JPBIBNR – Just Plain Bad Incurred But Not Reported

Nigerian GAAP, soon to be replaced by IFRS at least in the financial services sector, requires IBNR liabilities to be set equal to 10% of the Outstanding Claims Reserve. This is a terrible estimate of IBNR and there really are other, also very simple, better measures available.

As an aside, the use of IFRS balance sheet figures for regulatory reporting is also an unusual idea. There is no particular reason to believe that a shareholder financial reporting basis is appropriate as a regulatory measure. It can be, with specific capital rules perhaps, but it’s not automatically so.

Why the 10% of OCR rule for IBNR liabilities is so bad:

  1. For very long-tailed business with no or low claims reported in the first year, the IBNR will be massively understated
  2. as claims are reported (and before they are paid), the OCR will increase. The IBNR should decrease as the claims have now been reported, but given the 10% rule it will actually increase.
  3. The reconciliation of opening to closing IBNR and the comparison of actual vs expected IBNR claims over time is not useful since there are no explicit expectations built into the methodology
  4. Clearly the method is not sensitive to risks and delays of product lines or processes.

So what’s better? Well aside from the range of standard but fairly complex techniques (including Ultimate Loss methods, Basic Chain Ladder, Bornhuetter-Fergusson, Average Cost Per Claim and a whole range of stochastic methods) there are better simpler measures.

A starting point, although also very far from ideal, is the current (soon to be changed) South African statutory requirement of 7% of net written premiums. It also isn’t sensitive to different delay patterns and will give poor results if net written premium is growing or shrinking rapidly.

Really, the ideal simplification requires a little more complexity, but as a reward for this effort is a far more robust, more accurate measure that behaves sensibly in a far wider set of scenarios.

For each line of business for each delay year, we use a specified percentage of gross earned premium for the gross IBNR. Reinsurers’ share can be calculated similarly. The information relating to earned premium per line of business going back several years should be trivial to obtain and ensures we get a sensible pattern taking into account the growth in the business, the mix of business as well as change in mix of business. The method works well for start-up, mature or declining books.

The fundamental drawback of not reflecting a particular insurer’s patterns remains, but aside from using actual delay data this is about as good as one can hope for.

Frankly, why more regulators don’t prescribe this method is a mystery. The information is available, it’s trivial to calculate and verify and the results are robust.