Chapter 17: Assessment of reserving results Flashcards
The results of the reserving exercise need to be checked to ensure: (2)
- they are reasonable
- they are supported by emerging experience
2 Approaches to analysing the reserving results
- diagnostic checks
- carry out an analysis of the emerging experience
Diagnostic
A diagnostic is a measure used to help interpret data or results.
It can test and verify underlying methodology and assumptions.
5 Considerations when interpreting diagnostics
- Does the diagnostic fall within the expected range?
- One-off movements
- Materiality
- Treatment of large losses
- Underlying reasons for the results
Considerations when interpreting diagnostics:
One-off movements
Changes in diagnostics over time, or unusually high or low figures may result from unexpected emerging experience that is considered to be a one-off.
Considerations when interpreting diagnostics:
Materiality
When an analysis of the diagnostics does highlight unusual features in experience, an actuary may decide not to update his / her methodology or assumptions if the resulting change in reserves is immaterial relative to the size of the company’s total reserves.
Considerations when interpreting diagnostics:
Treatment of large losses
When examining the diagnostics, exceptional items such as large losses should be excluded, although of course it will be important that the end reserve does include an allowance for such items.
What should we do if the diagnostics highlight unusual features? (3)
We should:
- understand the reason for the unusual feature
- understand the implications for the reserving process
- take appropriate action (eg change methodology or assumptions if necessary)
Common diagnostics
- Changes in loss ratios
- Paid to incurred and/or
- case estimates to incurred ratios
- ultimate claims/exposure (similar to LR, but exp is not prem)
- average outstanding case estimate
- ratio of IBNR to case estimates
- survival ratios
- claim frequency and average cost per claim (severity)
- reinsurance to gross ratios
- settled to reported claim numbers
- development patterns (eg. changes, comparison)
- claim development vs premium development
- benchmark comparisons
- residuals of fitted link ratios
Loss ratios may highlight: (4)
- Changes in premium rating strength
- Sources of uncertainty (eg. very large open claim)
- Inconsistencies in the model assumptions (eg if the progression of IBNR loss ratios is not monotonically decreasing with age of the claims cohort).
- Errors in the reserving process
Changes in reinsurance (net) to gross ratios may be as a result of (5)
- changes in the amount of business being retained or ceded by the insurer
- changes in the mix of non-proportional and proportional reinsurance cover
- changing policy terms, such as deductibles, limits and reinstatements
- changes in the underlying gross experience
- inconsistencies in the treatment of gross and net claims estimates.
Where proportional reinsurance is in place, we can review the ratios to ensure this at least allows for the proportional element. For example, if a 30% quota-share is in place, we would expect at least 30% of premium, paid and incurred to be ceded to reinsurers. Splitting reinsurance by type can also be helpful to sense check the recoveries against each type of reinsurance.
5 Development pattern diagnostics
- Changes in the development pattern
- Stability of the development pattern
- Comparison between classes
- Claim development vs premium development
- Comparison to benchmarks
The development pattern can be checked against benchmarks such as (3)
- industry and market sources
- other closely related classes
- similar portfolios the actuary has encountered
An analysis of emerging experience can be broken down into differences due to (3)
- emerging experience being different to that expected out of the previous model
- changes in methodology
- changes in assumptions
Reasons for differences in reserve estimates
- the data used was different
- the methodology used was different
- additional information was available from underwriting and claims handling staff
- there may be genuine differences of opinion.
When comparing results with others, the actuary should be aware of professional issues (3)
- alternative estimate may have been prepared by someone with a financial interest
- be careful that challenges are not just to reduce figures, ie pressure from management
- analysis of reserves using a greater number of portfolios will in general result in a lower overall estimate
Suggest what we can learn from examining:
(i) IBNR divided by premium
(ii) ultimate loss ratios.
(i) IBNR divided by premium can highlight errors or inconsistencies in the reserving process or a change in premium rating strength
For example, we would expect that for any given development period, IBNR divided by premium for employers’ liability business would be higher than for household property business.
(ii) Ultimate loss ratios can indicate where there have been changes in the stringency of claims, quality of underwriting, an improvement or worsening of claims experience or a change to the rating basis.
Connection between premium rate index and loss ratio
Other things being equal, an increasing premium rate index should lead to a lower loss ratio.
What can paid and incurred loss ratios tell us?
By reviewing the paid and incurred loss ratios, we can see at an early stage how the experience to date has turned out for each origin year.
