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
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
46 CONTINGENCIES MAR | APR. 14 WWW.CONTINGENCIES.ORG
Actuaries and Reserve Adequacy CONTINUED
The question for actuaries is:
What can we do to mitigate the cyclical
movement associated with our most
commonly used methods?