Comparison of Incurred but not Reported (“IBNR”) Methods

1 Comparison OF Incurred BUT NOT Reported (IBNR) Methods Sponsored by society of actuaries Health Section Prepared by Cabe Chadick, FSA, MAAA Wes Campbell, ASA, MAAA Finn Knox Seith, ASA, MAAA October 2009 2009 society of actuaries , All Rights Reserved The opinions expressed and conclusions reached by the authors are their own and do not represent any official position or opinion of the society of actuaries or its members. The society of actuaries makes no representation or warranty to the accuracy of the of IBNR Methodologies Foreword Lewis & Ellis, Inc.

2 (L&E) would like to acknowledge those who participated in the development of this research paper, especially the society of actuaries Project Oversight Group (POG), who provided advice and guidance during the course of the project. We would also like to thank the research coordinators from the society of actuaries for their efforts in organizing and coordinating the project. The members of the POG were: Eric Smithback David Nelson John Governale Peter Howard Bernie Rabinowitz Martin Staehlin Michael Bears Pat Kinney John Stenson, Chair The project coordinators from SOA were: Steven Siegel Barbara Scott The researchers from Lewis & Ellis, Inc.

3 Were: Cabe Chadick Wes Campbell Finn Knox Seith Brian Stentz 2009 society of actuaries , All Rights Reserved Lewis & Ellis Page 2 Comparison of IBNR Methodologies Table of Contents 5 10 Executive Summary .. 13 Summary of Methods to Calculate 16 Tabular 16 Case Reserve Projection/Exposure 17 Development Methods ..18 Description of Typical Development Methods .. 18 Cross Incurral 18 Paid PMPM Stochastic Neural Network Methods .. 20 Practical Considerations for IBNR 21 Incurred Date Definition.

4 21 Methods Delineating ICOS versus True 22 Excess or Outlier Outside Influences on Health Claim Reserves and 24 24 Days in a Month to Generate 24 Claim Cost Trends ..25 Growing/Diminishing 25 Premium Changes .. 26 Benefit Changes ..26 Claim Administration Disruption/Backlogs .. 27 Methods and Issues of Managed Care .. 28 Margin and Confidence Intervals .. 28 2009 society of actuaries , All Rights Reserved Lewis & Ellis Page 3 Comparison of IBNR Methodologies Follow Up Studies ..29 Internal Consistency with Insurer Financials.

5 31 Documentation and Data Quality .. 31 Checklist for actuaries Calculating Claim Reserves .. 32 Basic Review of IBNR Methods Tested .. 33 Definition of Accuracy Applied for IBNR Testing Purposes .. 35 Data Simulation ..36 Summary .. 36 Description of Crystal Ball 37 Lag Set Simulation ..37 Determination of Number of Scenarios for Statistical Significance .. 40 Description of Stress Testing Scenarios .. 41 Results and Conclusions .. 44 Bibliography .. 54 Appendices Development Method Details ..A Algebraic Definitions of IBNR Methods .

6 B Description of Paid PMPM Method ..C Stochastic Method Literature, Our Tested Implementation and Stochastic Software Tools ..D Detailed Results of IBNR E Managed Care Issues ..F IBNR Margin ..G Advance Methods : Neural Network ..H Confidence Intervals for I 2009 society of actuaries , All Rights Reserved Lewis & Ellis Page 4 Comparison of IBNR Methodologies Introduction Abstract Recognizing the lack of comparative information on techniques used for estimating Incurred but not Reported (IBNR) reserves, the heath Section Council of the society of actuaries commissioned a research project to assess the accuracy of commonly used IBNR estimation Methods over a wide range of scenarios.

7 Lewis & Ellis, Inc. (L&E) was awarded the contract to perform this research. To conduct the study, a stochastic model was constructed to compare and score estimates produced by the IBNR Methods that were selected for testing. The testing was done over a significant number of iterations and alternative business situations. Findings from the model testing include the following: 1. When lag Methods were tested, the more robust average lag Methods and hybrid Methods produced better results than straight average Methods .

8 Hybrid Methods also produced fairly low mean errors and standard deviations 2. For the Methods and scenarios tested, the one exhibiting the most consistency, in terms of relatively lower variance and mean error, was the Paid PMPM method. The method also often provided useful claim reserve estimates in recent incurral months as well as handling claims administration disruptions relatively better. 3. Traditional lag Methods exhibited the least amount of variation in mean IBNR error when tested under an alternative business situation that entailed material shifts in per capita claims costs at various time points prior to the valuation date.

9 4. The two business situations tested that were the most problematic to the desired goal of reserve sufficiency were (a) very recent upward increases in claims costs and (b) rate spirals. The following comments describe limitations of the study and practical considerations when calculating IBNR estimates, and highlight specific areas where caution should be applied when interpreting the results: 1. Advances in computing power and increasing software sophistication are making new and non-traditional Methods more accessible to practicing actuaries .

10 Yet, more sophisticated IBNR calculation Methods , while possibly more accurate, often require additional assumptions and supporting data as well as adjustments ( , seasonality adjustment to Paid PMPM method) to derive reasonable results. These Methods may also require advanced technical knowledge and the purchase of specialized software as compared to those Methods generally in use by practicing health care actuaries . 2. The loss ratio method tested produced some of the more accurate results with fairly low standard deviations, but there are several important cautions in the interpretation of these results and the appropriateness of use of this method.