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Why use different methods to calculate reserve in Life and Non-life insurance ?

Discussion in 'General study / exams' started by Duc Thinh Vu, Sep 29, 2021.

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  1. Duc Thinh Vu

    Duc Thinh Vu Active Member

    Hi everyone,

    The context of this question: As in reserving in Life insurance, we use the technique of discounting the future cashflows (include future premium and future claims/ charges). In reserving in Non-life insurance, I often see that they use the method such as Chain Ladder to calculate the reserve and I don't see the concept like "discounting future cashflows" or taking into account future premium.

    So as a student, I would like to know why do we use different methods to calculate reserve in Life and Non-life insurance ? Or in other words, in calculating the reserve in life insurance, can we use the Chain Ladder method, or, say, to calculate reserve in non-life insurance, we use the formula: Reserve = PV(Future claims) - PV(Future Premiums) ?

    Thank you very much for your help!
     
    Duc Thinh Vu, Sep 29, 2021
    #1
  2. Ian Senator

    Ian Senator ActEd Tutor Staff Member

    Hi Duc

    Essentially, the methods are in fact the same. It's just that the components of that calculation are different because of the differences between life and general. To keep it simple, consider just one existing motor insurance policy, and one existing simple life insurance policy.

    For the motor policy, there are no future premiums. And for the claims, there can be multiple claims, adjusting (developing) in size over time too. You can indeed discount the payments very easily based on their timing. See Subject SP7.

    In life insurance though, you have a policy lasting years, you pay future premiums, you either claim once for a known amount (generally bad news!) or you don't claim at all. See Subject SP2. A triangulation is going to look very dull indeed.

    There are complications that will make this more interesting, eg the value of future new business, the different purposes of calculating reserves, etc. Welcome to SP2 and SP7!

    Ian
     
    Ian Senator, Sep 30, 2021
    #2
    Duc Thinh Vu likes this.
  3. Duc Thinh Vu

    Duc Thinh Vu Active Member

    Hi Ian,
    Thank you very much for your answer, it is much clearer for me now. However, could you please tell me why (in the general view) "A triangulation is going to look very dull indeed" ? In detail, the triangulation is "dull" in which sense in your point of view ? (i.e. why you call it "dull").

    As for me, isn't it just make the triangle "much bigger" (i.e. the dimension of the triangle will be much bigger) in the case of life insurance than in the case of non-life insurance. But with the modern technology, say, excel, I think we can manage a big triangle. And moreover, the triangle method is quite simple to implement comparing to the existing methods in life insurance.

    Thank you very much for your help!
     
    Duc Thinh Vu, Oct 2, 2021
    #3
  4. Ian Senator

    Ian Senator ActEd Tutor Staff Member

    'Dull' in that life assurance claims don't generally develop (individually) by themselves. The whole point of a triangulation (eg chain-ladder method) is to make use of the basic assumption that claims development is used to predict the future, based on past reporting delays and settlement delays. Not much of those delays in life assurance, I have to say. If development is just 'how many people will die in a particular year', then you may as well just use a simple probability (ie life table) rather than a triangle. Try putting a triangle together for a group of life policies and you'll see what I mean.
     
    Ian Senator, Oct 2, 2021
    #4
  5. Michal Piatra

    Michal Piatra Active Member

    Agree with the above. However, triangulation methods might be used also in life insurance for incurred claim reserves estimation such as IBNR.
     
    Michal Piatra, Oct 3, 2021
    #5

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