The Adjuster's Notebook: Getting Reserves Right (Part 1)

Editors Note: This is the first of a three part installment. Part 2 will run tomorrow.

Part One of Three: Introduction

When the claims audit was completed, it was clear that the self-insured program was under-reserved to the tune of $10,000.000.00. The program’s Board of Directors was incredulous. The actuary was distraught. The Third Party Administrator (TPA) was numb, and the TPA’s adjusters really had no idea what the “big deal” was. The implications to the financial integrity of the program were clear: the rates being charged for coverage were inadequate.  Further, dozens of reinsurance claims had gone unreported. When the current reinsurer was advised of the crisis, they had an auditor on a plane the next day. Reinsurers from the program’s earlier years were soon to arrive. It was obvious to all but the adjusters that the financial integrity of the program was compromised. Litigation between numerous parties that would last for years was soon to begin.

Inaccurate and untimely case reserving is one of the primary contributing factors of insurance company insolvency, and, while there are a number of departments within an insurer that can have an influence on reserves, getting case reserves right starts with the claim adjuster.

A case reserve is an amount of money that insurance regulators require to be set aside to pay a future claim liability. It represents the total cost of the claim, often referred to as the incurred loss. In certain types of insurance such as workers’ compensation, medical malpractice or products liability, the ultimate cost of the claim may not be known for years or decades. In the business of insurance this is what is known as a long-tail liability. It is incumbent upon the claim professional to forecast the ultimate cost of the claim as early as possible in the life of the claim.

In the business of workers’ compensation, recognizing a claim’s ultimate cost may be as simple as recognizing that a bump and bruise will only require one visit to the clinic, consequently incurring only a small dollar amount in cost. On the other hand, an employee falling ten feet from a lift device may suffer catastrophic orthopedic and closed head injuries. Such catastrophic severity will be reflected in the loss reserve for decades to come. In those instances, the ultimate cost can easily be in the millions of dollars.

What can go wrong?

Getting reserves right is critical to the insurance company or self-insured’s actuarial ability to predict their ultimate cost of claims. Briefly, here is a list of insurance/self-insurance processes affected by the under-reserving (aka deficiency) or over-reserving (aka redundancy) of claims liabilities:

• Insurer financial statements (balance sheets/income statements) are inaccurately valued.
• Tax labilities are incorrectly established.
• Frequency and severity rates are erroneous.
• Policyholder experience modification factors are too high/too low.
• Insurance rates aren’t calculated accurately.
• Incurred but not reported (IBNR) loss calculations are affected.
• The self-insured loss fund is over/under stated.
• Reinsurance programs (aggregate and specific) are adversely impacted.
• Letters of credit are incorrectly set.
• The reinsurer may be getting notice of too many or not all claims which contractually need to be reported.
• Policyholders, program members, do not receive the correct amount of dividend.

 - Rule for reserving: While you want your reserves to be as accurate as possible, a very general rule to follow is: It is better to be over-reserved than under-reserved. This rule does not condone inaccurate reserving, nor does it run contrary to the intent of this article. It says that being on the high side of a reserve, that is, being more conservative, allows for a cushion of reserve redundancy. Such redundancy moves the insurer towards a stronger financial position.

In our next installment we will look at how a financially sound reserving philosophy should read, and more rules for timely and accurate case reserving.

______________________________________________

Part 2, "Your Reserving Philosophy," will run, tomorrow, March 19, 2020.

About the Author

Brian Francis is a Licensed Insurance Counselor. He also teaches continuing insurance education on behalf of the Michigan Association of Insurance Agents. He can be reached at brian.riskresearch@gmail.com.

Share This Article: