Understanding IBNR

A loss reserve¹ as shown on an insurer’s financial statement is a provision for their claim liability as of a certain accounting date. It is composed of two elements: case reserves and incurred but not reported (IBNR) reserves. This article discusses IBNR reserves after a brief definition of case reserves.

Case Reserves are assigned to specific known claims, determined by claims adjusters or set by formula. Adjusters’ estimates are made for individual claims, based on the facts of the particular claims. Formula reserves are established for groups of claims for which certain classifying information is provided.

IBNR Reserves provide an aggregate provision for (a) development on known claims and (b) an estimate for claims that have occurred but have not been reported as of the accounting date. Development on known open claims is often called Case Reserve Development. Development can also impact closed claims, which are closed as of the accounting date, but may reopen due to circumstances not foreseen at the time the claims were closed. The tendency for closed claims to reopen varies substantially among lines of business. Judicial opinions and legislation can affect the reopening of claims, as can changes in an insurer’s procedures. While some people use the term Incurred But Not EnoughReported (IBNER) reserves to refer to the development on known claims, it is important to note that development can be positive or negative. Negative development implies that case reserves are redundant.

Many insurers consider a claim to be reported when it is first recorded in the insurer’s accounting records. Reserves for claims that have occurred but have not been reported as of the accounting date are called Incurred But Not Yet Reported (IBNYR) reserves. This provision results from the normal delay that occurs in reporting losses and may sometimes include claims in transit (incurred and reported, but not recorded). Incurred and Reported But Not Recorded reserves account for the additional time consumed by the insurer’s recording procedures. As a practical matter, it is not usually feasible to measure these two elements separately, but it is important to understand the effect reporting procedures can have on the amount of IBNR reserves. These two elements are often grouped together and collectively called IBNYR. For some insurers, claims in transit are considered known claims.

While IBNR is technically defined as claims with report dates later than a particular accounting date with accident dates equal to or earlier than the accounting date, in practice, a broader definition is sometimes used. The broader definition of IBNR includes case reserve development, a provision for reopened claims and IBNYR (including Incurred and Reported But Not Recorded) reserves. In these cases, the narrower definition of IBNR (aka IBNYR) is often called Pure IBNR to distinguish it from the broader definition.

The confusion regarding the definition of IBNR can result from the differing approaches insurers use in estimating loss reserves, either grouping claims by their report date or their accident date². By grouping claims based on report date, the adequacy of existing reserves can be estimated based on historical results but requires further analysis to measure the emergence of Pure IBNR. By using an accident date segmentation, the ultimate cost of all claims, both known and unknown, is estimated without segregation of claims incurred but not reported. The estimated loss reserve can be apportioned between Pure IBNR and known claims on a suitable basis. Because accident period techniques do not necessarily require separate treatment of known and unknown claims, their use can lead to the broader IBNR definition mentioned above.

Actuaries can determine IBNR using many different methods, and often do not distinguish between the different actuarial reserves discussed above. In these cases, the actuary’s IBNR represents a total provision for the ultimate value of claims not accounted for in the case reserves. IBNR can vary greatly depending on the characteristics of the line of business and claims handling practices and the type of policy coverage and insurance layer.

Property lines of business tend to have shorter reporting and settlement periods than casualty lines. At the same age of maturity, one would expect that the IBNR reserves for property lines would be smaller (as a percentage of the case reserves) than for casualty lines of business.

Claims’ handling practices can vary significantly among companies: How long does it take to set an initial claim file? Does the company use formula reserves? If so, how long before they review the specific claim details? Does the company increase case reserves incrementally or set a full ultimate estimate early on? Does the company set case reserves for expenses as well as losses? The answers to these questions will help determine the magnitude of IBNR reserves.

Policies providing claims-made coverage are triggered when a claim is reported, so there is no Pure IBNR reserve to estimate, only case reserve development and a provision for reopened claims. Occurrence and tail policy coverages would necessitate estimates for Pure IBNR reserves as well as case reserve development and reopened claims.

Primary insurers will generally have a faster claims reporting pattern than reinsurers, due to the reporting lag to reinsurers and claim development lag to reach reinsurance layer thresholds. Therefore, primary insurers’ IBNR needs may be different than their reinsurers.

Understanding the components of your loss reserves and, specifically, the different contributors to and characteristics of the IBNR reserves, will benefit your conversations with your actuaries, auditors, and financial team.

Steven Lesser, FCAS, MAAA is a consulting actuary with Huggins Actuarial Services, Inc., with over 30 years of experience.

https://hugginsactuarial.com/steven-j-lesser/ 

1 The term reserve applies to both loss and loss adjustment expense reserves.

[1] Claims can also be grouped by other segmentations, such as policy or underwriting year.