Page 167 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

notes Loss cycle: Incurred losses reported in financial statements are typically broken out into two
pieces, the initial estimate of incurred losses for the most recent exposure period, and changes in
the estimate of incurred losses for prior periods. This can frequently be translated in summary
form into:
l z Incurred losses for the current accident year.
l z Changes in incurred loss estimates for prior accident years.
There are also two general approaches to the initial recognition of losses for the current accident
year – those based on actual claim activity and those based on accrual of estimated incurred losses
based on the level of earned exposure. The following tracks the life-cycle of incurred claims for
each of these approaches, first when initial reserves are based on actual claim activity, and then
when initial reserves are estimated based on the estimated earned exposure.
Actual claim activity: Under this approach, the incurred losses for the most recent exposure
period are initially set based on the actual claim activity, with possible additional loss reserves
established to allow for IBNR claims or any expected deficiency/redundancy in claim adjuster
reserves. For subsequent valuations of the same group of claims, changes in claim adjuster
estimates directly impact incurred losses, and aggregate reserves such as bulk and IBNR reserves
are run off over time based on studies of historical data or other actuarial studies.

The following tracks the accounting entries resulting from claims for accident month January
2011 for a hypothetical company/line of business, from initial valuation to the final payment for
the accident month.

The following (simplifying) assumptions were made in the following example:
l z All claims are reported within 4 months of the loss event.
l z Earned premium for the month is ` 100.
l z Each claim is worth ` 10, half paid in the month of reporting, half in the subsequent
month.

l z The initial IBNR is set based on 30% of earned premium, run off evenly over the following
three months.

l z No bulk reserve is necessary (beyond that which may be implicit in the IBNR calculation).

Notes Some claim departments define the case reserve as their estimate of the ultimate
value for the claim, including amounts paid-to-date. This can occur even when the term is
used to represent unpaid amounts only among the actuaries in the same company.

Example 1: Where reserving is based at inception on actual claim activity

Assume
l z All claims are reported within 4 months of the loss event.
l z Earned premium for the month is ` 100.
l z Each claim is worth ` 10, half paid in the month of reporting, half in the subsequent
month.

l z Case reserves are established at` 10 once the claim is reported.
l z The initial IBNR is set based on 30% of earned premium, run off evenly over the following
three months.
l z No bulk reserve is necessary (beyond that which may be implicit in the IBNR calculation).

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