Model Solvency

Modelling the Claims Development Result
for Solvency Purposes
Michael Merz Mario V. Wüthrich

University of Tübingen ETH Zürich
ASTIN Colloquium
Manchester, July 2008
www.math.ethz.ch/∼wueth

c 2008 (Mario Wüthrich, ETH Zürich)
1. Introduction Non-Life Insurance
For accounting year I + 1 = 2008:
• Budget statement at 1/1/2008

• Profit & Loss (P&L) statement at 31/12/2008
Budget P&L
1/1/2008 31/12/2008
premium earned 4’000’000 4’020’000
claims incurred current accident year -3’300’000 -3’340’000
loss experience prior accident years 0 -40’000
administrative expenses -1’000’000 -1’090’000
investment income 500’000 510’000
income before taxes 200’000 60’000

c 2008 (Mario Wüthrich, ETH Zürich) 1
One-Year Claims Development Result (CDR)
8'000
7'000
claims development result
6'000
5'000
4'000
3'000
2'000
1'000
0
time I time I+1
payments in (I,I+1] reserves
Loss experience prior accident years (claims development result)

describes the changes of the insurance (runoff) liabilities over the
next accounting year I + 1 = 2008.

Best Estimate Claims Reserves
accident date claims payments reopening

reporting date claims closing payments claims closing
time
• Best estimate claims reserve at time I is an (unbiased) prediction

for the outstanding loss liabilities at time I based on the available
information at time I.
• The CDR describes how we update this prediction at time I + 1.
• The CDR is a short term view / one-year view.
• The traditional view is a long term view.

Claims Reserving is a Prediction Problem
• X future cash flow (random variable) to be predicted.
• DI information available at time I.
• Assume X
b is a DI -measurable predictor for X.
The (conditional) mean square error of prediction (MSEP) is

defined b
2
msepX|DI X b = E X −X b DI

2
= Var (X| DI ) + E [X| DI ] − X
b .
b is a predictor for X and an estimator for E [X| DI ].

Hence, X

2. Distribution-Free Chain Ladder Model
We use the following notations:
• accident years are denoted by i ∈ {0, . . . , I}
• development years are denoted by j ∈ {0, . . . , J}
• incremental claims are denoted by Xi,j
• cumulative claims are denoted by

j
X
Ci,j = Xi,k .
k=0
Here: Xi,j denote incremental payments.

Loss Development Triangle at Time I
accident development years j
year i 0 1 2 3 4 . . . j . . . J
0
1
... observations DI = {Ci,j : i + j ≤ I}
...
i
...
...
I−2 to be predicted DIc
I−1
I
• observations DI = {Ci,j : i + j ≤ I},
• to be predicted DIc = {Ci,j : i + j > I, i ≤ I}.

Distribution-Free CL Model
CL assumptions:
• Different accident years i are independent.
• {Ci,j }j≥0 is a Markov chain with
E [Ci,j | Ci,j−1] = fj−1 Ci,j−1, for all i, j.

2
Var (Ci,j | Ci,j−1) = σj−1 Ci,j−1, for all i, j.
Expected ultimate claim Ci,J , given DI , is

J−1
Y
E [Ci,J | DI ] = Ci,I−i fj .
j=I−i

3. Claims Development Result
The CDR is mainly concerned with updating the information.
DI = {Ci,j : i + j ≤ I and i ≤ I},

DI+1 = {Ci,j : i + j ≤ I + 1 and i ≤ I} ⊃ DI .
accident development year j accident development year j

year i 0 ... j ... J year i 0 ... j ... J
0 0
.. ..
. DI . DI+1
i i Ci,I−i+1
.. ..
. .
I I
Loss development triangle at time I and at time I + 1.
b I+1.
b I and C
This provides predictors C i,J i,J

CL Factor Estimation
CL factor estimators at times I and I + 1:

PI−j−1 PI−j
I i=0 Ci,j+1 I+1 i=0 Ci,j+1
fj = PI−j−1
b and fj = PI−j
b .
i=0 Ci,j i=0 Ci,j
Best estimate CL reserves at times I and I + 1:

J−1
b DI = C
Y
I
R i
bi,J − Ci,I−i = Ci,I−i fbjI − Ci,I−i,
j=I−i
J−1
DI+1
Y
Ri
b b I+1 − Ci,I−i+1 = Ci,I−i+1
= C fbjI+1 − Ci,I−i+1.
i,J
j=I−i+1

One-Year Claims Development Result (CDR)
8'000
7'000
claims development result
6'000
5'000
4'000
3'000
2'000
1'000
0
time I time I+1
payments in (I,I+1] reserves
accounting year I+1 DI+1

b DI
R −→ Xi,I−i+1 + Ri
b
i

Observable Claims Development Result
The observable CDR is given by

bDI − Xi,I−i+1 + DI+1
CDR
[ i(I + 1) = Ri Ri
b .
• Fluctuation of the observable CDR around 0

2
msepCDR
\ i(I+1)|DI (0) = E
[ i(I + 1) − 0 DI
CDR
2
= E C I
bi,J −Cb I+1 DI .
i,J
This exactly quantifies the prediction uncertainty of the position “loss

experience prior accident years” in the budget statement.

