Contingencies - March/April 2014

S H U T T E R S T O C K

One explanation could be that more economic activity leads to more human activity in general (e.g., more working, driving, building, and consuming), increasing the likelihood of loss from accidents and therefore the number of claims that develop.

This countercyclical relationship isn’t as strongly correlated for all of the years studied. If we include the years after 2003, there’s still an inverse relationship—just not as highly correlated. That is, there’s a correlation of -65 percent for years between 1989 and 2008, significantly smaller than the -90 percent correlation we see for the 1989-to-2003 range. A potential cause of this drop in correlation is that coverage years from 2004 on aren’t fully developed yet; they could still demonstrate a stronger inverse relationship as time goes on. The red U.S. unemployment line is decidedly fixed in time; the blue line, of course, will continue to move, upward or downward, as claims from these coverage years develop.

The more in-step relationship seen prior to 1989 may be the result of the unusually high inflation present during the early to mid-1980s, which very likely contributed to the adverse reserve development in these years. It is probable that our proxy for the economic cycle (the U. S. unemployment rate) may be a less than ideal representation of the economic cycle in these years.

More research is needed here—
ideally considering other economic
variables—to understand more fully
the complex relationship between the economy and the reserv-
ing cycle. But a generally strong inverse relationship over the past
20 years (and an overwhelming one from 1989 to 2003) is undeni-
able, based on these data.

Actuarial Methods and HDRs

Using data from industry aggregate triangles from 1989 to 2012, we compared the indications from 51 different methods against the carried HDRs.

Figure 6 summarizes results from our analyses of the two most popular actuarial methods, the paid and incurred chain ladders.

Anytime the red or green lines dip below 100 percent indicates that favorable reserve development resulted from either the paid chain ladder (red) or incurred chain ladder (green) methods, while adverse reserve development was indicated by the methods during any year when the red or green lines rose above 100 percent.

The blue line, moving very closely in tandem with both the red and green lines, represents reserves actually carried by P/C

companies on an industry basis from 1989 to 2012. The HDR results from the paid chain ladder method correlate with carried reserve development at 63 percent over those 23 years, while the results of the incurred chain ladder method correlate even more strongly at 94 percent.

We were surprised when we saw these results. It does appear, based on our formulaic analysis of industry data, that these most traditional actuarial methods of establishing reserves do exhibit a strong cyclical nature—and that this cyclical movement travels in tandem with the reserving cycle.

Why do these methods correlate with cyclical movements in carried reserves? We don’t know, and more study will be needed to determine causality. But it’s our belief that the underlying economic cycle influences the results of actuarial methods in much the same way it influences carried reserves.

An Unexpected Conclusion

As actuaries, we want to believe that while our projections will never be exactly accurate, the methods we use to calculate reserves are unbiased; that they show the most likely indications of how things are going to develop based on what