Loss Reserving
Encyclopedia
Loss reserving or Outstanding claims reserves
refers to the calculation of the required reserves for a tranche
of general insurance
business.
Typically, the claims reserves represent the money which should be held by the insurer so as to be able to meet all future claims arising from policies currently in force and policies written in the past.
Methods of calculating reserves in general insurance
are different from those used in life insurance
, pension
s and health insurance
since general insurance contracts are typically of a much shorter duration. Most general insurance contracts are written for a period of one year. Typically there is only one payment of premium at the start of the contract in exchange for coverage over the year.
Reserves are calculated differently to contracts of a longer duration with multiple premium payments since there are no future premiums to consider in this case. The reserves are calculated by forecasting future losses from past losses.
The more popular statistical methods in claims reserving are the Chain Ladder Method and the Bornhuetter Ferguson Method.
The Chain Ladder Method uses data in a two dimensional array representing occurrence and development of claims. The upper left of this matrix contains known values (in the past) which are used to estimate the remaining figures (i.e. arising in the future).
The Bornhuetter Ferguson Method is a Bayesian technique. This means that it incorporates both an independently derived prior estimate of ultimate expected losses as well as estimates generated by the same kind of matrix described above. These are weighted by what is called a credibility factor, ideally giving preference to the more reliable projection, but taking both into consideration.
Outstanding claims reserves
Outstanding claims reserves in general insurance are a type of technical reserve or accounting provision in the financial statements of an insurer. They seek to quantify the outstanding loss liabilities for insurance claims which have been reported and not yet settled or which have been incurred...
refers to the calculation of the required reserves for a tranche
Tranche
In structured finance, a tranche is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion, and is cognate to English trench . In the financial sense of the word, each bond is a different slice of the deal's...
of general insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
business.
Typically, the claims reserves represent the money which should be held by the insurer so as to be able to meet all future claims arising from policies currently in force and policies written in the past.
Methods of calculating reserves in general insurance
General insurance
General insurance or non-life insurance policies, including automobile and homeowners policies, provide payments depending on the loss from a particular financial event. General insurance typically comprises any insurance that is not determined to be life insurance. It is called property and...
are different from those used in life insurance
Life insurance
Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...
, pension
Pension
In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...
s and health insurance
Health insurance
Health insurance is insurance against the risk of incurring medical expenses among individuals. By estimating the overall risk of health care expenses among a targeted group, an insurer can develop a routine finance structure, such as a monthly premium or payroll tax, to ensure that money is...
since general insurance contracts are typically of a much shorter duration. Most general insurance contracts are written for a period of one year. Typically there is only one payment of premium at the start of the contract in exchange for coverage over the year.
Reserves are calculated differently to contracts of a longer duration with multiple premium payments since there are no future premiums to consider in this case. The reserves are calculated by forecasting future losses from past losses.
The more popular statistical methods in claims reserving are the Chain Ladder Method and the Bornhuetter Ferguson Method.
The Chain Ladder Method uses data in a two dimensional array representing occurrence and development of claims. The upper left of this matrix contains known values (in the past) which are used to estimate the remaining figures (i.e. arising in the future).
The Bornhuetter Ferguson Method is a Bayesian technique. This means that it incorporates both an independently derived prior estimate of ultimate expected losses as well as estimates generated by the same kind of matrix described above. These are weighted by what is called a credibility factor, ideally giving preference to the more reliable projection, but taking both into consideration.