Surplus - Concepts, Measures of Return, and Determination by Russell E. Bingham, 1993 - Discussion

Russell Bingham advocates such a decomposition of balance sheet surplus and income statement flows into the contributing accident years. Because a given exposure period frequently impacts many annual statements, this decomposition results in the formation of historical supporting surplus triangles that are analogous to the loss development triangles used in the analysis of reserve level adequacy. Two refinements to the model are then introduced. The first refinement involves changing the basis for determining the benchmark surplus from nominal loss reserves to discounted loss reserves. This allows for a reflection of both ultimate loss amount risk and payout timing risk. The second refinement involves replacing the constant reserve-to-surplus ratio with a variable leverage ratio. An examination of the behavior of Bingham‘s methodology in two extreme pricing situations (severe rate inadequacy and severe rate redundancy) discloses that the simplified model does not produce reasonable results under these extreme conditions unless the leverage ratio is a function of the expected retained operating gain.