Use Reserve Requirements to Your Competitive
Advantage
The Benefits of Strategic Reserving
March 2013
| AUSTRALIA, BELGIUM, BERMUDA + 13 more
| Pierre Laurin
1
SAVE
| SUBSCRIBE | DOWNLOAD PDF
Reserving is not only a regulatory accounting requirement, but also an opportunity for an insurer to
leverage information this exercise uncovers to support management's strategic direction.
Reserving is first and foremost used to establish the financial position of a company by evaluating
the company's total policy liabilities. The impact on the balance sheet and the income statement is
direct and unforgiving. More than one company has seen its financial position altered by significant
movements in the policy liabilities as determined at different accounting dates.
Beyond its immediate need and use, however, the reserving process unearths a wide range of
information that can be used strategically to steer an insurance enterprise.
STRATEGIC RESERVING
The process of determining a reasonable reserve amount to support the estimated unpaid loss and
loss adjustment expense liabilities provides critical insights about multiple facets of the business.
These facets include:
Frequency and severity trends affecting the portfolio
Actual claims experience that will have an impact on policy wordings
Pricing changes and the resulting impact on retained and generated portfolios
Administrative changes, both underwriting and claim management
IT systems changes
Reinsurance programs
Overall management of the corporation and its leadership
Strategic reserving leverages information generated during the reserving process to support a
company's strategic direction. These findings can help answer questions such as:
Are there lines of business that we should divest? Are there other actions that can be taken to
clean up the portfolio?
Are there diversification benefits in the current portfolio mix? Can diversification be enhanced?
What impact does the reserve change have on our capital?
Should we modify the investment strategy?
Is our reinsurance structure efficient? Should we be buying adverse loss cover?
How does the performance of individual lines compare to our competitors or the market? Are we
losing or gaining competitive advantage?
Do we think the underwriting was wrong, or does it just reflect insurance uncertainty?
Has any strategic action we have taken impacted the results — new claim-handling procedures,
replacement of personnel or outsourcing?
How do our expenses compare to those of competitors?
More generally, we can identify three major categories that impact a company's strategic direction
over which reserving can have a major impact, namely, capital position, operational effectiveness,
and pricing and marketing. We will address each individually.
IMPACT ON CAPITAL POSITION
It is clear that the carried reserves — liquid assets set aside for unpaid claim liabilities — are one of
the major items on the insurance company balance sheet. Their importance to the company's capital
position cannot be overstated. In addition to the difficulty of estimating the point estimate of the claim
liabilities, these liabilities are subject to variability stemming from a number of sources. These are
typically referred to as the process risks, parameter risks and model risks. While it is not the goal of
this article to expand on the specific aspects of the variability of the claim liabilities, the combined
risks of the variability of reserves is typically associated with solvency. The actuarial opinion alerts
regulators to risks of material deviation from a solvency perspective. The variability of reserves may
not threaten solvency, but may impact the ability to continue writing business. There may be
sufficient capital to absorb the fluctuation of the reserves; however, after a material loss event (e.g.,
a single, extremely high-severity loss or a catastrophic loss event), a company may not have
sufficient capital to continue writing and to take on the other normal financial risks associated with
the issuance of insurance policies.
The concept of strategic reserving suggests that both the impact of reserve variability on solvency as
well as the impact on the capital required to support normal operations should be considered. The
distribution of the variability of reserves is usually evaluated using stochastic methodologies. The
horizon period can be selected over a given period of time such as the next 12 months, akin to a
Solvency II requirement, or until all the claims are closed. In the former situation, one allows for
management actions to be taken after the review period, while in the latter, the variability reviews
potential outcomes of the cumulative payment of losses over time. Strategically, both are important.
The variability of reserves over a short time horizon will impact operations, and over the short to
medium term will affect financial results, but solvency is of greater concern on a longer time horizon.
Reserve variability is one of many risks that a company measures when developing an economic
understanding of its capital. Many management actions can be determined using the information
gleaned from the review of the short- and long-term variability of reserves and other material risks,
namely:
Reevaluating risk appetite, tolerances and limits
Mitigation strategies, such as reinsurance programs
Advanced communication to stakeholders on potential negative outcomes
Changes in underwriting and marketing direction for current lines of business
Elimination of certain lines of business or introduction of new lines of business to create a more
balanced portfolio
Stress testing of cash flow and refinement of investment strategies
The evaluation of reserve variability is an essential component for the creation of these strategies.
