Reserving for volatile inflation: a practitioner’s guide to setting best estimate reserves during periods of inflation volatility

Abstract

A period of prolonged, stable economic inflation across much of the developed world arguably reduced the relative significance of inflation assumptions in the reserving process. This stability leant validity to one of the inherent assumptions of the Chain Ladder reserving method – that inflation in future years would mirror that observed historically. The effects of the COVID-19 pandemic on global supply chains resulted in a state of persistently high economic inflation hitherto unexperienced since the 1980s. This spike in turn sparked concerns around the adequacy of general insurance claim provisions (loss reserves) and the methods for their assessment amongst insurance boards and their regulators. In this paper, we explore a variety of methods for attempting to incorporate a more volatile and variable state of claims inflation in reserving. These methods are largely those discussed by regulators in response to the 2021 inflation spike. The key findings are the importance of explicitly considering the inflation inherent in a claim cohort; how it compares with views of future inflation; and revising both our views of the future and actual inflation, as observations become available. We further consider the impact of “imperfect knowledge” or parameter uncertainty with regard these inflation assumptions, when setting reserves.