Reserving Models: How to choose the right one

Choosing the Right Model

I thought it might be a good time to write up a summary on the major considerations needed in regards to choosing the right reserving model for the purpose required.

Choice of method depends largely on a few key factors but certainly not limited to:

  • estimates purpose
  • nature of business (long tail vs short tail, payment pattern, motor/workers comp/public liability etc.)
  • data availability
  • regulatory requirements (PS300, GPS310 etc.)
  • claims handling procedures (potential changes, etc.)
  • case estimating procedures (potential changes, consistency etc.)
  • prior valuation methods used
  • time available

 

Model When to use Issues/Considerations
Chain Ladder data is scarce
incurred cost is available
may show trends in claims cost but not always able to explain
PPCI – Payments Per Claim Incurred per claim rates of payment are the same for all accident year
(Short tail classes)
Change in payment pattern may result in over or underestimating OCL (sensitive to small movements in data)
PPCF – Payments Per Claim Finalised lump sum payments
(when no significant lag between settlement and finalisation)
rates of finalisation and ACS per duration are stable
Rates of finalisation can be distorted:
– backlog of claims
– claim cleanup campaigns
– change in settlement payment levels
– ongoing legal and admin fees
should not be used for periodic payments
PPCS – Payments Per Claim Settled lump sum payments
(where there are potentially ongoing legal and admin fees post settlement and finalisation is delayed)
as per PPCF
PPCH/PPAC shorter term periodic payments
Operational Time change in claims reporting  or finalisation rate over time Forces claims to a fixed rate of finalisation
Does not allow order in which claims are finalised to change
Complexity
PCE – Projected Case Estimates small number of claims
(used for runoff portfolio, older accident years – the tail, etc.)
reliable, stable, consistent claim estimating processes (claim estimates may be wrong but as long as they are consistent the PCE method can still be used)
Bornhuetter-Ferguson – Loss Ratio Method portfolio with limited or volatile experience or inadequate size / incurred claim development is lumpy
(e.g reinsurance portfolios, new products, small liability portfolios etc.)
selecting loss ratios (as per pricing assumptions or industry experience)
change in level of pricing (would affect selected loss ratio)
Annuity Method / PPCOB longer term periodic payments (eg long term disablement payments) can be done at an aggregate or claim level
data must be available to develop a continuance table (may need disability and sickness tables or decrement rates if experience limited)
analysis of average weekly earnings needed
assumptions for rate of recovery

It is not always the case that one model must be selected, multiple models can be fitted and blended together to arrive at an acceptable OCL. Generally speaking a common approach to blending models together is to use BF method to model the latest years, a PPCI/PPCF approach for middle years, and the PCE method for the older years. Another reason for using a blended approach is when there is a significant departure from historical experience between accident years.

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