Incurred but not enough reported - Why short term insurers should set IBNER claims reserves

According to Patrick Ndururi, executive head: actuarial services at Centriq Insurance, “it is in insurers’ best interest to hold extra reserves for IBNER (Incurred But Not Enough Reported) claims until the proposed SAM (Solvency and Assessment Management)

“I don’t expect IBNER claims reserves to be an issue under these two pieces of legislation, but holding extra IBNER claims reserves until it takes effect is the wise thing to do,” he says.

Holding IBNER claims reserves is a good idea overall, as much could potentially go wrong if IBNER claims reserves are not properly raised.

Patrick explains it as follows:

Short-term insurers’ claims reserves generally come in two forms:

- Outstanding claims reserves

These relate to claims that have already been reported to the insurer, but that have not yet been settled in full at the accounting date. The values for some of these claims, and especially those relating to short tail business classes will be readily available without further need for estimation. Long tail business classes (e.g. liability) and also some larger claims however require skill and relevant expertise of claims assessors to come up with estimates as the information on the claim may not be sufficient to apply statistical models.

- Incurred But Not Reported (IBNR) claims reserves

These relate to claims that have already occurred, but that have not been reported to the insurer at the accounting date. These reserves are generally determined using statistical models. Most statistical models will estimate the ultimate claims values, deriving the IBNR claims reserves by subtracting the outstanding claims (mentioned under ‘outstanding claims reserves’ above) and paid claims from the ultimate claims. Through board notice number 169 of 2011, the FSB (Financial Services Board) produced scales for each business class for a 6-year development period, which set the minimum statutory IBNR claims reserves.

As mentioned under outstanding claims reserves above, the estimation for long tail business classes and especially larger liability claims require the skill and expertise of claims assessors who normally have detailed knowledge of the applicable legal framework that tend to influence claims processes and outcomes. “The assessors work on individual claims files and make their estimate. Inevitably, the qualitative nature of these assessments however could potentially result in either under- or overstatement of the claims as circumstances continuously change. This highlights the need for insurers to hold an additional reserve called the IBNER claims reserve,” he explains.

Another reason for insurers to hold IBNER claims reserves is found in the outstanding claims estimation policy applied by the insurer. “The policy may state that if there was little or no information regarding a potential claim, a claim value of let’s say R1 should be raised. Obviously this increases the claim numbers, but leaves the claim amounts largely unaffected. If historical analysis shows that some of these types of claims were ultimately finalised by some amount, there is good reason for the insurer to hold IBNER claims reserves. Cognisance must also be taken of the fact that there could be a historical trend of overestimating the reserves, in which case a negative adjustment to the IBNR should be considered,” he adds.

“Although the after effect of inappropriate IBNER claims reserves will eventually filter through in insurers’ books, one of the most immediate issues that could arise is a premature recognition of profits. Dividends could be declared on results that did not fully reflect the true underwriting performance, not to mention the acceleration of tax computed. Also, if the administration fees were based on a sliding scale loss ratio, the fee could be overestimated initially. The reinsurance treaty programme may also have a profit commission payable to the insurer based on the underwriting performance, and a premature recognition of the profit commission could arise. The noted timing differences could also affect various accounting items or strategic decisions to take place like mergers and acquisitions for example,” notes Patrick.

Depending on the type of claims an insurer is faced with, a simplistic method to set IBNER claims reserves would be to raise a percentage on the normal IBNR reserves figures for the affected classes of business, e.g. 10% of the liability IBNR claims could be raised as IBNER claims reserves. The agreed percentage should be reverse-tested however to determine its suitability,” he says.

Commenting on where one would raise an IBNER claims reserve within financial accounts, Ndururi concludes that “the current IBNR financial entry could be defined to consist of both ‘Pure IBNR’ [as defined above] as well as IBNER.”

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