For example, where loss ratios are unexpectedly high, we can then investigate further whether this is due to a unique claim or type of claim, or is an early indicator that claims experience is going to be materially worse than expected.
Triangulations of these ratios can be helpful to spot trends and sense check assumptions (eg initial expected loss ratios) for reasonableness.
Considering IBNR as a percentage of case estimates is useful in those situations where a complete paid or incurred claims development history is not available.
This will be useful for long-tailed classes, or immature portfolios where the earliest development year is yet to be fully run-off.
Paid to incurred and/or case estimates to incurred ratios
This diagnostic can indicate the strength of case estimates. An increasing ratio trend over time, when we are reviewing a triangle of cumulative paid claims divided by cumulative incurred claims, may have a number of possible explanations, such as:
case estimate strength has been reduced
-If the ratio of paid claims to incurred claims has increased, this may indicate that the strength of case estimates has reduced.
-However, if the ratio of case estimates to incurred claims has increased, this may indicate that the strength of case estimates has increased.
-Care needs to be taken that the definition of incurred claims (ie what has been included) has not changed.
an underlying change in business
an acceleration in the claims settlement pattern
a slow-down in the rate at which outstanding claims are established
a distorting large loss settlement.
A general insurer writes public liability insurance and reserves using the basic chain ladder method. On examining the relationship between paid and incurred claims it is found that the ratio is decreasing over time. Suggest what impact this will have on claims development and hence the reserves calculated
Actual claims development is slower than that suggested by the use of the basic chain ladder. If no adjustment is made to the basic chain ladder method, then the reserves calculated will be an underestimate of the amount required. If the reserves are also discounted, then the payments will be assumed to be made earlier than will eventually be the case, and will therefore be affected to a lesser extent by discounting. This will offset to some extent the inaccuracy in the basic chain ladder model. A revised model should take account of both of these factors.
Average outstanding case estimate
A review of this triangle can highlight changes in the strength of case reserves.
Ratio of IBNR to case estimates
For more mature cohorts, this diagnostic is helpful, particularly where IBNR is expected to be mainly in respect of IBNER, rather than ‘pure’ IBNR claims. Such a diagnostic gives a feel for the outstanding claims and the uncertainty relating to them.
Survival ratios
Survival ratios show how long a reserve or IBNR estimate will last (before all outstanding claims are paid) if current paid or incurred claims development continues at a given rate.
We may consider the ratios on a number of different averages (say one year, three years and five years) paid or incurred claims to avoid years of particularly high or low claims activity.
We can compare these survival ratios with other similar portfolios or market benchmarks.
In some cases, these may be used to set the reserves for particularly uncertain classes of business.
For example, a ratio often used to estimate asbestos loss reserve adequacy is the three-year survival ratio, which is the ratio of loss reserves to the three-year paid loss average.
Assuming that average paid losses remain constant, with no additional reserving, the survival ratio indicates how many years the reserves should last.
Claim frequency and average cost per claim diagnostics
These diagnostics are useful where claim count information is available. Changes in frequency and severity may highlight many of the features described above for other diagnostics. They may also identify inflationary trends in claims costs and trends in claim frequency per unit of exposure. Where policies have a maximum claim value, it may be useful to compare average claim size with this value.
A general insurer writes employers’ liability business. On investigation it is found that claim frequency per unit of exposure is increasing. Suggest possible reasons for this.
Reasons include:
change in policy terms and/or conditions
emergence of a new type of claim
increasingly litigious society
weaker initial and/or claims underwriting
Which diagnostics can indicate stability of the claims settlement process
A triangulation of the number of settled claims divided by the number of reported claims can indicate the stability of the claims settlement process.
Similar diagnostics can be considered on the number of nil claims as a percentage of reported claims to identify changes to the definition of a reported claim.
Open nil claims - what can it tell us?
For classes of business where open nil claim counts (that is, number of claims where no payment has yet been made) are recorded, monitoring these may provide an early warning of an anticipated increase in claims costs or problems arising in processing claims.
A general insurer writes domestic household business in the US. The ratio of gross to net of reinsurance claims has been declining over the last 10 years. Suggest the possible actions that may need to be taken.
Lower reinsurance recoveries are being made. The insurer needs to consider whether this is acceptable. A deliberate decision may have been made to self-insure to a greater extent, in which case no action is required.
