Chapter 8 - Claims Reserving

Question 1

Give 7 reasons why there is uncertainty in setting an appropriate reserve for claims

Answer 1

1. Legislation changes having a retrospective impact on existing claims
2. Future claims payment patterns differing from historical experience
3. Claims such as stress and disease emerging from risks written many years ago
4. Cases of latent exposures such as asbestos (e.g up to 40 years)
5. Outcome of litigation on existing claims
6. Failure to recover reinsurance
7. Unanticipated changes in claims inflation

Question 2

The claims reserving process is to?

Answer 2

Ensure an appropriate provision is set for the eventual cost of claims arising on policies written

Question 3

An accurate view on the required level of claims provision is needed to measure…

Answer 3

Financial performance

Question 4

Changes in the amount to set aside has a direct impact on…

Answer 4

Underwriting profitability

Question 5

Explain the fundamental accounting concept which is the accruals concept

Answer 5

Transactions are recognised when they occur

Question 6

When considering which claims should be accounted for in an accounting period, there is a requirement to…

Answer 6

Estimate all claims arising from incidents in the year, whether the claims have been reported or not

Question 7

If the amount set aside for claims is too little, in laters years…

Answer 7

Company’s financial position can be negatively affected

Question 8

Explain about IBNR, but not calculation

Answer 8

Based on using claims patterns from prior years up to the balance sheet date. These are then used to estimate the number of claims expected to be reported after the balance sheet date with incident dates prior to the balance sheet date.

Question 9

How is IBNR calculated?

Answer 9

From multiplying the number of such claims by average cost of claims. If claim numbers are stable the IBNR increased by claims inflation each year.

Question 10

IBNER is concerning what usually and how

Answer 10

Incurred but not enough reported. Liability claims are for example going to be understated, one reason is that it’s hard to predict which will develop into high cost claims. Estimates can be made on a portfolio basis, and this is when IBNER is used when referring to these claims.

Question 11

Unearned premium reserves are examined to test…

Answer 11

That amounts set aside are at least adequate to cover the expected cost of claims.

Question 12

If an unearned premium reserve is deemed inadequate what will be set up as a liability in the accounts?

Answer 12

An unexpired risk provision

Question 13

Why do insurance companies and reinsurance companies need to maintain adequate reserves?

Answer 13

To meet their liabilities at any one time

Question 14

Information on claims is usually gathered by what type of year and why?

Answer 14

Incident year (also called accident year) because premiums are earned up to the last day of the accounting period and for profitability purposes this needs to be matched to incidents that give rise to a claim up to the same day.

Question 15

The PRA also require claims to be reported by…

Answer 15

Incident year

Question 16

Information on claims is generally collected by…

Answer 16

Class of business e.g, property, motor, liability etc

Question 17

Within each class of business e.g property, claim statistics will be grouped into categories depending on…

Answer 17

How claims develop for each class

Question 18

In deciding the categories to use in regards to collecting claims information for each class of business, these will be…

Answer 18

• length of tail (being the time from the incident date through to advice and payment)
• expected claims pattern
• expectation of a surplus or deficit in the run off of claims
• average claim values

Question 19

Why when categorising claims for classes of business e.g motor, would you have split motor injury and motor damage?

Answer 19

Damage can be settled a lot quicker than the injury side of things.

Question 20

As a rule of thumb, liability claims are separated from…

Answer 20

Property damage claims

Question 21

Large claims will be extracted from claims statistics and assessed…

Answer 21

Separately

Question 22

For each claim development category for each class of business the following statistics are usually collected by incident year:

Answer 22

• number of claims reported
• number of nil claims
• total value of paid claims
• total value of the outstanding case estimate of claims at the period end

Question 23

Projections are typically performed from the claims development…

Answer 23

Triangles

Question 24

It is common to use a range of ???? When projecting the total cost of claims

Answer 24

Methodologies

Question 25

Why would a methodology that underestimates the total cost of claims still be of use?

Answer 25

May be used to help set a minimum value in the range of estimates

Question 26

Claims methodologies that do not take into account an improving trend may be used to set an…

Answer 26

Upper estimate

Question 27

If there are unusual claims trends, analysts will seek explanations from …

Answer 27

Underwriters or account managers to understand claim development patterns

Question 28

Give 4 main claim methodologies

Answer 28

1. Projection of paid claims
2. Projection of incurred claims
3. Loss ratio method
4. Bornhuetter-Ferguson

Question 29

Explain the projection of paid claims method

Answer 29

This is the simplest method. Claims given for incident year or report year are analysed to see how they develop to the ultimate value. If subsequent incident or report years can be assumed to follow a similar pattern then we have a simple estimate of the claims. E.g if 3 earlier accident years show that at the end of development year 2 this has proven to be 92% of the claim, then the figure can be grossed up to see 100% of the figure that should be reserved. The figure may have to altered for inflation costs. (These are perhaps best for property)

Question 30

What is the projection of incurred claims method?

Answer 30

Defined simply as the addition of the paid claims and the case reserves. Brings together the most that is clearly known to date about how the claims are developing on the business in question. Basically looking at what’s already been paid and what is still outstanding ( the reserves) this method will also be adjusted for inflation ( likely best for liability )

Question 31

What are some disadvantages of the projection of incurred claims method?

