Chapter 13: Reasons for estimating reserves and different reserving bases

Question 1

9 Reasons for assessing a general insurer’s liabilities

Answer 1

To determine liabilities:
— for demonstrating supervisory solvency
— for internal management accounts
— for published accounts

• to provide information to management on business performance by area
• to estimate claims costs for premium rating
• to value an insurer for sale or purchase
• to negotiate a commutation for the buyer or seller
• to transfer a book of business
• to ascertain tax liabilities
• to check reasonableness/adequacy of reserves
• to test the adequacy of case estimates

Question 2

Define ‘reserving basis’

Answer 2

the methodology and assumptions chosen in a reserving exercise.

Question 3

Considerations when setting reserving bases for:
Published accounts (4)

Answer 3

The legislation and accounting principles governing the preparation of those accounts in the territory concerned:

• Whether the accounts are to be prepared on a GOING concern basis?
• Whether the accounts are required to show a TRUE and fair view.
• Whether reserves are required to be assessed as BEST estimates or on some other basis.
• Whether reserves are required to be DISCOUNTED, and if explicit risk margins need to be held.

Question 4

Considerations when setting reserving bases for:
Tax purposes

Answer 4

Depends on the tax regulations in the relevant country.

Tax authorities may penalise an insurer when it is found to have over-reserved and therefore paid less tax.

Question 5

Considerations when setting reserving bases for:
Management accounts

Answer 5

The aim is likely to produce expected values of the future experience, based on realistic assumptions.

Management may also wish to have figures produced on alternative bases or scenarios.

Question 6

Considerations when setting reserving bases for:
Sale or purchase

Answer 6

A starting point for negotiations is the liabilities shown on the balance sheet.

A purchases will want a more prudent view compared to the vendor.

Question 7

Considerations when setting reserving bases for:
Commutation

Answer 7

Similar to sale and purchase, but also consider:
- the effect on reinsurance recoverability
- the relative strategic / commercial importance of the commutation between the two parties
- the actual / perceived financial strength of parties

Question 8

Commutation

Answer 8

The finalisation of an outstanding liability by payment of an agreed amount.

Question 9

Reserving methodologies are likely to vary according to (7)

Answer 9

• the PURPOSE of the reserving exercise.
• CLASS OF BUSINESS, in particular the timing of the run-off of the liabilities
• the TYPES OF CLAIM that have been incurred or may be expected to occur
• the key factors that determine the development of claims
• the extend and quality of the available DATA
• the AGE of the business
• HISTORICAL trends and patterns

Question 10

What extra information can be gained from modelling IBNER and pure IBNR separately?

Answer 10

We can determine whether a change in our required outstanding claims reserve is due to an increase in the number of claims reported, or due to prudence / optimism in our original case estimate assumptions.

Question 11

State how an actuarial report could communicate uncertainty (4)

Answer 11

• giving a RANGE, measure of the value at risk or other statistical calculation
• showing the NUMERICAL consequences of changes in assumptions
• presenting the outcomes of SCENARIOS, possibly including extreme scenarios
• DESCRIBING the uncertainty and explaining why it has not been quantified.

Question 12

Considerations regarding DISCOUNTING when reserving

Answer 12

Discounting makes allowance for investment income.

By deciding whether to discount reserves, we should consider whether discounting is allowed by regulation.

If allowed, regulation might specify a discount rate.

Question 13

If not specified, then the discount rate needs to be determined based on (3)

Answer 13

• currency of liabilities
• nature of liabilities and assets
• risk-free yield curve at the valuation date.

Question 14

14 main items or topics to be included in the scope of an aggregate report on the technical provisions of an insurance entity

Answer 14

• PURPOSE of the report and to whom it is addressed
• a statement of whether the results are the outcome of a planning exercise, a valuation exercise, or some other exercise
• a statement of which TAS the report complies with
• an indication of any material EVENTS that HAPPENED since the effective date of the data
• a description of the DATA used and the source of the data
• a description of any material uncertainty over the ACCURACY of the data and how this has been allowed for
• a summary of the ASSUMPTIONS used and the rationales behind these
• a description of any other material MATTERS relating to the work
• the nature and extent of any material UNCERTAINTY in the work / results
• the METHODS and measures used in any calculations
• the nature and timing of any CASHFLOWS being calculated
• a description of any PROBABILITIES
• a comparison with PREVIOUS WORK
• a PROJECTION OF RESULTS at future points in time

Question 15

When communicating the uncertainty of the results, an actuary should: (7)

Answer 15

• explain what has been allowed for the best estimate, and what has not
• ensure stakeholders understand the level of uncertainty
• comment on the uncertainty in the context of the scope and purpose
• emphasise the bigger issues
• emphasise the unusual issues
• avoid MISUNDERSTANDINGS
• be consistent with VOCABULARY used by other professionals, and explain terms