Custom-built Model Drives Better Reserving for Liability Claims

When Herc Rentals spun off from The Hertz Corporation in July 2016, many aspects of the organization’s finance and treasury function had to be rebuilt from scratch. “None of the treasury staff or management team transitioned to Herc,” explains Mustally Hussain, vice president and treasurer of Herc Rentals.

The new business was sizable, with US$1.6 billion in annual revenue and around 4,800 employees, but it was much smaller than its former parent. Managers soon found that many processes which had worked well for the former parent were no longer meeting the needs of the newly independent company. In risk management, this disconnect was particularly noticeable.

“When we first spun off, everything we did was the exact same process that Hertz used,” says Toni Boswell, senior director of risk and insurance for Herc Rentals. “But because the company was so dramatically different in size, not everything that we mirrored worked for us. One example was our accruals for casualty insurance. This is among our largest risks, and we were concerned that our internal reserves did not accurately reflect our true liability.”

Before the spinoff, Herc Rentals had managed general liability and auto claims through an internal administrator; essentially, casualty claims were self-administered. With the spin, Herc Rentals hired a new third-party administrator (TPA) because it didn’t have the same volume of claims that its former parent had, nor did it have the actuarial expertise on staff to continue to self-administer.

“What we were doing was not accurately reflecting how much we should set aside for our insurance accrual,” Boswell says. “A third-party actuarial analysis showed how dramatic the difference was.” Herc Rentals was concerned that continuing to use the old process might create inaccuracies in the accounting for these liabilities, which would lead to inaccuracies in how they were reflected in the general ledger (G/L). “As a brand-new company, we needed to make sure we had a tight rein on liabilities,” Boswell adds.

The risk management group launched an initiative to enable internal staff to regularly re-calculate the company’s casualty liabilities and set reserves for claims for 30 to 60 days at a time. The process needed to be acceptable to internal audit—which, Boswell reports, was something of a tall order, since no one on staff was certified as an actuary.

The project team worked with the company’s new TPA to determine best practices. They hired an external actuary to create loss development factors based on Herc Rentals’ loss history, claims history, and reserving practices. Then they engaged the actuary to create a model, based on those loss development factors, that internal risk analysts could use on a monthly basis to determine the company’s unpaid loss.

“The goal was to understand the reserves we needed to provide funding for our workers comp, general liability, and auto liability claims,” Boswell says. “Some companies take an old reserve from an actuary, subtract paid losses, and consider that amount to be their new liability. But it’s not accurate because it doesn’t take into account closures, new claims or large losses that may come in, or any reserving changes that may happen. We needed a model that reflected all those things, but that was simple enough for internal audit to be comfortable with it.”

A Microsoft Excel-based model resulted from this process. Now, once a month, a Herc Rentals risk analyst enters data on the volume of claims coming in, how quickly they’re being closed, and how they’ve been paid. The model calculates unpaid losses, as well as short- and long-term liabilities. The risk management team disseminates this information to the organization by the fifth business day of each month.

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An external actuary still performs a full analysis twice a year. As part of these third-party analyses, the actuary tests the monthly monitoring model using the company’s actual claims data from the prior six months, then updates the model. Herc Rentals has established a variance tolerance between the corporate G/L and the calculated monthly loss reserve contained in the monitoring model. If the risk management team feel an adjustment is necessary, they will reach out to the external actuary for an opinion, then adjust the reserve accordingly.

This process has been quite effective. “From an indication standpoint, it tells us where our losses are going and where they’re trending,” Boswell says. “General liability and auto liability are tough lines because they can be very volatile; they’re not predictable and can be severe. But this model gives us a good feel for the book of claims. When we run the model each month, we have a discussion with the entire accounting team, as well as our treasurer and CFO, about the outputs and what is driving those results. Everyone just has a better understanding of the types of claims we’re having and how that affects the number we’re going to adjust to.”

Boswell estimates that this initiative has returned about $1.7 million to the business. “We’re also better able to determine the right levels of insurance for our business,” she says. One more benefit of this process is that Herc Rentals is now more self-reliant. “In my prior experience, I’ve seen organizations typically rely 100 percent on the actuary,” Boswell says. Instead, the internal risk management team can now monitor losses and claims on a monthly basis, for a fraction of the cost of a full actuarial analysis. “The model gives us the same ability to react to any type of shock losses if we need to, right away, without having to get external advice,” Boswell adds.

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