underreserving

Underreserving is the practice of setting aside reserves that are insufficient to cover future claim liabilities for an insurance portfolio or line of business. It can occur when an insurer estimates claim reserves too low, either intentionally or unintentionally, and may involve insufficient reserves for claim development, incurred but not reported (IBNR) liabilities, or unallocated loss adjustment expenses.

Common causes include optimistic assumptions, model risk, data quality issues, changes in claim frequency or severity, tail risk, inadequate margins for adverse development, regulatory pressure, or incentives tied to short-term financial performance. Reserves may also be understated due to limitations in historical data, misestimation of claim development patterns, or failures to capture emerging risks.

The consequences of underreserving can be significant. Insurers may face solvency concerns, higher capital requirements, regulatory intervention, credit rating downgrades, higher reinsurance costs, and reduced policyholder protection. Over time, persistent underreserving can undermine market confidence and threaten financial stability.

Reserve adequacy is typically assessed by actuaries using best-estimate reserves plus a margin for adverse development, and through scenario analysis or stochastic modeling. Key concepts include IBNR and IBNER (incurred but not enough reported) liabilities, as well as considerations of discounting and risk margins under relevant regulatory frameworks.

Mitigation relies on robust governance and independent actuarial review, regular backtesting and model validation, updated assumptions, improved data quality, and comprehensive scenario testing. Organizations aim to maintain prudent reserve levels across economic cycles and lines of business to uphold policyholder protection and solvency.