FIN 460 INSURANCE PRODUCTS

INSURANCE RESERVES

Fall 2021
LIFE CYCLE OF A CLAIM

 For an insurance company, claims develop through a

claim’s cycle whose length and timing depends on the
nature of the underlying risk and the type and level
of coverage provided. The claims cycle is as follows :
 Occurrence,
 Reporting,
 Establishing an in initial reserve,
 Updating intial reserve estimates,
 Settlement
 Closure

IRAD CHAMMEM 2
INSURANCE BALANCE SHEET

IRAD CHAMMEM 3
TECHNICAL PROVISIONS

 Technical provisions represent the amount that an

insurer requires to fulfil its insurance obligations and
settle all expected commitments to policyholders
and other beneficiaries arising over the lifetime of
the insurer’s portfolio of insurance contracts.

IRAD CHAMMEM 4
TECHNICAL PROVISIONS

1. reserve for unearned premiums — the difference between written premiums and earned premiums. This
reserve can, depending on the national legislation, include a separate element relating to unexpired risks;
2. reserves for life insurance — such reserves reflect the present value of the expected future benefits (including
but not confined to declared bonuses) less the present value of future premiums. Supervisory authorities may set
a ceiling to the discount rate used in the calculation of present value;
3. reserve for claims outstanding — the difference between incurred and paid claims. It equals the total
estimated ultimate cost to an insurance undertaking of settling all claims arising from events which have occurred
up to the end of the financial year, whether reported or not, less amounts already paid in respect of such claims;
4. reserve for bonuses and rebates— comprising the amounts intended for policyholders or contract
beneficiaries by way of bonuses and rebates, to the extent that such amounts have not already been credited to
policyholders or contract

IRAD CHAMMEM 5
TECHNICAL PROVISIONS

1. equalization reserve comprises amounts set aside in compliance with legal or administrative requirements to
equalize fluctuations in loss ratios in future years or to provide for special risks. National authorities may not
permit this reserve;
2. reserve for unexpired risks - This item might also include ageing reserves taking into account the effect of
ageing on the amount of claims, e.g. with health insurance;
3. technical reserves for life insurance policies where the investment risk is borne by the policyholders. This
item shall comprise technical reserves constituted to cover liabilities to policyholders in the context of life
insurance policies where the value of the return is determined by reference to investments for which the
policyholder bears the risk, or by reference to an index, as is the case with index-linked life insurance. This item
shall also comprise the technical reserves concerning tontines.

IRAD CHAMMEM 6
UNEARNED PREMIUM RESERVES

 Premiums is the main source of income for an insurance company. Insurers differentiate between written
premiums and earned premiums. The former is the premiums that are contracted and usually paid for. The latter
refers to the part that is earned in term of the risk exposure.

 Usually the premium is collected in advance by the insurer. If a client for instance pays for one year of reinsurance
by 1 December then 1 month will be earned at year-end, 31 December. But 11 months will be unearned. The risk
exposure lies in the future. This 11 months will be set up as an Unearned Premium Reserve (UPR). Depending on
the business the premium not earned may cover several years.

 If the expected loss-ratio for this UPR is above 100% then a Unexpired Risk Reserve (URR) is needed.

IRAD CHAMMEM 7
UNEARNED PREMIUM RESERVES
Example:
 Reporting period 01/01/2021 to 31/12/2021,
 Contract START_DATE = 03/04/2020,
END_DATE = 03/04/2022.
 Written premium W_PREMIUM = 2 000 DT
𝐸𝑛𝑑 𝑝𝑒𝑟𝑖𝑜𝑑 −𝑆𝑡𝑎𝑟𝑡 𝐷𝑎𝑡𝑒
 Earned premium ∗ W_PREMIUM
𝐸𝑛𝑑𝐷𝑎𝑡𝑒 −𝑆𝑡𝑎𝑟𝑡_𝐷𝑎𝑡𝑒
 Unearned premium 1 − 𝐸𝑎𝑟𝑛𝑒𝑑 𝑝𝑟𝑒𝑚𝑖𝑢𝑚
 Earned premium for the next reported period
𝐸𝑛𝑑 𝑝𝑒𝑟𝑖𝑜𝑑 2021 −𝑆𝑡𝑎𝑟𝑡 𝐷𝑎𝑡𝑒
∗ (WPREMIUM −
𝐸𝑛𝑑𝐷𝑎𝑡𝑒 −𝑆𝑡𝑎𝑟𝑡_𝐷𝑎𝑡𝑒
EarnedPremium 2020)

IRAD CHAMMEM 8
UNEXPIRED RISK RESERVES

 This reserve is only required if the UPR is considered inadequate to cover claims and expenses to be incurred for
the remaining period of risk.
 Example :
 Loss Ratio : 115%
 URR = (Loss Ratio – 100% ) * UPR

IRAD CHAMMEM 9
RESERVE FOR CLAIMS OUTSTANDING

 Based on the status of the claim’s run-off we distinguish three types of claims in the books of an insurance
company.
 A first type of claim is a closed claim. For these claims the complete development has been observed.
 An RBNS claim is one that has been Reported, But is Not fully Settled at the present moment or the moment of evaluation
(the valuation date), that is, the moment when the reserves should be calculated and booked by the insurer. Occurrence,
reporting and possibly some loss payments take place before the present moment, but the closing of the claim happens in
the future, beyond the present moment.
 An IBNR claim is one that has Incurred in the past But is Not yet Reported. For such a claim the insured event took place,
but the insurance company is not yet aware of the associated claim. This claim will be reported in the future and its
complete development (from reporting to settlement) takes place in the future.

IRAD CHAMMEM 10
RUN-OFF TRIANGLES

 The triangular display used in loss reserving is called

a run-off or development triangle. On the vertical
axis the triangle lists the accident or occurrence
years during which a portfolio is followed. The loss
payments booked for a specific claim are connected
to the year during the which the insured event
occurred. The horizontal axis indicates the payment
delay since occurrence of the insured event.

IRAD CHAMMEM 11
THREE DIFFERENTS APPROACHES

 Average cost technique

Ultimate cost = Ultimate number of claims * Average cost of claims
 Loss Ratio technique
Ultimate cost = Premiums * Ultimate Loss ratio
 Run off Triangle approach

IRAD CHAMMEM 12
LOSS RESERVING

 All recent techniques aimed at improving the reliability of provisioning calculations are useful for:
 The Best Estimate certification,
 The justification of the adequacy of the provisioning,
With the auditors, auditors, etc.
 The quality of the estimate of the provision is based on a certain data stability: how were they generated? Which
are the risk factors for a possible change?
 Internal factors: evolution of the portfolio, subscription policy, pricing, reinsurance, claims management policy.
 External factors: market practices, economic cycles, cost inflation, change in claims (in terms of frequency and severity),
regulatory and accounting changes.

IRAD CHAMMEM 13
CHAIN LADDER METHOD

1. Compile claims data in a development triangle

2. Calculate age-to-age factors
3. Calculate averages of the age-to-age factors
4. Select claim development factors
5. Select tail factor
6. Calculate cumulative claim development factors
7. Project ultimate claims

IRAD CHAMMEM 14
EXAMPLE

IRAD CHAMMEM 15
EXAMPLE

Age to Age Factors calculations Formula

𝐶𝑖 ,𝑗+1
𝑓𝑖,𝑗 =
𝐶𝑖,𝑗
Evolution of the claims in the year j that had happened
in the year i

IRAD CHAMMEM 16
EXAMPLE

Projection and chain ladders factors Formula

IRAD CHAMMEM 17
EXAMPLE

Projection and chain ladders factors Formula

IRAD CHAMMEM 18