Reserves, Surplus and Uncertainty

With the passage of the Tax Reform Act of 1986, the topic of amending statutory and/or GAAP accounting to reflect the time value of money when stating reserves for loss and loss adjustment expenses has gained attention. In conjunction with the discounting issue, the subject of reflecting a provision for adverse claim development has also gained wider attention, The aim of this paper is to present a framework for the calculation of the size of this provision and to discuss the associated accounting issues. Actual company loss reserve information for several lines of business as well as companies of various size was considered. Both parameter risk and process risk are discussed and reflected in the model. Conclusions arising from these models include: The familiar 2 to 1 premium to surplus ratio is not appropriate for all companies nor for all lines of insurance, and that the difference between undiscounted and discounted reserves produces a greater margin than our model suggests.