Better consideration of insurance cycles and economic trends and transparent reporting will help insurers improve their reserving practices, according to Swiss Re's latest sigma study.
The study, "Non-life claims reserving: improving on a strategic challenge," examined various reserving techniques used by insurers, reported factors that contribute to reserving errors, and suggested ways the industry can more effectively set reserves.
In explaining the factors that can cause reserve revisions, the study noted, "Reserving decisions are based on forecasts of final claims payments. Any significant mismatch between assumptions and reality leads to reserve revisions."
Some of these mismatches could be due to industry- or sectorwide phenomena, such as unexpected legal developments, advances in medicine, increasing life expectancy, inflation and catastrophes. Other factors are more specific to an individual policy, such as underestimating or overestimating the consequences of an injury.
The study stated that the insurance cycle can drive reserve revisions and suggests that this part of reserving errors can be prevented by removing the price cycle from reserve calculations. One way to do this, the study said, is "to replace premiums by a better measure of exposure, such as sum insured, number of policies of the same kind, properly assessed expected loss, etc."
Greater transparency and discipline could also reduce the number of reserve revisions for insurers. The study stated, "It is tempting for various stakeholders to bow to the pressures of maintaining market share or even growing the business during the soft phase of the insurance price cycle."
Reserving actuaries can be caught up in this pressure as well, the study said, and they may "feel pressure" to release reserves during the soft market and reduce profits with reserve additions during the hard market.
"Proper accounting and more transparency about expected late claims and their cyclical variation could shift the focus away from using claims reserves to manage expectations and short-term results," according to the study.
Rudolf Enz, the author of the study, said in a statement: "Initial claims estimates will never be perfect forecasts of final claims paid because it is virtually impossible to predict with certainty the factors that could adversely impact long-tail insurance business. Nevertheless, insurers might substantially improve their reserving practices by factoring in the effects of the insurance cycle and by better reflecting trends, such as increasing wages, health costs and life expectancy."
The study is available electronically at www.swissre.com/sigma.
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