The Philosophy of Reserving

This paper is about how liability provisions should be set when there is material uncertainty. Conventional accounting practice is deterministic. A stochastic approach is needed. Since a single figure is needed in general purpose financial statements, the provision should include the value of uncertainty. There is a conflict between the measurement of solvency and profitability. The best estimate for provisions is a utility estimate, which is intended to provide a typical general user with a figure which will lead to the same decisions as a full understanding of the amount and uncertainty of the liability. Estimates should incorporate proper allowance for all known material influences, including discounting. Estimates made in isolation from previous estimates can be very erratic. A time series approach to estimation is needed, in which the estimates successively adopted only vary to the extent justified by the reliability of the corresponding isolated estimates.