Concepts Involved in the Expected Claims Method: Practice Questions and Solutions

This section of the study guide is intended to provide practice problems and solutions to accompany the pages of Estimating Unpaid Claims Using Basic Techniques, cited below. Students are encouraged to read these pages before attempting the problems. This study guide is entirely an independent effort by Mr. Stolyarov and is not affiliated with any organization(s) to whose textbooks it refers, nor does it represent such organization(s).

Some of the questions here ask for short written answers. This is meant to give the student practice in answering questions of the format that will appear on Exam 6. Students are encouraged to type their own answers first and then to compare these answers with the solutions given here. Please note that the solutions provided here are not necessarily the only possible ones.

Sources:
Friedland, Jacqueline F. Estimating Unpaid Claims Using Basic Techniques. Casualty Actuarial Society. July 2009. Chapter 8, pp. 131-138.

Original Problems and Solutions from The Actuary's Free Study Guide

Problem S6-23-1.

(a) What is thekey assumption of the expected claims technique? (See Friedland, p. 131.)

(b) Identify three types of situations in which the expected claims technique might be used. (See Friedland, p. 131.)

Solution S6-23-1.

(a) The expected claims technique's key assumption is that an a priori, initial claim estimate is more reliable than an estimate based on observed claims experience to date. (Friedland, p. 131)

(b) The following are types of situations in which the expected claims technique might be used (Friedland, p. 131):

1. An insurer's entry into a new line of business
2. An insurer's entry into a new territory
3. There is no data available to use with other methods.
4. Changes in the insurer's operations or environment render historical experience irrelevant.
5. Less mature periods cannot use the development (chain ladder) method because the development factors to ultimate are too large (i.e., too highly leveraged, leading to large possible volatility in the ultimate projections).

Any three of the above suffice as an answer. Other valid answers may also be possible.

Problem S6-23-2.

(a) According to Friedland, p. 132, what are the two challenges of the expected claims method?

(b) If the legal climate changes such that an insurer's liability for claims of a certain kind is affected, briefly describe one advantage and one challenge that the expected claims technique would present for the insurer.

Solution S6-23-2.

(a) According to Friedland, p. 132, the two challenges of the expected claims method are as follows:
1. Determining what the appropriate exposure base is
2. Estimating how claims are to be measured relative to the appropriate exposure base.

(b) This question is based on the discussion in Friedland, p. 137.

If the legal climate changes such that an insurer's liability for claims of a certain kind is affected, one advantage of the expected claims technique is that, if historical data have been rendered irrelevant by the legal changes, this would not affect the viability of the expected claims technique. One challenge would be actually estimating the expected claim ratio in the new legal climate; the ability to estimate such a ratio reliably is an assumption of the expected claims technique.

Problem S6-23-3. The fact that the expected claims technique does not take into account experience to date for a particular group of claims simultaneously poses an advantage and a disadvantage, described by Friedland, p. 137. State both the advantage and the disadvantage. What ability can an actuary use to overcome the disadvantage?

Solution S6-23-3. Advantage: Reliance on a priori estimates ensures greater stability of projections over time.
Disadvantage: Lack of responsiveness to recent experience.

To overcome this disadvantage, an actuary can use judgment to determine whether recent historical experience signals a fundamental change in the insurer's external or internal environment and adjust expected claim ratios accordingly. This can make the expected claims technique more responsive to real-world changes.

Problem S6-23-4. What effect do changes in the adequacy of case outstanding have on the ultimate claim projection using the expected claims technique? Explain your answer.

Solution S6-23-4. Changes in the adequacy of case outstanding do not have and effect on the ultimate claim projection using the expected claims technique. This is because adequacy of case outstanding is based on actual claims experience, and this does not get incorporated into the projection using the expected claims technique (See Friedland, p. 138).

Problem S6-23-5. Identify three kinds of adjustments that might need to be made to historical data in the use of the expected claims technique (See Friedland, p. 133).

Solution S6-23-5. The following are three kinds of adjustments that might need to be made to historical data in the use of the expected claims technique:

1. On-level adjustment for premium to bring it to current rate levels. The premiums should be restated as if current rates were in effect during the entire historical experience period.

2. Trend adjustment for losses to take account of systematic influences on claim amounts, such as inflation.

3. Adjustments for effects of major events, such as tort reforms, other legal changes, or operational changes of the insurer.

See other sections of The Actuary's Free Study Guide for Exam 6.