The ABCs Of IBNR

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So what are 'incurred but not reported losses,' and what do they mean to your agency? The key to a credible analysis of IBNR is to gather as much data as possible that’s unique to the insurance program. Al Rhodes shows you how to analyze your IBNR in this document.

 

INTRODUCTION

An insurance program analysis includes a calculation of outstanding liabilities for all incurred claims. These liabilities form a key component of the costs associated with funding the program. The outstanding liabilities almost always exceed the reserves found on a loss run. The reserves are an estimate of future payments for each individual claim. The sum of the reserves does not equal outstanding liabilities because this sum excludes the impact of IBNR.

IBNR is an acronym for 'incurred but not reported losses.' IBNR includes development on known claims, as well as a provision for claims that have occurred but haven’t been reported as of a certain evaluation date. An IBNR analysis is usually prepared to meet regulatory or financial reporting criteria and is often required by external auditors as part of the audit process. The analysis is most frequently prepared for a self-insured trust, a captive insurance company, a corporation that uses a loss sensitive cash-flow plan, or as part of the due diligence process for mergers/acquisitions or divestitures.

The uses of an IBNR analysis include:

· Actuarial reserve certification

· Satisfaction of self-insurance requirements

· Negotiation of security requirements and letters of credit

· Acquisition due diligence

· Evaluation of expected liabilities for financial statements

BASIC METHODOLOGY

The calculation of IBNR includes:

  • Calculating ultimate losses for each policy period using one or more actuarial techniques.
  • Comparing the estimates from each technique and making a selection of ultimate loss.
  • Subtracting paid losses and case reserves from the estimated ultimate incurred losses to calculate the IBNR.

DATA

The first step is to gather the necessary data, including incurred and paid losses summarized by policy period. Limit the losses to per occurrence and aggregate limitations. A current loss run of all claims has all the information needed to summarize the losses.

Adjust the limited losses to an ultimate cost level. The most common technique is to use loss development factors. These factors quantify the late developing aspects of certain losses. They also account for losses that occurred during a period but aren’t reported until a later date.

There are a number of sources of loss development factor data: actuaries, brokers, insurance companies, and risk management consultants all gather this information. The information received from an external source might not be appropriate for every situation. If the historical data is available, then calculate unique loss development factors. Unique factors would allow for a more accurate reflection of specific loss development patterns. Theoretically, the use of unique factors, as opposed to industry averages, produces a more accurate projection of ultimate incurred losses.

Select the development factors applied to reported losses based on the time that has passed between the beginning of a loss period and the evaluation date of the losses. In most cases, the closer the evaluation date is to the period effective date, the larger the loss development factor needed. Conversely, as the period matures, the loss development factor approaches 1.000. To estimate the expected ultimate losses for each period, multiply the development factors by the reported losses for each period.

If you use both incurred and paid losses, you’ll need to select a weighted average of the two estimates of ultimate loss for each period. The final step is to subtract paid losses from the selected ultimate losses.

A convenient way to demonstrate the impact of IBNR is to show the various components of the estimated ultimate incurred losses for the insurance program. This chart summarizes the components.

Estimated Required Reserves

Estimated

Ultimate

Reported

Estimated

Incurred

Paid

Required

Case

Period

Losses

Losses

Reserves

Reserves

IBNR

xx

$185,849

$185,849

$0

$0

$0

xx + 1

190,000

146,976

43,024

20,000

23,024

xx + 2

270,000

175,130

94,870

61,000

33,870

xx + 3

300,000

203,060

96,940

44,927

52,013

xx + 4

750,000

342,255

407,745

236,669

171,076

xx + 5

680,000

142,993

537,007

218,059

318,948

Total

$2,375,849

$1,196,263

$1,179,586

$580,655

$598,931

Estimated ultimate incurred losses are defined as the amount needed to provide for the cost of claims relating to events that occurred during each period. This includes the estimated required reserves, which is the amount that will be required for future payments on (1) claims that have been reported and (2) claims that have occurred, but haven’t been reported as of the evaluation date. The estimated required reserves are then segregated between case reserves and IBNR. Calculate case reserves as reported losses minus paid losses. IBNR includes development on known claims, as well as a provision for claims that have occurred but haven’t been reported as of a certain evaluation date.

SUMMARY

The key to a credible analysis of IBNR is to gather as much data as possible that’s unique to the insurance program. A current loss run allows the calculation of ultimate losses without relying on industry severities and frequencies. Prior yearly evaluation of losses will allow the calculation of unique development factors. An understanding of all per occurrence and aggregate limitations will allow the correct amount of each claim to be included in the calculation.


Al Rhodes, ACAS, MAAA, is president of SIGMA Actuarial Consulting Group, Nashville, TN. He can be reached at (615) 352-3944 or
e-mail 
alrhodes@aol.com.

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