A selected ultimate loss amount is then determined. Using the criteria of Actuarial Standard of Practice No. 36, a reserve range is then calculated that the actuary judges to be reasonable based upon appropriate actuarial methods and judgment. The actuarial methods utilized are considered standard for property and casualty companies with losses settling over a relatively short period of time, usually within 0 to 3 years (short-tail liability losses). The same basic assumptions and methods were used at both December 31, 2005 and 2004. Our aggregate actuarial estimate for the loss and LAE reserves, on a consolidated basis and net of reinsurance recoverable, ranges from a low of $764,60 0 to a high of $877,900, as of December 31, 2005. | ||||||
After taking into account all relevant factors, we believe that, based on existing information, the provision for losses and LAE at December 31, 2005 is adequate to cover the ultimate net cost of losses and claims incurred as of that date.However, loss reserves are estimates and are inherently uncertain; they do not and cannot represent an exact measure of the liability. The ultimate liability may be greater or lower than established reserves.If the ultimate payment is greater than or less than our estimated liability for losses and LAE, we will incur additional expense or income, as appropriate, which may have a material impact on our results of operations.As our business primarily involves losses with a short-tailed liability, our loss and LAE reserves have more predictable development patterns than other property and casualty insurers whose business involves losses with a longer-tailed loss p ayment pattern. | ||||||
As we base our estimate of loss and LAE reserves primarily on historical payment experience, the following sensitivity analysis assumes that our historical payment experience was impacted by the stated percentages. The factors which could cause the payment experience to change are not analyzed individually as these factors are imbedded in the historical information.Based upon historical results over the last five years, we show a redundancy for all five years, with a minimum redundancy of 7.3% and a maximum redundancy of 9.4% from the initially established reserves.See page 22 for an analysis of our historical loss and LAE reserve development. | ||||||
The following sensitivity analysis presents the pro forma effect of a 7.3 and 9.4 percentage point redundancy change in our loss and LAE reserves (prior to the effect of ceded reinsurance recoverable) at December 31, 2005: | ||||||
Hypothetical Change in Loss | Loss and LAE | Pro forma | Pro forma Percentage | |||
No change | 834,699 | - | - | |||
7.3% decrease | 773,766 | 39,606 | 3.0% | |||
10% decrease | 756,237 | 51,000 | 3.9% | |||
(1) | Net of income taxes at an assumed rate of 35%. |
The hypothetical changes noted above are based on historical experience.Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future.Accordingly, it is not appropriate to extrapolate future development based on the preceding table. |
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We believe that any additional payments due as a result of the inherent uncertainty of establishing loss and LAE reserves as noted in the sensitivity analysis above would be adequately met by our normal operating cash flow. | ||||||
The business we assume from CAR is a significant component of our loss and LAE reserves.Our assumed CAR loss and LAE reserves amounted to approximately 16% of our loss and LAE reserves at December 31, 2005 (prior to the effect of ceded reinsurance recoverable). CAR provides information to pool participants on a quarterly basis.CAR provides consolidated results, which consist of all companies' ceded business into the pool, as well as information specific to our company.CAR provides information by line of business onpolicy year and accident year bases.This information consists of premiums written, unearned premium, earned premium, paid losses, case reserves, IBNR reserves, incurred losses, incurred loss adjustment expenses and underwriting expenses.The starting point for CAR's determination of it s loss and LAE reserves is the separate loss and LAE reserves that CAR member companies provide to CAR.CAR then aggregates this information, which is reviewed by CAR's loss reserve committee, comprised of actuaries from member companies.This CAR actuarial committee establishes the total loss and LAE reserves for a given period.Our share of these loss and LAE reserves is derived by multiplying our participation ratio by the total CAR loss and LAE reserves.Management utilizes the information provided by CAR to book the initial amount related to the pool.The consolidated financial results produced by CAR are audited by independent public accountants and we rely on this audit for the incorporation of their reported results into our financial statements.CAR assesses the integrity of premium and claim data submissions by member companies by periodically auditing those me mber companies.Our actuary also reviews the CAR actuarial committee's work along with total CAR and company loss results for reasonableness. | ||||||
The quarterly reports that CAR provides to us are one quarter in arrears when we calculate this component of our financial statement loss and LAE reserves, and therefore, it is necessary for us to make an estimate of the most recent quarter results for CAR. In calculating this estimate we compare the CAR loss and LAE reserve data with historical premium written and earned amounts from CAR.We then utilize the estimated written and earned premiums from CAR for the most recent quarter to calculate losses, LAE and underwriting expenses that would relate to that quarter, and then incorporate that information into our financial results. | ||||||
CAR results are less predictable and therefore more susceptible to change than our loss reserves because they are comprised of individual ceded business from all CAR member companies which may or may not use similar reserving methodologies and ceding philosophies as we use. | ||||||
Based on the historical data of the five most recent accident years, CAR had redundancies and deficiencies within its accident years.The deficiencies had a low of 2.5% and a high of 3.7% of the initial reserve, while the redundancies had a low of 2.5% and a high of 16.7% of the initial reserve.These are the percentages utilized in our sensitivity analysis for loss and LAE reserves related to CAR at December 31, 2005: | ||||||
Hypothetical Change in Loss | Loss and LAE | Pro forma | Pro forma Percentage | |||
3.7% increase | $135,874 | $(3,151) | (0.2)% | |||
2.5% increase | 134,302 | (2,129) | (0.2)% | |||
No change | 131,026 | - | - | |||
2.5% decrease | 127,750 | 2,129 | 0.2% | |||
16.7% decrease | 109,145 | 14,223 | 1.1% | |||
(1) | Net of income taxes at an assumed rate of 35%. |
The hypothetical changes noted above are based on historical experience.Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future.Accordingly, it is not appropriate to extrapolate future development based on the preceding table. |
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