If these measures are adopted, I fail to see how a percentage of loss
reserves, including unearned premium, can be reasonable for volatile
long-tailed lines.
Brad Gile
Meyers, Glenn G. wrote:
> David:
>
> You idea of allocating surplus (or calculating risk load) in proportion
> to the loss reserve is conceptually different from allocating surplus in
> proportion to the duration - although in some cases the two could be
> close.
>
> Let me explain. The loss reserve should (at least in theory) be the
> same until the claim is paid. There is nothing in the loss reserve that
> indicates how long the supporting capital must be held. It indicates
> only how much loss should be paid.
>
> Now as you pay the claims, you reduce the loss reserve on the paid
> claims to zero and if you work through the math, the duration and the
> loss reserve (for the current and prior years) should be directly
> proportional ASSUMING THE UNDERLYING EXPOSURE HAS BEEN CONSTANT OVER
> TIME. In general, exposure is increasing. This could be really bad for
> a startup line of business.
>
> If given the choice between allocating surplus in proportion to the
> duration or the loss reserve, I would choose duration.
>
> Glenn Meyers
> Insurance Services Office, Inc.
> Internet: gmeyers@iso.com
> Voice:(212) 898-5938
> Fax: (212) 898-6060
>
> ----------
> From: Ruhm, David [SMTP:David.Ruhm@aig.com]
> Sent: Friday, June 26, 1998 11:07 AM
> To: 'CASNET'
> Subject: RE: Allocating Surplus and Risk Loads
>
> Three comments in reply to Glenn Meyers' comments on surplus
> allocation:
>
> 1) Mr. Meyers makes a good point that surplus allocation
> is primarily a pricing tool. In addition, it is also commonly used in
> the related, but retrospective, function of profitability analysis.
> When a company uses a surplus allocation method to calculate
> profitability (such as ROE), it makes sense for the company to
> prospectively price using a pricing model that is based on the same
> measure of profitability and that uses the same method of surplus
> allocation. Management's ability to aim for company targets is enhanced
> by use of such a "parallel" pricing model.
>
> 2) Mr. Meyers indicates that the "real purpose" of
> allocating surplus is risk load calculation. In fact, there may not be
> a singular ("real") purpose to allocation of surplus, but rather several
> practical applications.
>
> 3) Mr. Meyers makes the point that longer-tailed lines
> require surplus to be held longer, and that risk load should therefore
> be directly related to loss duration. This seems correct. One way of
> accounting for this is to allocate part of the surplus in proportion to
> loss reserves. An adjustment factor can also be included for the line's
> volatility of reserve development to ultimate. - David Ruhm
>
> Visit the CAS Web Site at http://www.casact.org
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