If this is not the case then the insurer should review the reinsurance programme, both the types and extent of cover, in order to achieve the desired reinsurance recovery as a proportion of gross claims.
You have a run-off triangle of paid claims split by accident year. Suggest possible reasons for:
(i) a row of figures that is unusually high
(ii) a column of figures that is unusually high
(iii) a diagonal of figures that is unusually low.
(i)
This represents unusually heavy claims in a certain accident year. Possible reasons could be heavy flooding or an unusually bad winter resulting in a large number of claims.
(ii) A column represents the payments made a certain number of years after the year of the accident. A high figure may imply that we settle many claims in the early years (property damage claims) and then there is a fall off in payments before liability claims are paid.
(iii) A low diagonal of figures represents a fall-off in payments being made by the insurer in a given calendar year. This could be due to implementation of a new system, loss of staff or a postal strike.
When to consider how recent cohorts develop compared to older cohorts
We should consider how recent cohorts develop compared to older cohorts to identify any changes in the trends over time to ensure the development pattern selected does not use history that clearly develops in a different way to recent history.
We would normally expect origin years to be more developed (where development has a positive tail) as they get older, unless there are particular reasons for this not to be the case. Such reasons may include:
external influences such as inflation, catastrophes or changes in the underlying nature of the risks
internal influences such as changes in underwriting, claim handling and settlement and recording procedures or reinsurance arrangements
changes in the type of business attracted within a class and types of claim emerging
random fluctuations or large claims (or even lack of expected large claims) in a portfolio
if policy limits have been exhausted on some or all of the policies in a portfolio, that would limit the scope for further deterioration of the incurred claims position.
We should seek to understand the reasons for features in the development pattern for each individual origin year and ensure that the underlying assumptions are appropriate in light of this.
Stability of development pattern
Where the development pattern is volatile, we should consider whether the estimates are reliable considering this. Where development patterns are too volatile or unstable, alternative approaches or benchmarks may be necessary.
As the scope for adverse development (that is, an increase in aggregate claims) often exceeds that for favourable development (that is, a reduction in aggregate claims), the distribution of final outcomes will often be positively skewed.
We should consider whether we have allowed for a sufficient tail beyond the claims development experience to date
Give examples of factors that would lead to favourable development and those leading to adverse development.
Favourable development could be a result of faster claims handling or a propensity towards small / simpler claims with shorter reporting and settlement delays.
Adverse development could be a result of a change in experience leading to more complex / large claims with longer reporting and settlement delays. An accumulation of claims due to one event (eg a hurricane) could also cause a slowing down of settlement. If the claims team take longer to deal with claims this will also adversely affect development
Comparison between classes
The speed of development patterns (how quickly claims develop to their ultimate position) will vary by class. Examples of where we would normally expect to see slower development patterns are:
liability classes compared to property damage classes due to delays caused by disease development, determination of liability through courts, etc
reinsurance classes compared to the equivalent direct classes due to the delay in being notified of reinsurance recoveries and settlement of them
classes with policies attaching at higher layers compared to those with policies attaching at lower layers as it tends to take longer for larger claims to develop up to the (higher) attachment point. Larger claims are also likely to be more complex, so it may take longer for the extent of the claim to be fully understood
business written on a risk attaching basis compared with a claims made basis. This is because late reported claims will fall into a subsequent policy year. This was discussed earlier in the course.
We should consider whether the relative speeds of the suggested development patterns for the different classes are appropriate.
Claim development versus premium development
Where there is evidence of a changing premium development pattern, we should consider the reasons for this, and whether this should affect the claim development pattern. In some circumstances, it may also be useful to compare earned premium patterns with incurred claim development patterns as we would always expect to earn premium faster than claims are incurred.
An earned percentage for an underwriting year lower than the incurred percentage developed would be an indication of either the development pattern being too fast or an error in the earned premium percentage.
In theory, the earned premium would be expected to develop to reflect the potential for claims over the period of exposure. In practice however, the earned premium development pattern is often estimated using formulaic techniques and such a comparison may be of limited use.
Comparison to benchmarks
There are a variety of sources of development patterns that could be used as benchmarks. These include:
industry and market sources
other classes of business that are closely related, eg household contents as a proxy for household buildings
similar portfolios within the actuary’s experience.
What is the underwriting cycle?
The underwriting cycle is the process occurring over a period of years when premium rates for a given class of business oscillate between a high level at the top of the cycle (a ‘hard market’) where the business written is typically profitable, and a low level at the bottom of the cycle (a ‘soft market’) where the business written is typically unprofitable.
