October 10th, 2012

What is the Reserving Cycle?

Posted at 1:00 AM ET

leong_jessica_gcciJessica Leong, Lead Casualty Specialty Actuary
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Reserve releases have helped support financial results in the face of significant catastrophe losses in recent years. There are nevertheless indications that reserve redundancies will soon run out even though the sector continued to benefit from reserve releases on a calendar year basis in 2011. Figure 1 shows how calendar year redundancies have been a feature of earnings for a composite of 26 large U.S. P&C carriers since 1995.

Figure 1

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By analyzing the reserving cycle, we can begin to understand the paradox of accident year deterioration and calendar year redundancy and get a better indication of what we may see in 2012 and beyond. It is generally accepted that the sector goes through cycles of reserve deterioration and reserve releases and that we are at the tail-end of the latter. But why do we have these cycles at all?

Guy Carpenter has begun to look at the reserving cycle in a unique way - by studying the booked ultimate loss by accident year. The reserve and therefore the booked ultimate loss for a particular accident year are re-estimated periodically. The reserving cycle in Figure 2 below illustrates these ongoing estimate revisions. Each line represents the booked ultimate loss at progressively older evaluations, indexed on the initial booked ultimate loss at 12 months of development, set at 1.00. The dotted lines represent the movement in 2011.

Figure 2

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Note:

4. The 11 lines are: commercial auto, commercial multi-peril, homeowners, medical professional liability – claims occurring, medical professional liability – claims made, general liability – claims occurring, general liability – claims made, private passenger auto, products liability – claims occurring, products liability – claims made and workers compensation.

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