13.1 7 Problems with Reinsurance Reserving

Problem 1: Longer claims report lag

• Claim must be perceived as report-able to the reinsurer by the cedant (e.g. half of the attachment point) and then flow through cedent’s system to reinsurer

  • Cedant’s reporting system \(\Rightarrow\) Cedant’s reinsurance accounting \(\Rightarrow\) Intermediary (broker) \(\Rightarrow\) Reinsurer books the claims \(\Rightarrow\) Reinsurer’s claim system

• Cedant may undervalue the claim for a long time and thus not reported to the reinsurer

  • See Problem 2 on the cedant reserving to the modal value

• Extreme delays in discovery or reporting for mass tort claims (e.g. asbestos)

Problem 2: Persistent Upward Development of Most Claim Reserves

• Economic and social inflation

• Tendency to underestimate LAE

• Tendency of claims to reserve at the modal value

  • Not initially clear which of a group of similar claims will become large so choose the same mostly likely value for all

  • Modal value likely under attachment point of treaty so reinsurer does not learn about claim until it is known to be large, which may be several years after reported to primary insurer

Problem 3: Reporting Pattern Differ Greatly

• Pattern differs by: LoB, contract type, contract terms, cedant, and intermediary

• Extremely heterogeneous exposures

• Extreme fluctuation in historical loss data due to low frequency and report lags

• Less information on the underlying exposure than primary carrier

Problem 4: Industry Statistics Not Useful

• Due to heterogeneity exposures

• Sch P doesn’t break down the exposure fine enough and ISO not directly applicable

• Reporting lag grows with attachment point

Problem 5: Reports Received Lack Important Information

• Proportional covers require only summary claims info

• Might only have UY or CY info (no AY or PY)

• Limitation of reinsurance premium by primary LoB as an exposure base

  • Reinsurance premium is assigned to line according to a % breakdown estimate made at the beginning of the contract and based upon the distribution of subject premium by line

  • To the degree that these % do not accurately reflect the reinsurer’s loss exposure by primary line, comparisons of premiums and losses by line maybe be distorted

  • Mostly a problem for multi-line proportional treaties

• Reporting is typically done with a quarter lag so always missing a quarter of premium

Problem 6: Data Coding and IT System Problems

• Again due to the heterogeneity in coverage

• Might have grown in size and complexity faster than data system could handle

Problem 7: Reserve to Surplus Ratio is Higher for Reinsurer

• More of a management problem

• Management may underestimate level of reserves need (due to problem 1-6) until claims emerge. Difficulty with actuary convincing management to post the appropriate reserve

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Standard techniques requires: Homogeneous book, sufficient frequency, and detailed exposure info (Problems 3, 4, 5); Difficult to supplement with industry info

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Side note on tax impact, reinsurer liabilities are much longer tail than primary and there for the discounted liabilities are smaller and will incur greater income tax