Page 168 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Unit 8: Accounting for Insurance Companies

Accident Accounting Reported Case Ending Beginning Incurred notes
Month Month Claims Paid Reserves IBNR Reserves Reserves Losses

a b c d e f g h i
(g) = (e) + (f) (i) = (d) + (g) - (h)
Jan. 11 Jan. 11 3 15 15 30 45 0 60
Jan. 11 Feb. 11 2 25 10 20 30 45 10
Jan. 11 Mar. 11 0 10 0 10 10 30 -10

Jan. 11 Apr. 11 1 5 5 5 10 0
Jan. 11 May11 5 0 0 5 0
60 60
The above displays the life-cycle for a particular accident month. The financials for a particular
accounting month will reflect various accident months with transactions or outstanding reserves
during that month.
The establishment of the initial reserves for an exposure period based on actual activity is most
typical where most of the claims are reported relatively quickly and settled quickly, such as
for certain property lines in many jurisdictions. Such an approach is not possible if claims are
reported slowly and/or where the initial claim adjuster estimates are not sufficiently reliable
indicators of ultimate payout.
For product lines with slower reporting and/or payment patterns or where the initial case
reserves are less reliable at initial valuation, it is common to set the initial incurred loss estimate
based on an “a priori” estimate of loss exposure for the period. The following is an example of
such an approach where the initial estimate of incurred losses is based on an expected loss ratio
times earned premium.
Accrual of estimated incurred losses based on the level of earned exposure: The following
(simplifying) assumptions were made in the following example:
l z Claim activity is tracked and reserves set by accident year.

l z Earned premium for the 2012 calendar year is running ` 1,000 a month.
l z Based on an analysis of pricing and loss trends and expected underwriting, management
expects a 60% loss ratio for the 2012 accident year.

l z Only two loss reserve accounts are maintained, case and IBNR.
l z These two reserve accounts are further split in two AY buckets, the current AY (which is
2012 in this example) and all prior.
In this example, management determines the incurred losses for the current AY based on earned
premium for the period, and performs regular reserve reviews to determine if prior accident
year estimates should be changed. The illustration shown has such a change in estimate for prior
years.

Example 2: June 2012 reserve setting

step 1 - Determine incurred losses
AY 2012
June 2012 earned premium 1,000 a
Expected loss ratio 60% b

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