INCREASED OPERATIONAL EFFECTIVENESS
Companies are always under pressure to improve operations and publish financial results faster.
Improving operational effectiveness and efficiency passes through either to clients via increased
pricing competitiveness or to shareholders via increased returns. The actuarial process, like other
operations within the corporation, is also subject to cost controls and operational efficiency.
The concept of strategic reserving also examines how the information generated during the
reserving review can help company profitability as a whole. Results, information and data are all
required to be provided more often and more quickly by the different stakeholders.
It is well understood that reserving is a time-consuming process requiring significant amounts of
data, energy and resources. Much time and effort are expended to set the information in a format
that can be analyzed. This element is getting increased attention. Industrialization, or how to
automate the reserving process, is about reducing the time and effort required to manipulate the
data and generate the required reports. Its goal is to increase the analytical portion of the reserving
process.
Operational improvements can also be made relative to the actuarial techniques used in the
analytical process. Actuaries use many actuarial methods to estimate claim liabilities. However, not
all of them are appropriate for all lines of business, nor do they all have sufficient levels of prediction
to warrant their use. Also, different techniques may consistently generate similar results, so the use
of these additional methods may not necessarily improve the overall precision of the analysis and
may actually provide a false sense of security afforded by the similarity of the projections.
Performance testing is a process that evaluates the predictive value of different actuarial methods.
This process will help to optimize the actuarial evaluation by improving the selection of actuarial
techniques with a higher level of precision in actuarial projections and by eliminating potential
duplication of work.
Other areas of improvement in the reserving process include the creation of new reserving
techniques, and new ways data can be interpreted and analyzed. Different actuarial methodologies
are being developed to improve traditional methodologies and mitigate some of the pitfalls of
traditional methods. Individual claim reserving and generalized linear models are advanced
techniques using individual claim-level details to estimate the total claim liabilities.
Moving beyond the actuarial techniques, information generated during the analysis can be used to
improve claim management, and to help in the identification of potential misrepresentations and
fraud.
Generally, strategic reserving helps the review of the actuarial process to improve the reserving
process, and helps control and reduce operational expenses.
ENHANCED PRICING AND MARKETING
The link between reserving and pricing has been known for some time. Payout and loss-
development patterns developed during the reserving process can be used directly in pricing
analysis. Further, loss trend, average payouts, frequency of large losses and many other elements
are aspects generated within the reserving process that have a direct bearing on the pricing process.
Additionally, the use of findings from the reserving process to assist in the modification of
underwriting guidance and policy wording has been in place for some time.
However, there is another element that is rarely used to help steer the marketing and pricing aspects
of the company: the review of the unearned premium reserve (UPR). The UPR is typically viewed as
an accounting figure established using the earning patterns per line of business. The reserve is
intended to cover the claims that will occur during the unexpired portion of the policy period. A test of
the adequacy of the UPR is needed to ensure that there are actually sufficient reserves set aside to
pay for the claims on the unexpired portion of the policies, plus all the deferred administrative and
underwriting expenses. If the UPR is not sufficient, then a premium deficiency reserve is set up to
cover all expected exposures. If the UPR is sufficient, then the test is passed, and no other actions
are required by the appointed actuary.
However, the UPR's profit level has a direct impact on the marketing and underwriting strategy of the
company. If the UPR has no expected profit or, stated differently, if the UPR barely covers the
expected claims and deferred expenses, then all of next year's underwriting profit will have to be
generated from new and renewal business (assuming no release of claim reserves). This position is
significantly different from one where the UPR has a reasonable level of profit, and puts less
pressure on new and renewal business to achieve financial goals. So it is important to review the
UPR's financial strength and its level of profitability to provide additional insight into the probability of
achieving next year's business plan and anticipated underwriting results. This review will help bridge
the gap between the pricing process and the business plan.
PREP WORK HELPS INSURERS HARNESS THE BENEFITS OF INDUSTRIALIZATION
Industrialization of the reserving process aims to improve and automate the function so that results
can be generated faster and with a higher level of precision. Industrialization will have a major
impact on claim administration, IT requirements, reporting procedures and the allocation of
resources.
