Multi-year contracts - Reserving and capital requirements

[vidhya36]

I have few questions in the context of reserving for Multiple-year construction GI contracts

1. What impact do I see in outstanding unpaid claims and in UPR/URR for multple-year GI contracts compared to annual contracts? It is my understanding that, the insurer may lose the ability to re-price the contract during the term of the contract. As a result, UPR/URR should tend to be a relatively higher portion of total reserves compared to annual contracts. How and when AURR is established in this context?

2. How does one estimate the unearned/expired loss reserves on a multi-year contract? Will the earning pattern considered be annual – if so, why and what’s the assumption driving this annual earning pattern assumption? If seasonal, how it is obtained and used in general, in the industry? What if the seasonality changes during the middle of the project?

I was initially thinking, the earning pattern would be based on project plan which may provide a view of risk exposure for the insurer. The reason for my doubt on second question stemmed post I read below towards last 5th passage from 4.2 Premium recognition and unearned premium liability (pwc.com)
There are two schools of thought on aggregate excess of loss contracts. Some consider the coverage to have risk over the whole period for a yet to be determined portion of each claim in the period and thus recognize premium evenly over the entire period. Others consider the risk covered to be concentrated in the later part of the period when the threshold for coverage is more likely to be exceeded.

 

[vidhya36]

* I wanted to say Will the earning pattern considered be uniform – if so, why and what’s the assumption driving this uniform earning pattern assumption?

 

[Aman Sehra]

1. What impact do I see in outstanding unpaid claims and in UPR/URR for multple-year GI contracts compared to annual contracts? It is my understanding that, the insurer may lose the ability to re-price the contract during the term of the contract. As a result, UPR/URR should tend to be a relatively higher portion of total reserves compared to annual contracts. How and when AURR is established in this context?

The AURR is the additional unexpired risk reserve, which is needed when it can be demonstrated that the UPR won't be enough to cover the losses on the unearned premiums. The term of the policy shouldn't have any impact on the AURR. For example, if a policy is one year or two years, if the losses are expected to be greater than the unearned premium can allow for, then there will be an AURR. The total AURR would be the same if there were a single two-year policy, or if there were two one-year policies (assuming all else being equal).

2. How does one estimate the unearned/expired loss reserves on a multi-year contract? Will the earning pattern considered be annual – if so, why and what’s the assumption driving this annual earning pattern assumption? If seasonal, how it is obtained and used in general, in the industry? What if the seasonality changes during the middle of the project?

The earning pattern will be linked to exposure. If I took out a 5 year policy to build a office block, the first year may be just digging in the ground (so you can't really have a loss there), but the final year may be a fully fitted and almost complete building (the potential loss is greatest here). So, it very much depends on the exposure. To help think about this, on the other side, we can think about an already built office block. The chance of a fire is pretty much the same all year round, so a consistent exposure, thus a uniform earning pattern.

In practice, the insurers own statistical analysis will be used to support the earning pattern used.