Chapter 15 Loss Reserving Methods

4-7 Identify the 4 major steps in calculating IBNR reserves from a loss triangle.

1. Organize historical data in a loss triangle format. 2. Calculate 12 month development factors from the loss triangle. 3. Calculate ultimate loss development factors from the 12 month development factors. 4. Use ultimate loss development factors to calculate the IBNR reserve.

1-3 Identify the components of incurred losses.

Incurred losses are the sum paid losses and loss and LAE reserves.

7-3 Describe how social inflation affects an excess of loss reinsurer's reserves.

As with monetary inflation, social inflation, such as legislative changes that benefit claimants and certain trends in the U.S. legal system, increases the value of claims that exceed the attachment point as well as the number of claims to which the reinsurer must contribute.

7-1 Identify the factors that affect an excess of loss reinsurer's reserves.

- Monetary inflation - Social inflation - Long loss development periods

4-1 Identify the categories of claim reserves for which bulk reserves can be established.

- Reported losses - payment uncertain - IBNR reserves - LAE and ULAE

1-4 Describe the distinction between ALAE and ULAE.

ALAE are those LAE that can be associated with a specific claim. ULAE are those LAE expenses that cannot be readily associated with a specific claim.

6-3 Describe the function of anticipated subrogation recoveries.

Anticipated subrogation recoveries serve to offset loss reserves.

1-5 Atwell Insurance expects that the general liability policies it sells in the current year will eventually result in $15 million in incurred losses. To date, Atwell has paid only $5 million in losses. Determine the amount of loss reserves and LAE reserves that are currently outstanding.

Atwell should have $10 million in loss and LAE reserves.

5-4 StartUp Insurance, in business for less than 3 years, write primarily product liability insurance. What method of loss reserving would be most appropriate for StartUp?

Because StartUps' losses are most likely not sufficiently mature to use the loss triangle method, they might use the Bornhuetter-Ferguson method. Immature loss data occurs because of the delay between when a loss occurs and when it is reported to the insurer. This delay is more pronounced for liability insurance than for property insurance; because they primarily write products liability insurance, the delay may be even longer for this type of liability insurance.

6-1 Explain why Sch P of the NAIC Annual Statement combines salvage and subrogation recoveries into one category.

Because both serve to reduce paid and reserved losses.

4-6 Explain why the percentage method of estimating IBNR reserve is more likely to be used for property loss reserves than liability loss reserves.

Because property losses can be estimated with reasonable accuracy soon after they are reported. This method is likely to be less accurate for liability loss reserves, which typically take longer to develop.

4-10 Explain how bulk reserves for LAE are estimated.

Bulk reserves for both ALAE and ULAE are estimated by applying a percentage factor to either earned premiums or incurred losses.

3-5 Explain how case reserves for ALAE can be established.

Case reserves for ALAE can be established by using the judgment method or by adding a fixed percentage to each case loss reserve.

2-3 Explain why a primary insurer's underestimation of losses may have a significant effect on excess of loss treaties.

Excess of loss reinsurers are often unaware of substantial losses until these losses directly affect them. Consequently, if a primary insurer understates reserves, that underestimation may have a significant effect on the excess of loss reinsurer's reserves.

4-4 Identify the 3 basic methods of estimating IBNR reserves.

I. The loss ratio method. 2. The percentage method 3. The loss triangle method

4-3 Explain why IBNR reserves are considered residual reserves.

IBNR reserves are considered residual reserves because, at any point in time, they equal the difference between incurred losses and ultimate losses.

4-8 Describe ultimate loss development factors.

It estimates the ultimate incurred loss from the most recent estimate of incurred losses for a specific accident year.

3-6 Identify the approaches that can be used to correct inadequate total case reserves.

It includes increasing the case reserve for each claim by the same percentage and reviewing each open claims file and increasing only those reserves that are inadequate.

4-9 Explain what systematic increase in loss reserves over time indicate.

It indicates a consistent practice of carrying inadequate reserves.

5-2 Describe when the Bornhuetter-Ferguson method is frequently used.

It is frequently used when the losses reported to the insurer are not sufficiently mature to use the loss triangle method.

4-2 Describe the losses that IBNR reserves are intended to address.

