Risks of Inaccurate Reserving

As you know from my previous posts, that in General insurance one of the main job of an Actuary is to do Reserving. There are risks involved if estimates of Reserves goes far from what it should be.
IBNR Estimates could be too low or could be too high in any given circumstances , which gives rise to UnderReserving or OverReserving.(These could be because of many reasons explained later).

Risks Associated with UnderReserving.

• Under Reserving gives wrong sense of profitability. When a company underreserves , it is actually underestimating its liability and hence wrong sense of profitability.
• Due to UnderReserving , your portfolio seems to be profitable, hence you see that your Loss Ratio is better , which makes you to reduce prices. Over some period you will become underpriced and your liability will increase. Loss Ratio which is actually higher than you have seen will further increase.
• As Warren Buffet has said , " To underReserve is to Under Price".

Risk Associated with Over Reserving.

• When you OverReserve, you actually is hiding your profit. Your profitability will reduce. You tend to see your Loss Ratio is higher , whereas it is actually lower.
• You tend to Over Price your products, hence loosing market share and profitable business.
• Over Reserving will decrease your profits, increase the capital demand to meet solvency putting strain on your balance sheet.

Factors Triggering Inaccurate Reserving.

• Tendency to improve profitability by under reserving.
• For long term portfolio like Liability , ignoring industry/past experience and going by own data.
• Over Estimating case reserves.
• Outdated methods of finding IBNR which tends to overestimate.
• Being over optimistic or very conservative without logic.