This article examines the various components of loss reserves for self-insured organizations.
It is often convenient to use the term “loss reserves” in a general way to describe loss and expense reserves. This shorthand makes communication easier, but it is important to identify the precise elements included in the reserve being considered. This article will identify and define the reserve components commonly encountered by self-insured organizations.
Background Terminology: Losses and Expenses
Before discussing reserve components, it may be useful to review the claim payment types that give rise to the need for loss reserves. Claim payments can be classified into two major groups: losses and expenses. Losses are those amounts paid directly to a claimant or to a third-party on behalf of the claimant. Expenses are the remaining costs incurred in the administration of a claims program.
Further, claim expenses can be summarized into two main categories: allocated and unallocated. Allocated loss adjustment expenses (ALAE) are those costs that are directly attributable to a specific claim. Examples of ALAE include legal costs, fees paid to investigators and outside experts, and costs related to medical bill reviews. Unallocated loss adjustment expenses (ULAE) are those costs not directly attributable to specific claims. ULAE can be thought of as overhead expense. Loss adjustment expense (LAE) refers to all expenses related to the administration of a claims program. LAE equals ALAE plus ULAE.
Loss Reserve Components
Loss reserve components can be classified by payment type (loss, ALAE or ULAE) and by the source of the reserve estimate (individual claim or actuarial). Table 1, below, presents loss reserve components organized by payment type and source of estimate.
When a potentially insurable accident is reported to an organization or its third-party claims administrator, a claims handler will review the details of the incident to help determine insurability. If an accident is determined to be covered under the insurance policy and thus compensable, the claims administrator will establish a case reserve. A case reserve is an estimate of future loss payments related to an individual claim. Although case reserves are established on an individual claim basis, the term is used in a similar way to describe the aggregate liability of a portfolio of claims as determined by the claims administrator.
ALAE Case Reserves
Claims handlers may or may not estimate future ALAE payments related to individual claims. When they do, an ALAE case reserve is established. In common usage, the term “case reserves” may refer to case reserves for losses or case reserves for both losses and ALAE.
A self-insured’s individual claim reserves typically compose a significant, but not complete portion of its overall loss reserve liability. Rarely are case reserves sufficient to fund all expected future payments. Therefore, an additional reserve component is necessary to recognize expected future payments not considered in the case reserves. This additional component, called IBNR, is calculated for a portfolio of claims. In other words, it is not calculated on an individual claim basis, but rather, in aggregate.
IBNR is short for “Incurred but Not Reported” and is sometimes referred to as “unreported loss”. It is inherently composed of the following key elements, though they are usually not individually quantified:
- Case reserve development
- Late reported claims
- Reopened claims
- Pipeline claims
These components are discussed in more detail in this article.
ALAE IBNR is similar to IBNR, discussed above, except that it relates specifically to the ALAE payment type. IBNR is yet another term that is often generalized to encompass a broader definition. Depending on the context, IBNR may refer to loss-only IBNR, or some combination of IBNR, ALAE IBNR, and ULAE IBNR.
ULAE IBNR relates specifically to the ULAE payment type. Since ULAE reserves are never established on an individual claim basis1, ULAE IBNR represents total ULAE reserves. . IBNR is yet another term that is often generalized to encompass a broader definition. Depending on the context, IBNR may refer to loss-only IBNR, or some combination of loss-only IBNR, ALAE IBNR, and ULAE IBNR.
In self-insured reserving applications, “loss reserves” most often refer to “Loss and ALAE Reserves” as illustrated in Table 2.
Somewhat less frequently, “loss reserves” refer to “Loss and LAE reserves” as illustrated in Table 3. An example of this definition is the one specified by the California’s Office of Self-Insurance Plans (OSIP) for qualified self-insurers of workers compensation.
Disclaimer: Information presented in this article should not be relied upon as actuarial or accounting advice, which should be provided by a credentialed actuary or accountant familiar with the details of your organization’s risk management program.
1. By definition, ULAE refers to claim costs that cannot be allocated to an individual claim.