Loss Simulation Model Testing and Enhancement

Abstract. This paper is a response to the Casualty Actuarial Society’s call for papers on the topic of “Testing Loss Reserving Methods, Models and Data Using the Loss Simulation Model.” Its goal is to test and improve the Loss Simulation Model (LSM). The testing methods used are good sources for analyzing real claim data. A two-state regime-switching feature is also built into the model to add an extra layer of flexibility to describe claim data.

Motivation. The testing and enhancement of the Loss Simulation Model helps improve and refine the model. The test method may also be a good reference for performing tests on real claim data.

Method. Statistical tests are applied to the data simulated by the Loss Simulation Model. Standard distribution fitting methods such as maximum likelihood estimation are used to analyze real claim data. The open-source software LSM is enhanced via programming in Visual Basic.

Results. The LSM is enhanced with two-state regime-switching capability. Testing of the Loss Simulation Model according to the list suggested by the Loss Simulation Model Working Party is conducted. It shows the consistency between model input and model output for the addressed issues except case reserve adequacy.

Conclusions. Categorical variable and two-state regime-switching capability are added to the LSM. Testing of the LSM increases the confidence in the accuracy of this advanced and useful tool.

Keywords. simulation model; loss reserving; regime-switching; copula.