Technical provisions: background: reported claims and 'incurred but not reported' (IBNR)
The provision for reported claims is the company’s estimate of the amount which it will have to pay out on claims which have been notified to it but which remain unsettled at the year end. Such claims are usually estimated by the company on a case by case basis, but paragraph 53(1) of Schedule 3 to the accounting Regulations SI2008/410 allows for statistical methods to be used where they result in an adequate provision having regard to the nature of the risks.
Reported claims do not often cause difficulties, except perhaps large claims that may be litigated, or the subject of prolonged negotiation between insurer and insured, or there is doubt about the statistical methods used.
Incurred but not reported (IBNR)
For claims incurred but not reported (IBNR), a company necessarily has to use statistical methods, whether or not it does so for reported claims. These will be allowable so long as they are quantified with an appropriate degree of reliability. In Southern Pacific Insurance Company (Fiji) Ltd v CIR, 1986 STC 178 a Privy Council case, the company claimed a deduction for an estimate of claims incurred but not reported. The court accepted that the liability of the company for accidents which occurred but were not reported in a particular year was part of the expense of the company in carrying on its insurance business during that year and should be deducted in arriving at the total income of the company. Two main principles emerged. First, it is a question of fact whether a company’s calculations and forecasts are sufficiently reliable to justify a deduction, and secondly, when the provision is being calculated, evidence in a company’s possession cannot be ignored: in this case there was evidence that a certain percentage of claims was normally unsuccessful and the company had to take account of this information.
A company just beginning to write general insurance business will have no claims experience of its own from which to predict IBNR. It could be argued that, until it can, there should be no deduction, and that was the outcome in the Southern Pacific case. However, the usual practice is to consider IBNR based on industry statistics where necessary, subject to the company demonstrating that these are appropriate to the business or are suitably modified. A company which is new to insurance business will have submitted a business plan to the FSA (or Home State regulator) in which it is likely to address the issue of IBNR.