Sept 2011 Exam Q5 - Technical reserves

[David123]

Hi,

I'm having trouble getting my head around the investment income on the accounts question. More specifically around the calculation of the technical reserves.

1) What specifically are the technical reserves - is it the reserves to cover all estimated future liabilities (expense and claims)?

In the answer they present the technical reserve to be UPR(net) plus Outstanding claims reserves. We assume no AURR in the question I think.

2) Am I right in thinking this is correct because the OCR is cash we have to cover claims that we know about but have not paid (so we still have the assets) and the UPR covers claims we do not yet know about (again we have the assets to earn a return on. Both of these together cover all our claims payments that will arise after the accounting date.

3)The OCR for the large claims in the question is calculated as 75% of the difference between premiums received on day 1 and the UPR at that time. Why is this?

Thanks,
David

 

[Coralie Clarke]

Hi David,

1) What specifically are the technical reserves - is it the reserves to cover all estimated future liabilities (expense and claims)?

In the answer they present the technical reserve to be UPR(net) plus Outstanding claims reserves. We assume no AURR in the question I think.

The technical reserves are the reserves needed to cover the claims arising from business already written. So this will include outstanding claims reserves (ie outstanding reported, IBNR, IBNER, reopened claims, claims handling expenses). Some of the business written will not yet be earned and so the UPR (and in some cases an AURR) will be held to cover these claims, and this will also form part of the technical reserves.

2) Am I right in thinking this is correct because the OCR is cash we have to cover claims that we know about but have not paid (so we still have the assets) and the UPR covers claims we do not yet know about (again we have the assets to earn a return on. Both of these together cover all our claims payments that will arise after the accounting date.

The OCR is not necessarily cash. It might be invested in gilts or short-term bonds.
Be a bit careful here: the IBNR component of the reserves covers claims that have happened but that we don't yet know about - but these are included within the OCR, not the UPR. The distinction between OCR and UPR is more about whether or not the exposure has been earned as at the accounting date.

3)The OCR for the large claims in the question is calculated as 75% of the difference between premiums received on day 1 and the UPR at that time. Why is this?

It's actually 25% (not 75%).
The OCR is the incurred to date minus the paid to date.

We are told that the expected loss ratio for the large contracts is 65%, so:
OCR = 65% of the earned premium - 40% of the earned premium
= 25% of earned premium.

The earned premium is the written premium minus the unearned bit of the premium.

So OCR@31/12/09 = 25% x (180,000-166,430)
and OCR @31/12/10 = 25% x (180,000-146,071).


Coralie

 

[mario]

Would you lose marks for not splitting the investment return between free reserves and technical reserves (and showing them separately?)

I assume you would... But hoping not more than a mark or so?

(I know in this question actually it was easy to split because you have to work out the free reserves using the technical, but wondering in general).

Tough question... I was stumped for ages because I'd forgotten we were given the loss ratios at the start of the question!

Thanks as always for any help!

 

[Coralie Clarke]

Hi Mario,

In some questions, you may not have enough information to split the investment income between the technical reserves and the free reserves but, if you do, I would always do that and show them separately.

It would depend on how generous the examiners were feeling but I don't think you'd lose much more than ½ a mark or so for not splitting, but every ½ mark is potentially the difference between a pass and a fail so I wouldn't take the chance...

When doing accounting questions, I always think it's useful to write out the layout of the accounts at the start and then fill in numbers as you calculate them. If you do this then you'll automatically have the two types of investment income as separate items.

Coralie

 

[DanielZ]

The retained profit for this P&L comes to 8.3m, however this is not reflected by a corresponding increase in shareholder funds. Isn't this inconsistent?

Thanks

 

[Darren Michaels]

Yes that's right. The requirement that the total assets stay the same from one year to the next coupled with the dividend payout restriction create the inconsistency you have identified in the question.

In any case it wouldn't have affected the marks given. You might have created a good impression with the examiner if you had noted it down though

 

[tf5g08]

Hi regarding the 2010 OCR calculation for large, I understand it's 25%*earned premium. But the earned premium for 2010 is 166.4-146.071 which is the change in UPR since written premium is 0. I don't understand why the notes says 25%*(180-146.071). Thanks for the help in advance!
Ting

 

[Darren Michaels]

To understand fully what is going on here, it probably helps to break things down into pieces.

The OCR for the large contracts will be the case estimates. This will be the different between the claims reported to date (ie the incurred claims) and the total claims paid to date.

To calculate the incurred claims at each point in time, we multiply the earned premiums by the expected loss ratio (65%). Here we need all of the earned premiums to date and not just those earned in the year in question.

So for 2009 incurred claims =65% * 13.57 = 8.82 and for 2010 incurred claims =65%*(13.57+20.36)=22.05

Similarly the total claims paid to date are 40% of the total earned premiums to date.

So for 2009 total paid claims to date =40% * 13.57 = 5.43 and for 2010 total paid claims to date =40%*(13.57+20.36)=13.57

Hence OCR=incurred claims - total paid claims to date

for 2009 OCR c/f = 8.82-5.43=3.39
for 2010 OCR c/f = 22.05-13.57=8.48