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Old 02-20-2018, 11:42 AM
juandeoyar juandeoyar is offline
 
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Default Best Estimate Technical Provisions Duration

Hi everyone,

Well, second post in my welcome day. I hope I won't bother you much.

I was working with assets and liabilities matching, specifically with credit and suretyship insurance.
To estimate the duration of liabilities we use the best estimate of claim provisions, which come from the loss reserving method and its cash flows (given by the lower triangle).
The first challenge appears when the provision method is based on an incurred claim method, where the lower triangle represents the changes in the cost of claims and not the pure cash flows -payments.
So, in this case one option may be using a paid method that results in a similar ultimate cost. Then we can calculate the duration from the cash flow generated by this method (discounting the diagonals by a technical rate).
Second problem is that in somecases, where we have negative cash flows- recoveries- in long tail business lines, it could give us a negative duration.
In my opinion, the interpretation in this case would be just "a rise in the interest rate, will rise the present value of the liability", which is not easy to justify by the recoveries.


Any opinion is welcome,
Thank you.

Last edited by juandeoyar; 02-20-2018 at 05:58 PM..
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Old 02-20-2018, 11:57 AM
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Originally Posted by juandeoyar View Post
To estimate the duration of liabilities we use the best estimate of claim provisions, which come from the loss reserving method and its cash flows (given by the lower triangle).
The first challenge appears when the provision method is based on a incurred claim method, where the lower triangle represents the changes in the cost of claims and not the pure cash flows -payments.
So, in this case one option may be using a payments method that results in a similar ultimate cost. Then we can calculate the duration from the cash flow generated by this method (discounting the diagonals by a technical rate).
Second problem is that in somecases, where we have negative cash flows- recoveries- in long tail business lines, it could give us a negative duration.
In my opinion, the interpretation in this case would be just "a rise in the interest rate, will rise the present value of the liability", which is not easy to justify by the recoveries.
Anybody who looks at duration as a time frame is misusing the concept. The whole point of "duration" is to estimate the change in liability with respect to change in interest rate.
Of course, I am no longer an actuary, and my career was all on the life side. So take that into consideration.
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Old 02-20-2018, 11:59 AM
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You have to carry a provision for all unpaid components, regardless of whether you are using an incurred or paid triangle. One possibility is to use the reported method to calculate the ultimate cost, then a paid method to calculate the timing of when they will occur.
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Old 02-20-2018, 12:02 PM
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I forgot to mention that having cash available when needed is more important that "average" duration.
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Old 02-20-2018, 12:24 PM
juandeoyar juandeoyar is offline
 
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You have to carry a provision for all unpaid components, regardless of whether you are using an incurred or paid triangle. One possibility is to use the reported method to calculate the ultimate cost, then a paid method to calculate the timing of when they will occur.
Yes, that's the idea. But which paid method would you choose? There are a few alternatives.
Additionally, we have to accept that the paid method has not the same timing, but we don't know the timing though.

PD: If you mean to use the same method but on the paid triangle, I already tried to see the results, and they are really different in many cases. If the ultimate in the paid method is much higher, and you have strong cash flows at the beggining (or irregular cash flows), the final duration will differ a lot from the hypotetical one.

Last edited by juandeoyar; 02-20-2018 at 12:31 PM..
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Old 02-20-2018, 12:28 PM
juandeoyar juandeoyar is offline
 
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I forgot to mention that having cash available when needed is more important that "average" duration.
Yes sure, sometimes it does not make sense to match durations, even if there will be strong recoveries at the end. In that case I'd suggest analyse the short term and matching cash flows, not durations, since we are adding interest rate risk to inflows.
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Old 02-20-2018, 09:32 PM
IANAE IANAE is offline
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I'd recommend you sort out your cash flow patterns - a standard set might be helpful - then scale them to exposure or expected loss including wherever you decide to allocate the IBNR.

Cash flows are the fundamental unit for financial modeling including liquidity (first and foremost...) and ALM.
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Old 02-21-2018, 10:12 AM
juandeoyar juandeoyar is offline
 
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I'd recommend you sort out your cash flow patterns - a standard set might be helpful - then scale them to exposure or expected loss including wherever you decide to allocate the IBNR.

Cash flows are the fundamental unit for financial modeling including liquidity (first and foremost...) and ALM.
How do you identify the cash flow patterns? What do you mean by standard set?
Scaling to the expected loss should be easy if I have the distribution of the payments, even though it doesn't matter because the duration only takes into account the weights.
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