For some companies, the setting of claim reserves can be mysterious; however, it is an art that can be bolstered by data and science. The definition of claim reserves is “the funds set aside for the future payment of incurred claims that have not yet been settled.” To fully understand the reserving process, one must understand a simple formula:
Paid (what has already been paid on a claim file) + Reserves (what is expected to be paid in the future on the claim file) = Total Incurred.
To augment this formula, actuaries use a term called IBNR (incurred but not reported) to account for additional development of the claim file that the adjuster can’t predict when they are setting reserves. IBNR is also known as future development of the claim file.
Adjusters consider many facts but also use their intuition to establish reserves, as they review injuries, co-morbidities, the injured worker’s occupation, the employee/third-party’s medical history, attorney representation, medical care, and other important demographics of each claim.
Essentially, the adjuster calls upon their experience of past reserving/claim outcomes to project the funds needed to bring the claim to final adjudication. Certainly, with predictive modeling and the advent of AI in the claim process, the adjuster has more accurate data points to assist in the establishment of reserves — yet must also consider the human factor in each claim, because no two claimants are identical. And here the art comes into play. The adjuster must be able to subjectively review each claim (despite what reserving models/technologies may/may not present). Very often, they can get a gut feeling about the outcome of the case early on as their interaction with a claimant/third party provides them with a general perception of how any claimant/third party will behave throughout the claim process.
Typically, reserving occurs at several intervals. First, there is a temporary standard reserve called a transitional reserve, set when a claim is established. Then, after an investigation and a determination of compensability/liability is made, an initial reserve is established. Reserves are then re-evaluated when 1) a material fact changes in the claim and/or 2) at an interval of every 30, 60 or 90 days.
The importance of establishing accurate reserves cannot be overstated. Over-reserving a case could cause an over inflation of future financial obligations, which could negatively impact a company’s balance sheet, also resulting in difficulty in obtaining coverage, increased premiums and increased collateral costs. If an adjuster is under-reserving cases, a company could be understating their potential liabilities, adversely affecting statutory financial reporting obligations. Companies have been sued via class actions for understating their claim liabilities.
It’s important to partner with a respected insurance carrier/third party administrator to ensure you have confidence in your claim reserves. Likewise, your broker can assist in conducting annual reserve audits. A company can rely on the expertise of their actuary in determining future liabilities based on the claims reserves and IBNR.
Despite all the technology and science available to today’s adjusters, reserving is still an art, enhanced by various tools, which, by themselves, cannot predict human behavior or substitute for human intuition.
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
