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Inflation adjustment - reserving vs pricing

H

Hong Hong

Member
Hi all,

I just want to clarify on the below understanding of mine if it is correct:

The inflation adjustment workings for Inflation-adjusted Chain Ladder (Reserving) and Burning Cost (Pricing) are different:
- Inflation -adjusted Chain Ladder: inflation factor is applied on "future projected incremental payment"
- Burning Cost: inflation factor is applied on total ultimate claim cost (to bring it on level to pricing period)

I took SP7 2 years ago, SP8 last year, working on SA3 now, I think I have gotten confused. Greatly appreciate some help to clear my mind on this.
 
Hi Hong Hong

Yes I would expect that the inflation adjustments to be different depending on the precise circumstances of what you are trying to calculate in each case. There is no obvious reason why they would necessarily be the same.

With the IACL method you typically first adjust the historical claim payments to current terms by allowing for assumed historical claims inflation. Once you have carried out the chain ladder projection, you then project the estimated future claims payments in each future time periods forward, using assumed future inflation rates. The amount of inflation applied to each payment amount, will depend on when you expect it will be paid.

With the burning cost method for pricing claims, you typically apply estimated historical inflation rates to bring past payment amounts to the same time period (which as you say is on-levelling them) so you can estimate your overall burning cost and then typically project that forward to the average date of payment of the claims that are expected to arise from the period for which you are trying to set the premium rates for.
 
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