H.3 Estimating ULAE

Question 1

Describe how ULAE can be estimated using a market

value approach

Answer 1

With this approach, the market value of the unpaid ULAE
would be equal to the cost that a Third-Party Administrator (TPA) would require to take over handling of the book of claims.

Using this approach to quantify unpaid ULAE is common
among self-insurers.

Question 2

One common assumption for dollar-based techniques

to estimate unpaid ULAE

Answer 2

One common assumption of the dollar-based techniques is that ULAE costs track with claim costs in both timing (similar payment patterns) and amount. The amount assumption implies that a single $10,000 claim would have the same ULAE costs as ten $1,000 claims.

Question 3

Formula for the claims basis for the dollar-based

Generalized Approach

Answer 3

B = [(U1 x R) + (U2 x P) + (U3 x C)]
-B = claims basis for the calendar year
-U1 = percent of ultimate ULAE spent opening claims
-U2 = percent of ultimate ULAE spent maintaining claims
-U3 = percent of ultimate ULAE spent closing claims
U1 + U2 + U3 = 100%
-R = ultimate cost of claims reported in the CY
-P = paid claims during the calendar year
-C = ultimate cost of claims closed during the calendar year

Question 4

Three ways to estimate unpaid ULAE using the

generalized approach

Answer 4

1. Expected Claims approach: Unpaid ULAE = (W* x L) -

Question 5

Key assumptions of the Generalized Approach

Answer 5

-ULAE costs are proportional to the dollars of claims being handled.
-ULAE amounts spent opening claims are proportional to
the ultimate cost of claims being reported.
-ULAE amounts spent maintaining claims are proportional to payments made.
-ULAE amounts spent closing claims are proportional to the ultimate cost of claims being closed.

Furthermore, the generalized approach also assumes that there is no cost to re-open or re-close claims.

Question 6

One weakness of the generalized approach

Answer 6

It does not account for the case when ULAE inflation is

occurring at a different rate than claims inflation.

Question 7

Formula for the claims basis and unpaid ULAE for

the Simplified Generalized Approach

Answer 7

B(est) = (U1 x L) + (U2 x P)

Unpaid ULAE = W* x [Pure IBNR + U2 x (Case + IBNER)]

Question 8

Additional assumptions of the Simplified Generalized

Approach

Answer 8

-R is approximated using the accident year ultimate claims when calculating W.
-That no extra effort is required to close claims, so U3 = 0.

Question 9

Key assumptions of the Classical Approach

Answer 9

-ULAE costs are proportional to the dollars of claims being handled.
-Half of ULAE is spent when opening a claim (U1 = 50%),
and half of ULAE is spent when closing the claim (U3 =
50%).
-ULAE amounts spent closing claims are proportional to the ultimate cost of claims being closed.
-There are no partial payments, so all claim payments are made when the claim is closed (i.e., C = P).

Question 10

When the Classical Approach does not work well

Answer 10

The classical approach does not work well for long-tail
lines of business, in times when ULAE inflation rates differ from claims inflation rates, when the insurer is significantly growing or shrinking, or when the 50/50 assumption is not appropriate.

Question 11

Claims basis formula under the Kittel Approach

Answer 11

B(est) = (50% x CY Incurred Claims) + (50% x P)

Note that CY Incurred = CY Paid + change in TOTAL reserves (including IBNR)

Question 12

Unpaid ULAE formula for Classical and Kittel

approaches

Answer 12

Unpaid ULAE = W* x [Pure IBNR + 50% x (Case + IBNER)]

Question 13

How the Kittel Approach is an improvement over the

Classical Approach

Answer 13

The Kittel approach is an improvement over the classical
approach when the book of business is growing or shrinking and for longer tailed lines of business. This is because when an insurer grows, ULAE tends to increase quickly, but the claims from the additional exposures may not be paid for many years (resulting in higher paid ULAE-to-paid claim ratios). However, the reserves will start increasing sooner, so including incurred claims will reduce this distortion.

