Using Utility Theory For Describing Best Estimate Reserves

Actuarial analysis has been described as a blending of science and art. Mathematical modeling involving probability, statistics, regression, and basic arithmetic form the scientific component. Business knowledge, insight, and experience regarding the influence of internal and external conditions and events on insurance data provide the art, also known as judgment. In the context of best estimate claims reserving for property casualty insurance, the quantitative and qualitative viewpoints are brought forward by the various professionals associated with the reserving process. These professionals include actuaries, management, regulators, auditors, and others. Their associations may be at the time the reserve provisions are being decided, or through subsequent review or testing of the reserves. Utility theory provides a useful framework in which to identify and describe the various interests and motivations of the various parties with an interest in the recorded reserves. We discuss each party’s view as to the preferred or optimal estimates, for which each party’s utility is maximized. We conclude by defining a best estimate as the one that maximizes the aggregate utility for the parties directly involved in the process.