What impacts the length of the Underwriting cycle?
The length of the underwriting cycle varies by class of business and territory. For example, in some UK personal lines classes, it is around seven years. It will be dependent on, for example: macro-economic effects, eg people pay less for insurance and claim more when economic conditions are poor investment conditions (if it is expected that good returns can be made on invested premiums then the insurer may be prepared to offer softer premium rates) major industry losses, eg natural disasters or terrorism
Impact of Underwriting cycle on reserving
The underwriting cycle can have an influence on claims development. For example, in a hard market, individuals who perceive themselves as low-risk may choose to self-insure rather than pay high premiums, resulting in anti-selection against the insurer.
When assessing the reasonableness of the results of a reserving exercise, we should consider whether we have allowed appropriately for the underwriting cycle.
One way to allow for the underwriting cycle in reserving exercises is to use a rate index when deriving the initial expected loss ratios for use in credibility-type methods.
macro
Suggest what impact the following will have on claims development patterns: (i) looser terms and conditions
(ii) lower deductible.
(i) Looser terms and conditions – leads to claims arising which have different reporting and/or settlement patterns. It may also lead to more protracted claims due to litigation.
(ii) Lower deductible – leads to a shorter claim development pattern.
Correlation between reserving and underwriting cycle
Recent studies have also suggested the existence of a ‘reserving cycle’ which is highly correlated with the underwriting cycle.
This appears to show that in a soft market, incurred claims development patterns are slower to develop (or longer-tailed) than in a hard market so that an unadjusted projection can underestimate ultimate claims in a soft market (and, equivalently, overestimate them in a hard market, when insurers can afford it).
Potential reasons for this phenomenon include:
the effect of weakened terms and conditions an increasing tendency to dispute claims
a possibly less conservative approach to case reserving when results are worse.
The evidence of a reserving cycle is more noticeable for business which is already thought to be long tailed.
The initial expected loss ratio can be chosen to take account of changes in the reserving cycle as well as changes in the underwriting cycle.
Dangers of Anchoring
(i) Anchoring
Anchoring is the tendency to rely too heavily on one piece of information when making a decision affected by a range of factors.
(ii) Anchoring and reserving
There can be a danger of anchoring on past experience when setting future claims estimates even when new trends are beginning to emerge. By not taking enough account of these new trends, the results gradually cease to be reasonable.
Anchoring and its danger
“1. It is a term used in behaviral economics to indicate how humans tend to use a particular number or method or assumption as a intuitive benchmark which influences all future decision making even if unsupported by empirical evdentce
it is the tendency to rely too heavily on one piece of information even though there are a large number of other factors that should ideally be considered in the decision making.
eg. claims inflation, reliance on only a particular method
2. The danger in anchoring when reserving arises from the fact that, the methods and assumptions could be biased such that the reserving numbers end up being close to the anchor. this may prejudice the actuary’s judgement on what is a best estimate and results are not longer reasonable.”
Underwriting cycle
“Underwriting cycle refers to the changes in the insurance business as a result of premium rate changes and changing underwriting standards/conditions due to competitive pressures which results in hard and soft market cycles
The length of the cycle is different for different lines of business.
1. Top of the cycle is a hard market and bottom is soft market
Hard market:
in which premiums are high and
underwriting is stringent
business is profitable
capacity is limited
there are new entrants trying to enter the market and capacity eventually increases
Soft Market:
More capacity
Rates are lower
Underwriting is not stringent
business is not profitable
Some companies exit the market
Capacity eventually reduces once insurers exit causing a cycle to repeat the hard market later on.”
impact of the underwriting cycle on the estimation of reserves
“The reserving exercise should account for the changes introduced by the underwriting cycle appropriately.
Using a rate index helps when deriving initial expected loss ratios in credibility type methods such as the BF method.
However, if such loss ratios are developed on the basis of Accident Year cohorts, the underlying claims will pertain to different U/W periods. Care must be exercise in such cases.
Any change in policy T&C should also be adjusted in the loss ratio
IN a soft market when premiums and profitability is lower, there is a tendency for claims to be longer tailed than usual. This could be because of disputed claims, or contract terms being tightened, etc. Care should be exercised to avoid under reserving.
Also, rate indices are available only for renewal and not new business. This may lead to underreserving as well.”