Question 14

When the Kittel Approach does not work well

Answer 14

When the 50/50 assumption is not appropriate or when

ULAE inflation rates differ from claims inflation rates.

Question 15

How the Mango-Allen Approach differs from the

Classical Approach

Answer 15

The only difference between the Mango-Allen approach and the classical approach is that expected paid claims are used instead of actual paid claims when estimating the claims basis for each year.

The Mango-Allen approach is useful when insurers have
limited or volatile calendar year paid claims. However, for
larger companies with more stable actual paid claims, the
extra effort to estimate the expected paid claims may not be justified.

Question 16

Reasons for the development of the Generalized

Approach

Answer 16

-Recognize an insurer’s rapid growth
-Be consistent with the insurer’s ULAE expenditures over the life of a claim
-Reproduce key concepts underlying the Wendy Johnson technique
-Use commonly available and reliable aggregate payment and unpaid claims data
-Allow for alternatives to the 50/50 rule.

Question 17

Two issues in dollar-based techniques that are

addressed by count-based techniques

Answer 17

1. That ULAE is not directly proportional to claims (e.g., the ULAE for a single $10,000 claim would be less than the ULAE for ten $1,000 claims.)
2. That using ULAE-to-claims ratios results in volatile ULAE when claims are volatile.

Question 18

Key assumption of and challenge with count-based

techniques

Answer 18

A key assumption of count-based techniques is that the same kind of transaction costs the same ULAE regardless of claim size.

A challenge with count-based techniques is obtaining
accurate and consistent claim count data.

Question 19

Briefly discuss the Brian technique

Answer 19

Brian assumed that ULAE would be split into 5 types of
transactions: opening claims, maintaining open claims,
making payments, closing claims, and reopening claims.
Brian then assumed that the ULAE costs for each of these types of transactions was similar, and could be estimated using historical ratios of ULAE to number of transactions.

One weakness of this technique is the assumption that all
transaction types require similar ULAE. A second more
important weakness is the difficulty in estimating the number of future transactions as well as the average cost per transaction.

Question 20

Briefly discuss the Johnson technique

Answer 20

Wendy Johnson assumed ULAE could be split into 2 types of transactions: opening claims and maintaining claims. Johnson then assumed that the ULAE costs for each of these types of transactions could be estimated using historical ratios of ULAE to number of transactions. However, unlike Brian, Johnson allowed the costs per transactions to vary for the different transaction types.

One benefit of Johnson’s approach was that only the relative ULAE per transaction type was needed instead of the actual ULAE.

Question 21

Briefly discuss the Mango-Allen Claim Staffing

Technique

Answer 21

Mango-Allen first calculated a new count base as Opened claim counts + Closed claim counts plus Pending (ending) open claim counts (OCP). They calculated the workload for claims adjusters as OCP counts per adjuster, and projected OCP counts and divided by this workload (with any anticipated adjustments) to get the projected number of claims adjusters. Finally, they multiplied the projected number of adjusters by the trended historical ULAE per claims adjuster to get the ULAE reserve. One concern with this approach is that the ULAE reserve estimates are sensitive to the magnitude of the selected parameters.

Question 22

Briefly discuss the Spalla approach

Answer 22

Spalla suggests that modern computer systems can now track the time spent on individual claims by each claims employee. This can be used to calculate the average ULAE per type of transaction at different stages in a claim’s duration, and these can be loaded for other ULAE costs (e.g., overhead). Alternatively, instead of calculating the absolute cost per transaction, a relative cost per transaction could also be calculated.

Question 23

Formulas for the Generalized Approach for counts

Answer 23

M = w x b = w x [(v1 x r) + (v2 x o) + (v3 x c)]

Unpaid ULAE = sum( wi* x [(v1 x ri) + (v2 x oi) + (v3 x ci)]