In order to do this, all the different sub-tasks need to be identified and redesigned, such as:
Data sources
Frequency of reports
Level of detail by lines and sub-lines of business
Individual claim information
Levels of aggregation of results
Timelines linked to the reporting process
Selection of actuarial methodologies
Resources, personnel and team structures
IMPLEMENTING STRATEGIC RESERVING — A POTENTIAL CULTURAL SHIFT
As described here, the concept of strategic reserving means leveraging the findings from the
reserving process to improve the strategic position of the insurance company. In other words, it
implies that results of the reserving process should be used throughout the enterprise.
Implementation requires that the work of the actuaries be communicated across the organization
and used in strategic decision making.
The first step in implementation is to communicate results and ensure that leaders in all parts of the
organization understand the findings. Second, the broader organizational implications of the analysis
and findings need to be tested. Finally, leadership needs to have the courage to take action on the
basis of these findings along with findings from other sources. Implementing this concept of strategic
reserving may imply a cultural shift within the organization if the various departments have
traditionally worked independently. However, if the change can be made, the potential benefits to the
organization are great.
THE STRATEGIC ADVANTAGE OF THE RESERVING PROCESS
We have seen the complexity of the reserving process and the wealth of information that can be
generated from that process. The concept of strategic reserving leverages that information to
support the strategic direction of the company. It identifies areas where mitigation strategies are
required and provides input into many of the financial aspects of a company. It will provide insight
into the capital position of the company beyond normal financial reporting. Pricing and marketing
strategies can be supplemented using information gleaned from the reserving process. Leadership
will need to embrace this new concept to fully realize its benefits.
For comments or questions, call or e-mail
Pierre Laurin at +1 416 960 2851,
pierre.laurin@towerswatson.com.
https://www.towerswatson.com/en/Insights/Newsletters/Global/emphasis/2013/Use-Reserve-
Requirements-to-Your-Competitive-Advantage dated 10.02.2018
comparative advantage is that NICL have covered big government
institution and defence and non defence institutions
analysis of growth of reserves
claim ratios as compare to others
business in market as comparative to other insurance companies
clients ratios as compare to other companies
competitors of NICL
NICL covers all areas of Pakistan and branches are available in all
big bcities of pakistan
Your competitive advantage
Your competitive advantage is what sets your business apart from your competition. It
highlights the benefits a customer receives when they do business with you. It could be
your products, service, reputation, or even your location. For example, do you offer
home delivery, a money back guarantee, a 2-hour call-out service or childcare facilities?
How to identify your competitive advantage
To identify your competitive advantage, you need to understand your competitors and
your customers. Ask yourself:
Why do customers buy from us?
Why do customers buy from our competitors and not us?
Why do some potential customers not buy at all?
What do we need to do to be successful in the future?
Market research will help you to answer these questions. Good market research will
reveal how your business is different from your competitors, and what you have to offer
that appeals to your customers. In-depth customer research will help you identify your
customers' needs and increase your competitive edge.
Use our market research kit to find key economic, demographic and statistical
information about your industry.
Customers buy benefits
When customers buy your product or service, they are buying the benefit that it gives
them. It may be that your product makes their life simpler, or your service helps them to
feel better about themselves. Think about how your competitive advantage benefits your
customers.
For example, the competitive advantage for a sandwich shop may be: We use fresh,
local ingredients to make-to-order the highest quality gourmet sandwiches in the local
area.
Different customers may see different benefits:
customers with allergies or particular dislikes will enjoy the convenience of
ordering a sandwich with their preferred ingredients
customers who want to treat themselves will be attracted by the fresh, high-
quality ingredients, and the fact that the sandwiches are gourmet
customers who want to support local businesses will appreciate that you use only
local ingredients.
Thinking about how your business can benefit your customers will help you to pinpoint
your competitive advantage. A strong competitive advantage:
reflects the competitive strength of your business (e.g. quality of service)
is preferably, but not necessarily, unique
is clear and simple
may change over time as competitors try to cash in on your idea
must be supported by honest and ongoing market research
must highlight the benefits to customers rather than boast of your business itself.
After you have highlighted your competitive advantage, the best way to tell your
customers about it is to create your unique selling proposition.
Also consider...
Find out how you can use your competitive advantage in a SWOT analysis.
Read about gaining a competitive advantage through innovation.
Learn more about responding to competition.
Find out how to create a successful marketing strategy.
Learn about benchmarking your business against other similar businesses to
identify opportunities for improvement.
Consider using public relations to get your message out to your audience.
Find out how to attract and keep new customers.
https://www.business.qld.gov.au/starting-business/planning/market-
customer-research/competitive-advantage Dated 10.02.2018
