A variety of methods to measure the variability of property-liability loss reserves have been developed to meet the requirements of regulators, rating agencies and management. These methods focus on nominal, undiscounted reserves, in line with statutory reserve requirements. Recently, though, there has been a trend to consider the fair value, or economic value, of loss reserves. Insurance regulators worldwide are starting to consider the economic value of loss reserves, which reflects how much needs to be set aside today to settle these claims, instead of focusing on nominal values. If insurers switch to economic values for loss reserves, then reserve variability would need to be calculated on this basis as well. This approach will add considerable complexity to reserve variability calculations. This paper combines loss reserve variability and economic valuation. Loss reserve ranges are calculated on a nominal and economic basis for a simplified insurer to illustrate the key variables that impact loss reserve variability. Nominal interest rate and inflation volatility, interest rate-inflation correlation, and the relationship between claim cost and general inflation are key factors that affect economic loss reserve variability. Actuaries will need to focus on measuring these values accurately if insurers adopt economic valuation of loss reserves.
The model used in this project is available for download at: http://www.business.uiuc.edu/~s-darcy/papers/LossReserveRangeModelv2.xls
Keywords: loss reserve ranges, economic value, stochastic simulation
