Q&A Question 6.2

[marymaj86]

Hello

I am finding some parts of Question 6.2 in the Q&A Bank (parts (ii) (a) and (b)) very difficult to understand, and I was hoping to ask a few queries about them.

Firstly, part (ii) (a) involves calculating the underwriting result for three years. The solution shows that part of the underwriting result is a claims adjustment, which is a release of surplus due to a reduction in loss ratios. I cannot see where the adjustment comes from, though, apart from the 20.25 in 2008 - which seems to be ((80% - 70%) * 202.5).

In part (ii) (b), I am unsure how the surpluses arise at the end of each year. For example, there is a 4.05 surplus at the end of 2007, even though we had just been told that a loss of 2.03 had been incurred in 2007.

At the end of 2008, there is a release of surplus of 12.27 - again, I cannot see where it came from. Also, 8.18 is "released immediately" (perhaps to cover the loss in 2008), but why does the remaining 4.09 stay in the fund if it, too, has been released?

It seems to be the case in this question that if a loss occurs, it is recognised immediately, but if a profit is made, it is not recognised until the end of the 3rd year; is this correct?

Many thanks in advance for any advice that you can give me on this.

 

[Ian Senator]

Part ii(a):

The 20.25 is the 10% (80-70) of 202.5, as you say.
10.13 is 5% (ie 70-65) of 202.5 (the further drop in the LR from 2007).
40.88 is 15% (ie 85-70) of 272.5 (the further drop in the LR from 2008).

Part ii(b):

4.05 is the difference (ie ceded amount) between 20.25 and 16.20 from the earlier table.
12.27 is the difference between 40.88 and 28.61, and 2.03 is 10.13 minus 8.1.

You're right, losses are recognised each year, yet profits are not recognised until the end of the 3 years. This is normal for funded accounts. Similar things happen in accident year accounts too - because profits in the future are not recognised, but if you think you'll ultimately make losses, you have to set up an AURR.

Hope this helps
Ian

 

[marymaj86]

That's great, thanks!!

 

[jack123]

Hi, I am very confused on this question! Are we trying to construct UW year accounts for the reinsurer? What is the definition of ultimate in the table? What type of year is in the ultimate table header - AY/UWY/accounting year? I can't seem to make sense of any of the options

 

[Ian Senator]

Yes, you're constructing accounts for each underwriting year - but as the loss ratio changes, you have to 'update' your view on the claims as you gather more information on the losses, which acts to change how the experience is recorded (which is what accounts is all about) for each original underwriting year. Don't forget that funded accounts tracks one year of written business over so many years (3 for Lloyd's), it's how experience changes from year to year and the effect on the accounted figures that this question is examining.

 

[jack123]

Sorry, I'm still confused. On revisiting this question, I assumed it was asking for annual accounts to be produced for each particular underwriting year. But then the question states they have 'three year' accounts, which suggests funded accounting. If the question is asking for a funded accounting approach, shouldn't we be using paid claims rather than incurred?

 

[Ian Senator]

Annual accounts can refer to accident year accounts. However, many people use 'annual accounts' to refer to any accounts that are produced or reported annually (which is pretty much all of them!). Funded accounts can be three year, two year, one year, 10 year, anything - although Lloyd's use three year funded accounts for internal purposes.

As for your second question, don't make the mistake of assuming that reserves aren't calculated (is that what you mean by 'used'?) for funded accounts - they are still calculated and reported, and changed over time. It's just that for funded accounts, you don't crystallise the profit/loss until the end of the funding period (eg 3 years). I think you may be confusing the use of paid claims when you're calculating investment returns on cashflows.