This is the second instalment in our series of blogs on improving your reserving through better analysis and understanding of case reserves. If you've missed our introductory instalment, you can find it here.
In this blog, I look at the use of paid to incurred ratios. This is perhaps the most basic metric used by reserving actuaries to assess case reserving strength. A key advantage is that the data is readily available from the triangles used in the main reserving process. It is also a metric that has featured heavily in challenge from regulators - including Lloyd’s and the PRA - having been included in the PRA’s ‘Dear CRO’ letter in 2020 and its ‘Dear Chief Actuary’ letter in 2019.
I will show how this simple ratio leads to valuable insights by being analysed over time and by using alternative presentation of the data. It is essential to first identify trends in order to investigate them fully, gain an understanding and ensure your assumptions and results remain appropriate.
Example: Plotting ratios across development periods by accident cohort
This relatively simple method involves plotting ratios by accident cohort over development periods, as in the chart below. This allows us to identify changes between the cohorts; such as spotting areas where a greater proportion of incurred claims have been paid compared to other cohorts at the same development period. The method can be applied to both accident and underwriting cohorts.
The above example shows an increasing trend - or ‘fanning out’ - in the paid to incurred ratios. A potential driver of this may be the standard case reserving estimates remaining the same year on year while the actual claim payment amounts have increased, perhaps due to inflation. Alternatively, the trend might reflect a speeding up of claims settlements; for example, due to changes in the claim handling process.
Once you have identified the trend, you can then investigate its cause to gain a better understanding of the portfolio movements and respond appropriately when setting your reserves.
Example: Plotting ratios across accident cohorts by development period
Further insight can be achieved by looking at the same ratios in an alternative way. Plotting by development period allows you to identify changes that have impacted all cohorts at the same time. This draws focus to the date in question and allows you to investigate further where needed, such that you can recognise and understand the driver of such changes.
The above example is based on the same data as the first chart. In this version, each line represents a development duration (3 months, 6 months etc, from the bottom-up). The transposed view shows that there is a sharp decline in paid to incurred ratios at almost all development durations in 2013. This may have been driven by a change in legislation, a systematic case reserve review, or a change in case reserve methodology at the given time period. Understanding the cause of the change and its potential impact can help ensure you are using appropriate assumptions and that your future claims analysis accounts for such systematic changes.
Limitations and implications of the analysis
The paid to incurred metric is most appropriate for relatively stable business and where claims data isn’t significantly distorted by large losses.
The key limitation is the potential difficulty in isolating the impact of changing settlement speeds verses true changes in case reserves. Therefore, the metric should be considered in tandem with other metrics and will be most valuable where there is clear communication between the actuarial function and other business functions - particularly the claim management function.
Next steps
In the next instalment I will consider how you can gain deeper insight into case reserving strength by analysing claims development using reporting cohorts. At the end of the series, we’ll bring it all together into a handy ‘best practice’ guide for assessing and tracking your case reserve strength.