Revisions in Loss Reserving Techniques Necessary to Discount Property-Liability Loss Reserves

Statutory accounting principles for property-liability insurers in the United States in all but very special circumstances do not recognize the time value of money in the establishment of the loss reserves. The Tax Reform Act of 1986 stipulates an interest rate and a methodology for discounting loss reserves for tax purposes. The National Association of Insurance Commissioners (NAIC) is studying the discounting issue. Insurers need to consider the appropriate procedures and interest rates to be used in discounting loss reserves. This paper proposes a method of calculating loss payout patterns ‘based on paid loss development data combined wit?) other reserving techniques that would minimize the additional effort involved in adopting discounting and also analyzes the repercussions of adopting discounting for statutory accounting purposes. Discounting loss reserves would have both positive and negative effects on the property-liability insurance industry. Discounting at an appropriate interest rate would increase the usefulness of the combined ratio as a profitability measure, with values less than 100 indicating profits and in excess of 100 indicating losses subject to the accuracy of loss reserves. Statutory surplus would increase as a result of discounting, which, although having no real economic effect, might provide more capacity for the insurance industry due to regulatory reliance on statutory values. Conversely, discounting would increase the complexity of loss reserving, create a dependence of reserve adequacy on future interest rate levels, and increase the expenses of insurers by raising tax levels. Discounting would have its greatest impact on commercial and professional liability insurers.