It is intended to estimate and reserve for losses that have occurred but have not yet been reported.

4-5 Explain why the loss ratio method of estimating IBNR reserves is more likely to be used.

It is more likely to be used in the early states of development for long-tail liability insurance because, during this time, the loss triangle method is not completely reliable. After 24 months, the loss triangle method is likely to be more reliable than the loss ratio method.

7-4 Describe how long loss development periods affect an excess of loss reinsurer's reserves.

It often causes an excess of loss reinsurer to have understated loss reserves because the reinsurer is unaware that the losses have occurred.

5-1 Describe the two-part combination method.

It weights the results of the loss ratio method and the triangle method with weights by the number of months after the start of the policy year.

5-3 Explain how the three-part combination method operates.

It weights the results of the loss ratio method, the loss triangle method and the case loss reserves.

1-2 Identify the components of reserves.

Reserves consist of reserves for both losses and LAE.

7-2 Describe how monetary inflation affects an excess of loss reinsurer's reserves.

Monetary inflation affects an excess of loss reinsurer's loss reserves by increasing the ultimate value of a claim that takes a long time to settle.

1-1 Describe primary insurer's and reinsurer's reserves.

Primary insurers' and reinsurers' reserves are estimates of the amounts they will have to pay in the future for losses that have already occurred.

2-4 Blithe Insurance writes primarily property insurance but is considering expanding its product mix to include more casualty insurance. What effect may this have on Blithe Insurance's excess of loss reinsurers?

Property insurance losses are usually reported and reserved sooner than casualty insurance losses. Although long loss reporting delays significantly affect the adequacy of primary insurer reserves, the financial consequences of these delays also have a substantial effect on the excess of loss reinsurer. Reinsurance premiums are based partly on a primary insurer's reserves. If Blithe's reserves are understated, the reinsurance premiums charged to Blithe may be inadequate for the loss exposures that are reinsured.

2-1 Explain why reinsurers have an interest in the reserve adequacy of the primary insurers they reinsure.

Reinsurers have an interest in primary insurers' adequacy because reinsurers establish their loss reserves on reserve data recorded by the primary insurers they reinsure. If a primary insurer's reserves are inadequate, the reinsurer's will also be inadequate. In addition, reinsurance premiums are based partly on a primary insurer's reserves. If these reserves are understated, the reinsurance premiums charged to primary insurers may be inadequate for the loss exposures that are reinsured. Finally, reinsurers are interested in the long-term survival prospects of primary insurers. If a primary insurer has inadequate reserves, it may indicate that the primary insurer is in financial difficulty, possibly facing insolvency. A reinsurer that deals with an insolvent primary insurer could experience problems, including lengthy and expensive litigation regarding the disposition of outstanding claims.

2-2 Explain why a primary insurer's underestimation of losses may have a significant effect on pro rata reinsurers.

Reinsurers providing pro rata reinsurance are responsible for a proportional share of the loss reserves established by the primary insurer. Because the liability of pro rata reinsurance exists from the first dollar of loss, a pro rata reinsurer usually follow the reserving practices of its primary insurers.

6-2 Describe how salvage received in the current year is recorded when the related loss occurred in a previous year.

Salvage is recorded in the year in which it is received even though the salvage might have resulted from a loss incurred in an earlier year.

3-4 Explain how the average amount for a claim is determined when using the average method.

The average amount for a claim is based on an analysis of past claims and is trended for inflationary changes, changes in amounts insured, and other factors that may cause future payment to differ from past payments.

3-3 Identify the three methods of determining case reserves.

The judgement method; the average, or factor method; and the tabular method.

3-1 Identify the two general methods for establishing reserves for losses and LAE.

They are case reserves and bulk reserves.

3-2 Identify the components of a case loss reserve that appear in the claim file.

They are the claim representative's estimate of the ultimate loss, less any payments already made.

3-7 PQR Insurance specializes in providing automobile physical damage insurance, and most of its written premium is for this exposure. What method would PQR Insurance use to set its case loss reserves?

They would most likely use the average method, a method to establish case reserves by using an average amount for specific categories of claims. This approach is most suitable for types of insurance in which claims are relatively frequent, reported and paid promptly, and not subject to extreme variations such as automobile physical damage insurance.