A new wrinkle in IBNR

Behind its firewall, SNL writes about reinsurers establishing cat IBNR reserves that aren’t tied to an event:

Typically, reinsurers establish IBNR reserves to cover future payments on individual losses that have occurred but have yet to be reported or reported losses that have not been recorded in full.

Unallocated IBNR reserves are a slightly different animal. They are an additional reserve, on top of event-specific reserves or account-specific reserves, created to respond to any potential deterioration in losses across a number of events. One way to think of them is as “just-in-case” reserves when just-in-case losses really get out of hand. Ian Gutterman, an analyst with Adage Capital Advisors LLC, referred to it as “cookie jar IBNR.”

As an example, PartnerRe Ltd., in addition to recording charges in its fourth-quarter 2011 earnings for the flooding in Thailand, twin earthquakes in New Zealand and Tohoku earthquake in Japan, created an IBNR provision of $50 million for all the catastrophe events of 2011.

I’m not on the ground reserving this stuff, but I think the practice stems from the unusual number of poorly understood exposures that produced losses. Japan quake models didn’t contemplate tsunami. New Zealand models didn’t know about fault lines beneath Christchurch. Thai floods were unmodeled.

Add to that, as SNL notes, the fact that the companies reporting losses are slower than usual:

The advent of unallocated IBNR reserves comes at a time when reinsurers are struggling to pin down their ultimate losses from the string of large catastrophes that occurred last year around the globe. In the case of the Tohoku earthquake, loss estimation has been hindered by reporting delays from the large mutual insurer Zenkyoren. In New Zealand, the government decision to deem wide areas of Christchurch as uninhabitable is said to have slowed down claims settlement. The complexity associated with certain types of claims, such as contingent business interruption, has also been a factor. Altogether, the delays have led to significant increases to reinsurance IBNR reserves.

Meanwhile, no one truly knows what the ultimate losses would be for certain events. The Thai floods, for example, could eventually be a $12 billion industry loss event, or a $15 billion or $20 billion, said Validus’ Noonan. “I am starting to sound like Donald Rumsfeld,” he said, adding: “There are things that we don’t know that we don’t know.”

As a result, a couple of companies – PartnerRe and Platinum, perhaps some others – have been dinged by upwardly creeping loss estimates for catastrophes. In recent years, companies have been expected to reserve adequately at the first estimate with those estimates perhaps creeping down over time. Rising cat estimates disappoint Wall Street, so stock prices can fall if the estimates keep going up.

I’d be surprised if this became a standard practice. It’s unusual to have so many highly uncertain events to reserve against. And you can’t just throw some IBNR against the wall figuring you’ll need it someday.

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