When a policy of general insurance is written it will typically cover a 12 month period from inception of the policy. When the policy is sold, a premium is paid by the insured party to the insurer. The number and cost of claims that will arise from the policy are unknown and unknowable amounts at inception. Indeed, at expiry of the policy there can be a high degree of uncertainty as to what the cost of claims will ultimately be. There might be some information available on incurred claims amounts but this can often be zero.
The insurer will conduct a reserving exercise with a view to assessing what this ultimate cost will be. This enables them to assess the profitability of the business that they have written and are planning to write in the future.
Typical reserving methods used to assess ultimate claims and hence IBNR reserves include:
Other methods such as the Average Cost Per Claim and Separation are sometimes used. It has become fashionable to consider reserving on a stochastic basis.
There is an exceptionally low degree of agreement within general insurance as to what much of the terminology actually means. IBNR is a widely accepted term with a fairly standard meaning.
This balancing item between the incurred claims and the ultimate claims is commonly referred to as the IBNR or the IBNR reserve. In pure terms, it only allows for those claims that have occurred before the valuation date but have not yet been reported to the insurer either directly or through the broker, hence the name. This pure usage is not used in practice. The more common usage includes reserves for items such as reopened claims, future claims on exposures to be written within the projection period, salvage and subrogation.
The calculation of the IBNR reserve is a process that requires judgement and the results of which will remain uncertain for several years. The reserving process is typically done at an aggregate level. For example, at a class of business, underwriting year and currency level. It is important to try to achieve a homogeneous data grouping and to treat any special claims separately. For example, US Banks business written in 2001 needs to have any claims relating to the collapse of the Enron Corporation treated separately. Similarly, US Property Excess of Loss business written in 2004 and 2005 needs to have any claims relating to Hurricanes treated separately.
Such reserving calculations should be performed at a gross of reinsurance level and also for outwards proportional reinsurance and outwards excess of loss reinsurance separately.
Reserving is increasingly undertaken by actuaries who are professionally qualified people. There is still a large number of statisticians with years of experience but no formal qualifications undertaking such work.
The above description is appropriate for most of the world and reflects the practices in the London Market, although practices can differ.