Question

Describe the factors that affect the increase in policyholders’ surplus from discounting loss reserves.

Answer 1

Discounting loss reserves would have both positive and negative effects on the property-liability insurance industry. Discounting at an appropriate interest rate would increase the usefulness of the combined ratio as a profitability measure, with values less than 100 indicating profits and in excess of 100 indicating losses, subject to the accuracy of loss reserves. Statutory surplus would increase as a result of discounting, which, although having no real economic effect, might provide more capacity for the insurance industry due to regulatory reliance on statutory values. Conversely, discounting would increase the complexity of loss reserving, create a dependence of reserve adequacy on future interest rate levels, and increase the expenses of insurers by raising tax levels. Discounting would have its greatest impact on commercial and professional liability insurers.