3 year accounting: Q&A Bank 6 Q6.7

This question asks us to distinguish between accident year and 3-year accounts in terms of the technical reserves required.

The solution tells us that IBNR is 'less of an issue' for 3 year accounts. It also says that a URR/UPR will not be required unless policies are more than 2 years in length.

I find this a bit confusing. What exactly are we comparing? Are we comparing AY accounts at the end of the first year against 3 year accounts after 3 years? Isn't that a bit odd? Presumably, whichever type of accounts you use, you would normally prepare accounts at the end of each year (at least), so it seems a strange comparison. Or should we assume 3-year accounts are prepared only once - after 3 years, and 1-year accounts only once - after 1 year? Surely not the latter at least.

 

Assuming all the policies written are 1-year, IBNR for 3-year account is less of an issue because the claims (including IBNR) have developed more compared to 1-year account by the time the account is done. Both types of account are done only once for the year in question. For instance, if we are doing the accounts for year (UY and AY) 2010:

UY2010: consider a 1-year policy which was written on 30 June 2010 for coverage until 31 May 2011, by the end of 2012, it would have "expired" for 1.5 years. This "additional" time after the full exposure allows the claims (and of course IBNR) to stabilize.

AY2010: for the same policy, by the end of 2010, only half of the exposure "expired". However, there is no time for the expired exposure to develop when we do the account, i.e. we do it right after the expiry. So the claims reserves is more unpredictable and that is why it is more of an issue compared to UY2010.

I think we are comparing 1-year account at the end of the first year against 3-year account at the end of the third year. By definition, they are done only once for the year (either AY or UY). So if we are looking at two such accounts as of 31 December 2010, we are comparing AY2010 against UY2008 results. Note that both are done annually, i.e. as of 31 December 2011, we will be comparing AY2011 against UY2009 etc.

 

This is what is confusing me - why are we assuming that accounts are only done once? Surely AY accounts are done at least once a year, with a re-forecast of any years for which there are outstanding liabilities, until they are considered to be all fully run-off (or until o/s liabilities are transferred). Is that not correct?

 

Sorry to have been confusing. But I really wanted to explain what Ian just explained. Haha!

So could anyone point me out where I had been wrong / confusing so that I can avoid that in both exam and practice? Does it help if I change the "done" to "published"? I think there can be many versions of interim AY or UY accounts before the published ones.