Gross vs. Net Retained Reserves: Considerations for Year End 2015 Actuarial Reports

Many companies have a liability associated with retained losses through self-insured retentions or large deductible programs for a wide array of risks. These can include workers compensation, automobile liability, general liability, medical professional liability, and property. Most companies use an actuarial report to determine the net retained liabilities for these risks. However, many auditors and internal accounting departments are now seeking to examine the gross unlimited loss exposure and the expected related insurance recoverable for these risks. This blog will discuss some of the reasons for and benefits of reviewing losses on a gross basis, as well as some common issues that arise.

In August of 2010, FASB released an accounting standards update (No. 2010-24) for Health Care Entities (Topic 954). A pdf of this standard is available on the FASB website.

In summary, the standard indicates that in regards to the ultimate cost of malpractice claims, “A health care entity should not net insurance recoveries against a related claim liability. Additionally, the amount of the claim liability should be determined without consideration of insurance recoveries”.

In light of this standard, many of our health care clients have added a gross liability analysis to their actuarial report. Therefore, instead of the financials simply having net retained liabilities, the liabilities reflect the gross liability and a receivable of expected insurance recoveries is established. The difference balances back to the net amount, but there is more transparency. Some clients outside of the health care industry have also initiated the gross and receivable approach. Examples of these companies include restaurants, retail stores, religious institutions, and financial institutions. Some simply want to review the gross exposure but some record gross and the associated receivable on the financials.

The estimation of gross liabilities may require different or additional actuarial methods. Standard methods may be appropriate for lower retained layers where large losses are capped. Losses above a certain loss level may be rare and the loss data at high layers may lack credibility. Gross liabilities may also be subject to significant volatility compared to net liabilities.

For example, consider product liability with a $100,000 retention and one or two claims per year. The retained liabilities should be fairly stable from year to year, because the effect of a single large claim is mitigated by the retention and frequency is low. However, a single large claim could significantly affect the gross liability estimate.

Simulation techniques or industry benchmarks for large claims may be considered and used to estimate unlimited expected losses and the associated variation or confidence levels. This could be used to navigate changing market conditions and to monitor the most appropriate level of risk retention over time.

Reviewing historical retained losses on a gross basis provides a complete view of the risk—partitioning the risk into retained and insured. While this approach gives more transparency to historical retained losses, it can also provide information for upcoming prospective periods. A review of actuarial loss projections for the upcoming year on a gross unlimited basis, as well as at various retained limits, supports decisions related to an appropriate amount of risk transfer.

Please contact us to discuss how a gross analysis may be beneficial to your firm.

We welcome your feedback by posting a comment, or contacting Michelle Bradley at mb@SIGMAactuary.com.
© 2015 SIGMA Actuarial Consulting Group, Inc.

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Michelle Bradley, ACAS, MAAA, ARM, CERA

About Michelle Bradley, ACAS, MAAA, ARM, CERA

Michelle graduated summa cum laude as valedictorian from Lipscomb University in 1988, receiving a B.S. Degree in Mathematics. She then attended Vanderbilt University and received a M.S. degree in Mathematics. Michelle is an Associate in the Casualty Actuarial Society and is a Member of the American Academy of Actuaries. She also obtained the Associate in Risk Management designation in 1996 and received the award for academic excellence in that program. She served as president for the Casualty Actuaries of the Southeast for the 1999-2000 year. From 1990 to September 2003, she was Vice President and Consulting Actuary for Willis Risk Solutions of Willis North America. During this time she consulted extensively in the areas of actuarial, risk management and enterprise risk management. Michelle received the CERA (Chartered Enterprise Risk Analyst) designation in 2013. She has also served on the board of directors for the Society of Risk Management Consultants. She currently serves on the Advisory Council for Middle Tennessee State University’s Master of Science in Professional Science Program (MSPS). In the area of enterprise risk management, she has focused on modeling issues as regards integrated programs that often include non-traditional risks. She has significant expertise in risk mapping and alternative risk transfer mechanisms. She has been a member of numerous project teams that provided enterprise risk consultancy services and was part of the project team that completed the integrated program that was hailed the “Deal of the Decade” by CFO Magazine (June 2000).

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