Answer 31

Settled claims can be reopened, initial reserves may not be that accurate and claims handling procedures may change.

Question 32

What is the loss ratio method?

Answer 32

Not usually used on its own. Relationship between claims to premiums. By expressing claims as a percentage of premiums. Once payment of claims is complete then ratio can be used with certainty. It is seen as a natural way of summing up the result as a single figure. Problem is that most recent years will not be fully developed so cannot contribute properly to it. 3 years old or more can be used and then applied to the earlier less developed years.

Question 33

What is the bornhuetter-Ferguson method?

Answer 33

Combination of the loss ratio method and either the paid claims method or incurred claims method. The paid claims or incurred claims help towards knowing what is already know, and then a more general estimator like the loss ratio method is combined to help towards predicting the future. By adding these parts together, it is the most reliable estimate we can get for overall losses and hence for required reserves.

Question 34

What is the average cost of claims method?

Answer 34

When claim amounts paid or incurred are divided by the relevant number of claims, an average cost per claim results. This average cost can be projected as the claim amounts themselves, and once with a separate projection for the number of claims it will yield the new estimate for the ultimate loss.

Question 35

What is exposure based method?

Answer 35

Used for long tail liability claims such as latent claims like asbestos, pollution and health hazard exposures where there is high levels of uncertainty.

Question 36

Ultimately, who is responsible for deciding the amount to set aside for claims?

Answer 36

The board

Question 37

When deciding the claims reserving policy, this will usually be headed by…

Answer 37

Chief financial officer.

Question 38

The team preparing the estimates for the claim reserves is likely to be headed by?

Answer 38

Actuary or someone with actuarial skills

Question 39

How often are claims reviewed?

Answer 39

Monthly for most volatile claims and quarterly for the rest of the portfolio

Question 40

Who will be involved in meetings regarding the amount to set aside for claims?

Answer 40

Claims reserving specialists, account manager, underwriters, pricing specialists and the person responsible for claims handling. Recommendations will be made to the executive team and the executive team will make recommendations to the board.

Question 41

The amounts set aside for claims will allow for…

Answer 41

Future inflation

Question 42

Some companies ???? Long tail claims. If they do this they must…

Answer 42

Discount long tail claims. They must explain this in their policy for discounting claims in the accounts.

Question 43

What are discounted claims?

Answer 43

Claims where the amount set aside is reduced by the investment income expected to be earned in the future on the investments supporting the claims.

Question 44

Why do company’s employ external actuaries to review the amount set aside for claims on a regular basis?

Answer 44

To increase confidence in the investors and external analysts that the provision is fairly stated.

Question 45

The accuracy for the amount set aside for claims is likely to be judged by the…

Answer 45

Claims run off

Question 46

The run off in the year is the incurred cost during the year on the amount set aside for claims at the start …

Answer 46

Of the year. Hence it will be the opening provision less the closing provision for the same claims adjusted by claims payments made.

Question 47

Investors and external analysts will form an opinion on the adequacy of the amount to set aside for claims in the latest set of accounts based on the…

Answer 47

Run-off of the most recent years

Question 48

If the run-off of a company has been adverse in previous years, analysts such as rating agencies may believe…

Answer 48

The amount set aside for claims is inadequate

Question 49

If there is a favourable run off, it is not unusual to expect the amount set aside for claims in the latest accounts will …

Answer 49

Also produce favourable run-off in the future

Question 50

On what is the IBNR calculation based?

Answer 50

Extrapolation of the pattern of claims reported in prior years and up to the balance sheet date. The prior year patterns are used to estimate the number of claims expected to be reported after the balance sheet date with incident dates prior to the balance sheet date. The total value of IBNR is calculated from multiplying the number of such claims by the average cost of claims.

Question 51

State briefly what an unexpired risk provision is

Answer 51

An amount set up as a liability in the accounts if an assessment of the unearned premium reserve is deemed to be inadequate to cover the expected cost of claims

Question 52

What are the factors that will be considered when deciding how to categorise claims statistics for the purposes of determining the appropriate amount to set aside for claims?

Answer 52

Regards will be paid to;

• length of tail (being the time from the incident date through to advice and payment)
• expected claims pattern
• expectation of a surplus or deficit in the run off of claims
• average claim values

Question 53

True or false. The standard projection of paid claims method would be suitable for estimating the total claims on a household property account?

Answer 53

True

Question 54

True or false. The standard inflation adjusted projection of incurred claims method would be suitable for estimating the total claims on a commercial motor account, where there have been recent changes to the claims handling process to reflect changes in legislation.

Answer 54

False because the reserves are likely going to be affected in line with the changes in legislation.

Question 55

True or false. The loss ratio method uses the most recent incident year to establish the loss ratio to be projected forwards.

Answer 55

False. The loss ratio method looks at older years and uses this information in regards to less developed newer years.

Question 56

True or false. The bornhuetter Ferguson method uses a combination of all of the other methods of claims projection.

Answer 56

False. This method combines the loss ratio method and either the paid claims or incurred claims.