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.
