Speaker Name & Country :

Topic:

Karsten Wantia, Singapore

Manish Singh, India

Claims Inflation the silent killer?

Why bother?

What is claims
inflation?

1
How to model
claims inflation?

2
What to do right
now?

4
2

The end is certain

The end is certain

Known knowns

Known knowns

Unknown unknowns

Unknown unknowns

Known unknowns

Known unknowns

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
10

Lets compare and contrast

Hypertension

1 Can remain undetected over

long periods of time?

2 Can have serious

consequences?

3 Kills an estimated 9.4m people

each year

Claims Inflation

Probably not

11

Examples from Asia-Pacific

China
Developing
into a more
litigious
society?
India
Strong CPI
and judicial
inflation
drive BI
claims costs.

SOUTH
KOREA

SEA
Medical
Insurance
Inflation in
SEA highest
in the
World.

Australia
Sudden recent
spike in motor
claims which is
not yet
understood.

Japan
Negative
interest
rates.
Continuous
aggressive
monetary
easing.

Malaysia
Devaluation
of Ringit has
made car
parts
substantially
more
expensive.
12

Why and how it impacts

Superimposed
inflation

Claims
frequency

Reporting and
payment lag

CPI/FX

Claims
severity

Vicious cycle
underpricing/
-reserving
Rate
agility

Litigiousness
and legal costs
Public
consciousness
and media

Reserve
risk

Present
value

Reinsurance
coverage
13

Why bother?

What is claims
inflation?

1
How to model
claims inflation?

2
What to do right
now?

4
14

Price inflation vs. claims inflation

15

Claims inflation
Lloyds definition
Claims inflation is the change in the expected claims cost level the
Impact of economic and social inflation, e.g. CPI related inflation,
changes in laws, regulation, moral standards, etc.
180
160
140
120
100
80
60
40
20

Policy changes

Last year's
Limits/
premium, deductibles
last year's risk

Coverage

Changes in
exposure

Changes in
volume

Last years
premium,
this year's
risk, last
years costs

Claims
inflation

Last year's
premium,
this year's
risk, this
years costs

Change in
margin

This year's
premium

16

What drives claims inflation?

External changes:
Legislative changes resulting in
an increase or decrease of legal
expenses
l New medical diagnostic
guidelines
l Jury decisions and court
interpretations
l Increase in structured annuities
l Introduction of inflation target
by Central Bank
l Change in FX rate policy

Insurance market specifics:

Internal aspects:
Portfolio cleansing
l Change in business/customer
strategy
l Changes in claims department
l Treatment of expected inflation
levels in outstanding claims
l

Knock-for-knock agreements
l Market cycle
l Claims get regulated with
specific tables that include
assumptions on inflation
l Market cycle
l

Factors that
might lead to
claim cost
changes

Claims culture:
Increased litigiousness sparked
by simplified court rules
l Changes in the public attitudes
l Increase in awareness on
accessibility of compensation
through, e.g., social networks
l Strong lobbying from victim
associations
l

17

The other side of the coin:

CPI vs interest rate
China
1 year Spot Rate

CPI Inflation Rates

0.07
0.06
0.05
0.04
0.03
0.02
0.01
0
-0.01
-0.02

18

The other side of the coin:

CPI vs interest rate
Japan
1 year Spot Rate

CPI Inflation Rates

3.0000%
2.5000%
2.0000%
1.5000%
1.0000%
0.5000%
0.0000%
-0.5000%
-1.0000%
-1.5000%
-2.0000%

19

The other side of the coin:

CPI vs interest rate
India
1 year Spot Rate

CPI Inflation Rates

14%

12%

10%

8%

6%

4%

2%

0%

20

Why bother?

What is claims
inflation?

1
How to model
claims inflation?

2
What to do right
now?

4
21

Our example:
India MTPL claims
Inflation drivers:

Earning inflation
Medical Inflation
Judicial Inflation /
Penetration
Landmark Court rulings

Push for in-court / out-ofcourt settlement

Average settlement time
of 4-5 years
Interest Provision varies in
range of 7-10 %
Case reserve philosophy

2004
2005
2006
2007
2008

Claim Amounts

2009
2010
2011
2012
2013
2014
2015
2016

10

12

14

Development Year

22

The default approach

Paid / Incurred claims

Ultimates

Accident year effects

Development year effects

Development
model

Pro
l

Easy and possibly sufficient

approach in calm market
environments

Con
l

Inadequate if future claims inflation

deviates from levels seen in the past
Inflation impact (level and risk)
standalone cannot be quantified
23

This does not look right

Easiest test is to plot residuals in all directions.
(Difference from expected values scaled by standard deviation)
2.5

