I'm struggling to understand the solution to this question. a) It appears to assume that the 2m reserve relates to premiums earned in 2005 only, as it divides by the 2005 earned premium to get the loss ratio. But wouldn't the reserve cover claims from premiums earned in 2004 and maybe 2003 too? b) It calculates the ultimate loss ratio as paid plus IBNR (ie 10% / (1-25%) = 13%) which it then compares to the market loss ratio of 20%. But what about outstanding reported claims. How has it allowed for these? c) It also says that the fact that the paid loss ratio is increasing may suggest that the earnings pattern is inappropriate. But I would expect the paid loss ratio to increase given that initially there will be very few claims reported (due to low exposure), so payments will be low. The payments will increase as more claims are reported. Does anyone have any insight? Thanks.
I think they're maybe making the assumption that the business is stable. So the change in outstandings would be zero each year to give paid = incurred claims. The business is also quite short-tail (claims reported quickly and only paid for 12 months generally) If the business was expanding then you would expect the paids to increase over time but if it was stable then you would expect them to be the same over time (and they're not which implies the earnings pattern could be wrong). If they started writing in Jan 2003 then the business could be stable 3 years later. Just a thought.....
I can see that if the business is stable then the answer would make sense. But I don't believe the business will be stable after 3 years. The underlying loans are 3-5 years long, so the number of new policies will be greater than the number lapsing.