MSEP, Observable CDR (1/2)
Conditional MSEP for the one-year runoff uncertainty is:
msep
[ CDR\ (I+1)|D (0)i I
2
2 σ
"2 I
bI−i / fbI−i
bI
= C i,J
Ci,I−i
2 2 #
2 I J−1 2 bI
σ
bI−i / fbI−i X CI−j,j σ
b j / f j
+ Pi−1 + PI−j PI−j−1 .
k=0 Ck,I−i j=I−i+1 k=0 Ck,j k=0 Ck,j
Compare to the CL Mack (1993) formula (total runoff uncertainty,

long term view)!

MSEP, Observable CDR (2/2)
The conditional MSEP for aggregated accident years is estimated by
X
msep
[P (0) = msep
[ CDR\ (I+1)|D (0)
i CDRi (I+1)|DI
\ i I
i
 2 2 
2 bI J−1 2 bI
X σ
b I−i / f I−i X CI−j,j σ
b j / fj
I bI 
+2 Ci,J Cl,J  Pi−1 + .
b 
PI−j PI−j−1
i<l k=0 Ck,I−i j=I−i+1 k=0 Ck,j k=0 Ck,j
This is the one-year solvency view: Budget vs. P&L statement.

Example
i b DI
R msep
[[ (0)1/2 msep
[ I bi,J )1/2 Mack ’93
(C
i CDRi (I+1)|DI C |DI
i,J
0 0
1 4’378 567 567
2 9’348 1’488 1’566
3 28’392 3’923 4’157
4 51’444 9’723 10’536
5 111’811 28’443 30’319
6 187’084 20’954 35’967
7 411’864 28’119 45’090
8 1’433’505 53’320 69’552
cov1/2 39’746 50’361
Total 2’237’826 81’080 108’401
1/2
• msep
[ CDR[ (I+1)|D (0) is the one-year CDR view (short term).
i I
• msep b I )1/2 is the whole runoff uncertainty (long term).

[ Ci,J |DI (C i,J
We see that the ratio is around 75%.

Stochastic
claims reserving
methods
in insurance
MARIO V. WÜ THRICH

MICHAEL MERZ


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Modelling the Claims Development Result

for Solvency Purposes

Michael Merz Mario V. Wüthrich

For accounting year I + 1 = 2008:

• Budget statement at 1/1/2008

payments in (I,I+1] reserves

Loss experience prior accident years (claims development result)

accident date claims payments reopening

• Best estimate claims reserve at time I is an (unbiased) prediction

• The CDR describes how we update this prediction at time I + 1.

• The CDR is a short term view / one-year view.

• The traditional view is a long term view.

• X future cash flow (random variable) to be predicted.

• DI information available at time I.

The (conditional) mean square error of prediction (MSEP) is

b is a predictor for X and an estimator for E [X| DI ].

We use the following notations:

• accident years are denoted by i ∈ {0, . . . , I}

• development years are denoted by j ∈ {0, . . . , J}

• incremental claims are denoted by Xi,j

• cumulative claims are denoted by

Here: Xi,j denote incremental payments.

• observations DI = {Ci,j : i + j ≤ I},

• to be predicted DIc = {Ci,j : i + j > I, i ≤ I}.

• Different accident years i are independent.

• {Ci,j }j≥0 is a Markov chain with

E [Ci,j | Ci,j−1] = fj−1 Ci,j−1, for all i, j.

Expected ultimate claim Ci,J , given DI , is

The CDR is mainly concerned with updating the information.

DI = {Ci,j : i + j ≤ I and i ≤ I},

accident development year j accident development year j

Loss development triangle at time I and at time I + 1.

CL factor estimators at times I and I + 1:

Best estimate CL reserves at times I and I + 1:

payments in (I,I+1] reserves

accounting year I+1 DI+1

The observable CDR is given by

• Fluctuation of the observable CDR around 0

This exactly quantifies the prediction uncertainty of the position “loss

Conditional MSEP for the one-year runoff uncertainty is:

Compare to the CL Mack (1993) formula (total runoff uncertainty,

The conditional MSEP for aggregated accident years is estimated by

This is the one-year solvency view: Budget vs. P&L statement.

• msep b I )1/2 is the whole runoff uncertainty (long term).

We see that the ratio is around 75%.

MARIO V. WÜ THRICH

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