1.5

0.5

Average Residuals

Residuals
Significant Residuals

-0.5

-1

-1.5

-2

-2.5
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Calendar Year

24

Possible solutions:
1. projecting adjusted data
Payments

4.00%
3.75%
3.50%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

(1) Inflationadjusting
claims
triangles

(3) Expected claims inflation development

Inflation-adjusted
payments

Inflation-adjusted
ultimates
(2) Development
model

Basis
l

Payments, as incurred claims may

include some unknown
expectation of inflation

(4) Combining the

two effects that are
assumed to be
independent

Pro
l

Separation of inflation effect from

pure claims development effect
Hence increased transparency on
impact of claims inflation
25

Possible solutions:
2. ex-post adjustments
Payments

Ultimates
(1) Development model

(2)
Estimating
historic claims
inflation

4.00%
3.75%
3.50%

Inflation implicitly
projected
(3) Inflation adjustment
of cash flows

Basis
l

(4) Expected claims inflation

development

Payments, as incurred claims may

include some unknown
expectation of inflation

1 3 5 7 9 11 13 15 17 19

Inflation-adjusted
ultimates

(5) Combining the

two effects that are
assumed to be
independent

Pro
l

Inflation effect (arising from company

or market developments) is taken out
of the pure claims development effect
Inflation modelled autoregressive
26

Our example
adjusted
900000000

800000000

700000000

2004
2005
2006

600000000

Claim Amounts

2007
2008

500000000

2009
2010

400000000

2011
2012
300000000

2013
2014

200000000

2015
2016

100000000

0
0

10

12

14

Development Year

27

Our example
adjusted
2.5

1.5

0.5

Average Residuals

Residuals
Significant Residuals

-0.5

-1

-1.5

-2

-2.5
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Calendar Year

28

Possible solutions:
3. GLMs & calendar year effects
Model design:
For origin year i and development year j, let
incremental loss amount, with exposure

be the

We model / =

(Poisson, Gamma models) or its
logarithm (Lognormal model)
Linear predictors are parameterized as
= +

29

Possible solutions:
3. GLMs & calendar year effects
Parameters can be estimated by maximizing the log-likelihood
Avoid over-parameterization by specifying model structures
(constant values, trends) instead of keeping variables free
Models can also be automatically optimized
As always, no algorithm can replace understanding the model
and its parameters
Use Markov-Chain Monte-Carlo to simulate from the model

30

Comparison of outcomes
1.6E+09

1.4E+09

DFM Paid Claims - adjusted Ultimate

1.2E+09

Paid Claims - adjusted Cashflow Projection

GLM Paid Claims - Ultimate

Claim Amounts

1E+09

800000000

600000000

400000000

200000000

0
2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Accident Year

31

Whats missing?
Above models will give best estimate ultimate claims,
including an explicit (or implicit) allowance for claims
inflation.
Bootstrapping or MCMC also give distribution of possible
outcomes and stochastic cash flow
But:
Inflation risk is only implicitly included, may distort risk
assessments significantly
Claims inflation levels not linked to economic scenarios (CPI,
interest rates, GDP growth)
Poor understanding of drivers of claims inflation as a risk
No way of including peak risks or evaluate lack of diversification
in tail risks

32

A model to assess inflation risk

We developed a model to help project claims using a synthetic inflation index and
assess the underlying risk from both claims development and inflation movements.
Measure
actual claims
inflation

Stage 1

Using techniques
such as the
separation
method, industry
data or
individual claims
information.

Source
inflation
measures

Stage 2
Could be CPI, wage
inflation (WI),
medical inflation
(MI), etc.

Create
synthetic
index

Adapt and
adjust

Stage 4
Qualitative
understanding
Adjusting for
superimposed
and one-off
effects

Stage 3
Create a synthetic inflation index using measures from stage 2
Will be different across lines of business
Mathematically, can use regression models with autoregressive components,
Result is a linear combination of known indices (also
available in the ESG) that best approximate the measured
level of inflation

Project
stochastically

Stage 5
Use ESG and
stochastic projection
of inflation-adjusted
data to create a full
stochastic view of
future claims
development.

33

Claims vs measured inflation

In our example, we have extracted
(calendar-)annual claims inflation
Potential indices include CPI, wage
inflation and medical inflation
Plot shows good historical fit, but
worse match for more recent years
In reality, estimating actual claims
inflation levels will be much more
difficult and require additional
analysis and simplification.

