Claim Reserves (Benefit Tips ® - © 2002)
Actuaries use "incurred but not reported claims reserves" (IBNR) in the same way that accountants use accounts receivable and payable. The goal is to uses the accrual method of accounting to recognize liability when it occurs in order to match revenue with expenses. This accounting principle gives a more accurate picture of profitability for pricing and funding purposes.
Various approaches are used to calculate the IBNR, but most are based on either claims or premiums of the previous year. The IBNR is established when coverage is introduced in order to account for the lag in reporting and paying claims. Annual adjustments are made to the IBNR, which reflect changes in the estimated claims lag. The change in IBNR is added to the paid claims to estimate the claims that were incurred during the experience period. Changes are in direct proportion to the changes in claims or premium levels. During times of growth the IBNR will grow and during times of contraction it will shrink. The IBNR is ultimately used to pay claims that are submitted after coverage terminates.
It’s important to understand who owns the claim reserve, how reasonable the formula is and whether there is consistency over various accounting periods.