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Introduction

Once you have finished ratemaking, you will know how the Insurance product is priced by looking at the past year losses. But now we are waiting for insureds with their claims. Unfortunately, we don't know when they will get into accidents (God Forbid!) and when they will file their claims. Thus, what we need to do is to set up a system by which we have a good estimate about how much to keep aside for paying off the claims.

Wait a minute. If we had collected premiums from them, then we definitely have enough rates to pay them off. Why then do we need to estimate how much to keep aside from them. And if so, what are we doing with the money not kept aside?

Investments!

If you remember, we mentioned that the profit margins are not the only way the insurer gets to earn profit.

Goals of Reserving

Why is it important to accurately estimate unpaid claims?

  • Internal management
    • Make business decisions in Underwriting (UW) and pricing.
    • Inaccurately high estimates can lead to raising rates, tightening UW guidelines.
  • Investors
    • Profitability of insurer affects returns paid to investors.
    • Inaccurately high estimates lower the insurer's profits, making it a worse investment to potential investors.
  • Regulators
    • Monitor insurer solvency.
    • Inaccurately high estimates cause low profit, leading to intervention and restriction of the insurer's ability to write new business.

Responsibility Appointed Actuary (AA)

  • In the U.S., Property & Casualty (P&C) insurers must obtain a Statement of Actuarial Opinion signed by an AA.
    • It's a financial reporting requirement. AA also required in other countries: Canada, Australia, Slovenia.

Terminology

  • Accounting Date
    • Group of claims being analyzed. Paid/unpaid split. e.g., Unpaid amount as of 12/31/2013.
  • Valuation Date (<=> Accounting Date)
    • Transactions included in the analysis. e.g., Data through 3/31/2014 to estimate unpaid claims as of 12/31/2013.
  • Review Date (> Valuation Date)
    • Material information known to the actuary is included in the analysis.
  • Development
    • Changes in values between Valuation Dates for a given Accounting Date.
  • Estimated claims reserve
    • Estimated unpaid claims.
  • Carried claims reserve (aka Booked Reserves)
    • The reserve value that actually appears on the insurer's financial statements.

Components of Unpaid Claims

Ultimate claims = Paid claims + Unpaid claims.

  • 1 Case Reserves
  • 2 Provision for development on known claims
  • 3 Reopened claims reserve
  • 4 "Pure" IBNR
  • 5 Provision for claims in transit
    • Incurred and reported but not recorded.
  • IBNR = #4 + #5
  • IBNER = #2 + #3
    • Some insurers consider #3 as new claims, in which case it becomes part of "pure" IBNR.
  • Broad Def of IBNR = #2 + #3 + #4 + #5
  • Ultimate claims = Paid + Case Reserves + IBNR (Broad definition of IBNR).
  • Ultimate claims = Paid + Case Reserves + IBNR Reserve + IBNER Reserve.

ASOP 43

About the ==estimation==.

  • Consider the intended use of the multiple purposes.
    • Check if they have conflicting outcomes.
  • Limited Data & Resources constraints should be documented and communicated.
  • Regarding an ==estimate==, considerations:
    • Identify the intended measure.
      • "High estimate" or "Mean estimate"... ==NOT "Best" or "Actuarial" estimate==.
    • Note if any amounts are discounted for TVM.
    • For specified recoverables.
      • Is the estimate gross or net?
      • Extent of collectability when estimates are affected.
    • Types of Loss Adjustment Expense (LAE) included in estimate.
    • What claims does this estimate cover?
    • Are there any other items needed to describe the scope sufficiently? #doubt
    • Discard any immaterial items (out of scope).
      • But, document those items.
    • Be familiar with the nature of the claims being estimated. Be familiar with the Line of Business (LOB).
      • Don't mechanically apply a method on the data without understanding what exactly is happening.
      • Coverage conditions impacting Frequency & Severity.
      • Claim Adjustment Process.
      • Potential Recoverables.
  • While performing ==analysis==, considerations:
    • Appropriate method and model for producing estimates.
    • Different methods for different components of the analysis.
    • Should you rely upon a single method?
    • What methods were used in prior analysis?
    • Sensitivity analysis: Reasonable alternate assumptions.
    • If there are interactions between different sources of recoverables.
    • Should estimates be net/gross/both of recoverables?
    • Impact of external (economic/regulatory) conditions?
      • A law change that is being debated, and if it's passed, it affects the insurer's rates.
    • Any operational changes?
      • That might impact the estimate.
    • Uncertainty associated with the analysis and estimate.
      • Point vs Interval estimates. Are we in the ballpark?
  • Reasonability check of estimates.
    • Sanity check.
  • Presentation of the estimate, depends on intended purpose.
    • (e.g., point vs range).
  • Document and communicate.
    • Intended purpose.
    • Scope.
    • Significant limitations.
    • Important dates.
    • Significant risks/uncertainties.
    • Significant events.
    • Assumptions.

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