Stage
Measure
actual claims
inflation

Source
inflation
measures

14
12
10
8
6
4
2
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Measured Inflation

CPI

WI

MI

34

Our synthetic index

Create
synthetic
index

Adapt and
adjust

10
9
8
7
6
5
4
3
2
1
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Adjusted

Synthetic

We have found that there has been

an additional effect from changes in
legislation for 2014-2016.
Accounts for around 3%-points of
inflation for those years.
Synthetic index now fits much
better in recent periods
Driven by WI (25%) and MI (75%) in
this case.
Projection of SI simplified based on
judgmental assessment of mean
and variance.

35

Projecting forward
Project
stochastically

Overview of stochastic simulation model that combines reserve risk (using

bootstrapping techniques) and stochastic inflation modelling.
36

Projecting forward results

7 , 0 0 0 , 0 0 0 ,0 0 0

6 , 0 0 0 , 0 0 0 ,0 0 0

8,000,000,000

8 , 0 0 0 , 0 0 0 ,0 0 0

8 , 0 0 0 , 0 0 0 ,0 0 0

A) Bootstrap
on unadjusted data,
No inflation modelling

7 , 0 0 0 , 0 0 0 ,0 0 0

6 , 0 0 0 , 0 0 0 ,0 0 0

B) Bootstrap
on adjusted data,
inflation modelling

6,000,000,000

5,000,000,000

5 , 0 0 0 , 0 0 0 ,0 0 0

4 , 0 0 0 , 0 0 0 ,0 0 0

4 , 0 0 0 , 0 0 0 ,0 0 0

3 , 0 0 0 , 0 0 0 ,0 0 0

3 , 0 0 0 , 0 0 0 ,0 0 0

3,000,000,000

2 , 0 0 0 , 0 0 0 ,0 0 0

2 , 0 0 0 , 0 0 0 ,0 0 0

2,000,000,000

1 , 0 0 0 , 0 0 0 ,0 0 0

1 , 0 0 0 , 0 0 0 ,0 0 0

1,000,000,000

Cumul ati ve Amounts by Method and Cal endar Year [1,*]

Value

5 , 0 0 0 , 0 0 0 ,0 0 0

2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

C) Bootstrap
on adjusted data,
inflation and SI modelling

7,000,000,000

4,000,000,000

2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

Cumul ati ve Amounts by Method and Calendar Year [2,*]

Cumul ative Amounts by Method and Cal endar Year [3,*]

Results will vary substantially

between approaches, depending on
model fit, inflation volatility, etc.
Mean will often change as well!
Explicit allowance for superimposed
inflation can make a big difference
Validation and qualitative insights
are key

Approach

Mean

5,111.8

5,334.0

5,719.1

StDev

433.0

456.9

512.1

Median

5,095.0

5,314.1

5,696.5
37

Why bother?

What is claims
inflation?

1
How to model
claims inflation?

2
What to do right
now?

4
38

Example inflation dashboard

Methods deployed

Estimation of past and future inflation levels

Conclusion

14.00%
l

Mathematical algorithms
applied to historical claims data
(e.g. separation method,
General Linear Models)
Analysis of official historical
economic inflation and their
dependencies to estimate
claims inflation
Taking into account other
calendar year effects (see
previous slide)

12.00%
10.00%

Price Inflation

8.00%
Wage Inflation
6.00%
4.00%

We deduce an
average claims
inflation rate of
10.5% to be
implicitly included
in the best estimate
reserves.

Claims Inflation :
LOB X

2.00%
0.00%

Expert judgement

Evaluation of the impact of claims inflation scenarios on case reserves

Methods deployed
l

Regression based on projections

in economic scenario generators
and calibrated on history

Taking account of planned legal

and governmental changes

Stressing superimposed
inflation

Conclusion
Inflation spike due to Central Bank
intervention / court awards
Linear combination of price and wage
inflation and construction costs, with
weights estimated from history

Claims reserves are

under-estimated by
10% in an adverse
scenario.

Favourable business mix by geography

leading to lower impact on case
reserves

39
towerswatson.com

Understanding and Modelling

Inflation the Roadmap
Develop company-specific strategy to
actively manage inflation risks
Management
Actions
Monitoring &
Reporting

Holistic
view
Explicit
Assessment
Implicit
Consideration

Establish an integrated approach on

claims inflation:
l

Implicit
consideration of
claims inflation

Assess your
exposure to claims
inflation
standalone

Integrate claims inflation model into

companys risk model
Analyse inflation together with
interest and FX rates
Economic scenarios combine internal
know-how & external expertise

Implement monitoring &

reporting processes to
guarantee sustained control
of inflation risk
l

Controlling function needs to

combine reserving and
pricing & UW expertise

40

Speaker Name & Country :

Topic:

Karsten Wantia, Singapore

Manish Singh, India

Claims Inflation the silent killer?