New Swiss Re sigma study: Non-life reserving: Improving on a strategic challenge
28 May 2008, Zurich
Swiss Re's latest sigma study focuses on how the insurance sector can improve its non-life reserving practices. In addition to explaining reserving methodologies, the study suggests that improvements in reserving will be beneficial for the industry as well as its clients and shareholders.
Claims reserves (or provisions) are funds that are set aside for claims that have not yet been paid. Because claims reserves are often bigger than an insurer's equity, changes in reserves can heavily impact an insurer's profits.
According to Swiss Re's latest sigma study, "Non-life claims reserving: improving on a strategic challenge", claims reserves are particularly important for "long-tail" lines of business, where the identification and settlement of claims can take a long time. In liability, claims reserves on the balance sheet typically represent 300% to 450% of premiums earned in any one year.
"Insurers are increasingly recognising that they have to pay more attention to reserving" explains Rudolf Enz, the author of the study. "Shareholders are becoming more reluctant to accept that blocks of business originally identified as being reasonably profitable could instead trigger substantial losses. At the very least, they want to understand when and why such revisions take place."
Factors that lead to reserving errors
While insurers use well-tested actuarial approaches to determine reserves, even the best reserving methods will always be subject to adjustments – as the nature of risks and the resulting claims are subject to unforeseen events and other factors, such as technological and legal developments, medical progress and changing attitudes in society and legal developments.
Many of the reserving errors in the past occurred due to factors that were beyond the control of the insurers. Unexpected legal developments have cost insurers billions of USD.
The US asbestos and liability crisis, which led to dramatic reserve adjustments in the 80s, is a prominent example.
The escalation of health and wage costs, coupled with increasing life expectancy, has also had an adverse impact on claims. Although some of the developments may have come as a surprise, others were expected and reserving practices may not have been adapted sufficiently.
Reserve changes are also tied to the insurance price cycle
The sigma study also describes how under and over-reserving is tied to the insurance price cycle. The data suggests that low pricing and under-reserving are interrelated.
Why improved reserving is important
Rudolf Enz points out that "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."
Better reserving is supported by the trend towards more transparency, which is strongly supported by changes in accounting standards and regulatory rules. According to Rudolf Enz, "policyholders benefit because adequate reserves help insurers avoid the risk of insolvency. Moreover, shareholders benefit because transparent and adequate reserving will help to promote rational pricing and this in turn will lead to more stable and most probably also more profitable insurance results."
Notes for editors
Swiss Reinsurance Company Ltd
Swiss Re is a leading and highly diversified global reinsurer. The company operates through offices in more than 25 countries. Founded in Zurich, Switzerland, in 1863, Swiss Re offers financial services products that enable risk-taking essential to enterprise and progress. The company's traditional reinsurance products and related services for property and casualty, as well as the life and health business are complemented by insurance-based corporate finance solutions and supplementary services for comprehensive risk management. Swiss Re is rated "AA-" by Standard, Poor's, "Aa2" by Moody's and "A+" by A.M. Best.
How to order this sigma study:
The English, German, French, Italian and Spanish versions of the sigma study No 2/2008, 'Non-life reserving: improving on a strategic challenge' are available electronically on our publication section. The versions in Chinese and Japanese will appear in the near future.
Printed editions of sigma No 2/2008 in English, French, German, Italian and Spanish versions are also now available. The printed versions in Chinese and Japanese will be available shortly.
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