What is Reserving Uncertainty and why is it Important?
In order to make informed business decisions, it is important to understand the level of risk assumed by holding any particular reserve. For some purposes, it is appropriate to need high levels of reserve certainty, such as a 99% probability that the reserve will prove adequate. For other purposes, a strict best estimate is appropriate. Similarly, If the best estimate is held, this may mean a 1% chance of insolvency in the coming year or it may mean 20% -- the management must understand which it is to decide whether the best estimate is appropriate. Either way, techniques are needed for establishing the uncertainty of the reserve needed.
The total amount of future claim payments is uncertain. The sum held as the reserve in the balance sheet will therefore be highly unlikely to be the amount of money actually needed to pay down claims. It may be too high, in which case future surplus will be realised. Alternatively, it may be too low, in which case extra funds will need to be found.
Not all insurance business is alike. For some business, it will be possible to estimate to a high degree of accuracy the reserve needed whilst for other types of business the uncertainty will be much greater. Consider the different challenges posed by reserving a large motor property book (low uncertainty levels) and a niche US liability book (high uncertainty levels).
Calculating Uncertainty
Case Estimate and IBNR Uncertainty
Combining Models
