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Legislation
 
More smoothing to IBNR results

05/05/2011

How to introduce a stronger reserving basis is always a tricky issue. Regulators wish to see higher reserves where necessary to protect policyholders. However a large change to a reserving basis can not only adversely affect profits in the period it is introduced; if the company has insufficient free reserves to cover the increase and any associated solvency margin, shareholders may need to pump capital in to the company to shore up reserves. 

In 2010 the Treasury took much-needed action to strengthen outstanding claims reserves by requiring companies to include a realistic reserve for claims incurred but not yet reported. For non-life branches this meant using a form of actuarial chain-ladder method (see related articles under tags below). Although mainly a non-life issue, this applies for accident and health branches. For life branch a late reported claim/average sum assured methodology is prescribed.

 

The impact of the change to IBNR has been much discussed in the sector, particularly being blamed in part for severe losses declared in the traffic branch since it was introduced in September 2010.

 

For example, during 2010 the outstanding claims reserves for the whole industry increased by 516 million TL, of which 461 million TL came from traffic branch.

 

Investigating the results of large players in the market shows the effect of the IBNR on results. Axa Sigorta, Axa’s non-life Turkish subsidiary, declared a new IBNR due to the introduction of the actuarial chain-ladder method of some 116 million TL.

 

Of course, increasing reserves does not actually change the profitability of a line of business. If a valid claim is coming it will come, whether it is notified last year, this year, or next year. A change in reserving just changes the timing of the incidence of profits. Under-reserving leads to over-declaration of profit that will turn into a loss when more claims are paid than expected next year. Conversely, over-reserving leads to under-declaration of profit that will turn into a profit when fewer claims are paid than expected next year, and reserves are released.

 

In order to sweeten the bitter pill of increasing reserves to more realistic levels, the Treasury allowed companies to take advantage of transitional arrangements and only reserve for 80% of the chain-ladder difference. (For example, above, Axa did this). If we extrapolate the 516 million to a 100% basis, the total sectoral IBNR reserve should have been over 600 million TL.

 

The 80% was to have been replaced by 90% this year. But the Treasury has just issued a general directive (Genelge No: 2011/10) which allows this transition, too, to be phased in over each quarter. That is to say IBNR at 31/03/11 should take at least 82,5%, 30/6/11 at least 85%, 30/9/11 at least 87,5% and 31/12/11 at least 90%.

 

This may well make life easier for some shareholders, and also avoid sudden increases to losses which may be viewed negatively in the financial press. But in discussions with shareholders about realistic solvency, and in calculating loss-reserves and setting premium rates, actuaries must have regard to the real position using 100% IBNR.

 
Tags: claims | reserves | IBNR | solvency |
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