Reserve risk

Category: Underwriting practice · Reviewed by Mark Fox, Broker · Renewals · Last reviewed

Reserve risk

Reserve risk is the risk that the technical provisions (reserves) held for incurred but unsettled claims prove inadequate to meet the ultimate settlement cost. It is a major component of the non-life Solvency Capital Requirement and one of the two major underwriting risks alongside premium risk.

Drivers of reserve risk

• Parameter uncertainty — the chain-ladder factors might be wrong.
• Model uncertainty — the underlying loss development pattern might shift.
• Process variance — random fluctuation around the modelled mean.
• Inflation shocks — claims inflation higher than reserved-for, particularly for long-tail liability.
• Legal and judicial change — Whiplash Reform, Ogden Discount Rate, Mesothelioma scheme changes.
• Late-emerging perils — abuse, occupational disease.

Quantification

Under the Solvency II standard formula, reserve risk in the non-life underwriting risk module is calibrated using standard deviation factors by line of business set in Article 218 of the Delegated Regulation (2015/35). For internal models, firms typically use:

• Stochastic chain-ladder (Mack, bootstrap).
• Over-dispersed Poisson GLM.
• Bayesian models with prior distributions on tail factors.

Reserve releases and strengthening

Reserve risk is the cause of insurer earnings volatility separate from current-year underwriting. UK and Lloyd’s results regularly include large reserve releases or strengthening that swing reported combined ratios by several percentage points.

References

• Solvency II Delegated Regulation (EU) 2015/35, Article 218.
• Mack, T. (1993).
• IFoA. Reserving practical guides.

Cross-references

• Premium risk
• IBNR
• Loss development
• Outstanding claims reserve

Maintained by Matt Bartlett, Director, Apex Insurance Brokers Limited. FCA FRN 724952. Companies House 07014570.