Premium Deficiency Reserve Calculator (ASC 944-60 and SSAP 53)

The method

Under ASC 944-60, a short-duration insurer recognizes a premium deficiency when the costs still to come on in-force business exceed the unearned premium that will pay for them:

GAAP deficiency = expected claims + claim adjustment expenses (LAE) + maintenance costs + policyholder dividends + unamortized DAC − unearned premium − anticipated investment income (if elected)

Recognition runs in a fixed order. The deficiency first writes DAC off, and only the excess over DAC is booked as a premium deficiency reserve liability. Including investment income is a policy election, and it has to be disclosed.

The statutory test under SSAP 53 has no DAC, because acquisition costs were expensed when paid. Policyholder dividends are not required in it either. So it compares claims, LAE and maintenance costs alone with unearned premium.

Every ratio in this calculator is a percentage of unearned premium. That keeps one denominator on the page. A calendar-year loss ratio on earned premium is a different number, so don't paste one in.

Anticipated investment income is computed by the discounting approach: expected claims and LAE, discounted at the portfolio yield over the average years to payment. At the defaults the four lines earn $1,901,574, $1,027,642, $3,478,846 and $1,830,810. That is a single-lag approximation of a payment pattern, and the limits below say so.

The worked insurer writes four lines with $120,000,000 of unearned premium between them:

Bracketed figures are sufficiencies. As a check on the arithmetic, the workbook reproduces Blanchard's published example from the CAS Forum exactly. That example has $100 of unearned premium, $20 of acquisition costs, $5 of maintenance and $5 of dividends. It gives GAAP reserves of $0, $10 and $30 and statutory reserves of $0, $0 and $5 at expected losses of $60, $80 and $100.

This spreadsheet is the form above, and every figure on this page is a formula in it. Your own version could become the quarterly test your reserving team reruns with each new loss pick, or an API that feeds the result into your close checklist.

How does grouping affect a premium deficiency reserve?

It can decide whether you book anything at all. The same contracts and estimates need anything from $0 to $9,240,000 here, depending only on how lines are grouped and whether investment income counts.

Offsetting is allowed inside a group and never between groups. Blanchard puts it plainly: "Unlimited offsetting is allowed within a line grouping, but no offsetting is allowed outside the group." Test the whole book as one group and the other three lines' $7,091,231 of sufficiency absorbs homeowners' $5,572,358 deficiency. Test each line and it can't.

You don't get to pick the grouping that gives the answer you want. ASC 944-60 and SSAP 53 use nearly identical wording, and both tie grouping to the way the company manages its business. If homeowners is priced, managed and reported as its own line, testing it inside the whole book is hard to defend. The finer the grouping, the more likely a reserve: a deficient line has nowhere to hide.

Should anticipated investment income be included in the premium deficiency test?

It is your election, it has to be disclosed, and on long-tail lines it can be the whole answer. Commercial general liability is $2,640,000 deficient without investment income. With $3,478,846 of investment income it is $838,846 sufficient, so a deficiency of that size disappears entirely.

The effect depends on how long claims take to pay. At an average of 4.5 years to payment, general liability earns $3,478,846 on $19,360,000 of claims and LAE. Homeowners claims are paid in about 0.8 years, so the same yield earns only $1,027,642 on a larger $29,700,000. Investment income rescues the slow-paying line, not the deficient one.

The yield matters too. In the workbook's own tests, with investment income included and each line tested separately, the charge falls from $9,240,000 at a 0% yield to $4,419,612 at 10%. Use the expected portfolio yield over the payout period, not a market rate on the day of the test, and keep the assumption stable from quarter to quarter.

Why is the GAAP charge so much bigger than the statutory premium deficiency reserve?

Because most of the GAAP charge isn't a reserve at all. It is a write-off of DAC, an asset statutory accounting never recognized. Under the defaults the GAAP charge is $5,572,358: $5,400,000 of homeowners DAC written off, plus a $172,358 liability. The statutory reserve is $172,358.

That match is no coincidence. Statutory accounting expensed homeowners' acquisition costs when they were paid, so its test leaves them out. Homeowners pays no dividends, so once its DAC is gone the GAAP liability and the statutory reserve measure the same shortfall. Lines that pay dividends break the match, because GAAP includes dividends and SSAP 53 does not require them.

The ordering matters for the balance sheet. A deficiency smaller than the line's DAC never shows up as a liability: it just shrinks the asset. In the workbook's tests, homeowners books a liability only once its deficiency passes $5,400,000. At a 95% expected loss ratio that liability is $1,620,457.

What this calculator does not do

Stated plainly, so you know when you need an actuarial model:

• Short-duration contracts only. Long-duration and universal life contracts follow different premium deficiency and loss recognition rules.
• Four lines and two groupings. Each line on its own, or all four as one group. Real groupings can sit in between, such as by legal entity or by distribution channel.
• A single payout lag per line. Investment income discounts claims and LAE at one average lag, not a full payment pattern. A long-tail line with a skewed pattern needs the full cash flows.
• No investment income on the unearned premium cash itself. Funds approaches that project the whole balance sheet can give a somewhat different figure.
• The expected loss ratio is an input. It should come from your reserving and pricing work, on the unexpired exposure, catastrophe load included.
• Maintenance costs are runoff servicing only. General overhead is a period cost and stays out of the test.
• One measurement date, no recapture. Gross of reinsurance, with no tax effect and no reversal of a previously booked reserve.

Sources

• PwC Viewpoint, Insurance contracts guide 7.2: Loss recognition for short-duration contracts
• Blanchard, "Considerations in the Calculation of Premium Deficiency Reserves", CAS Forum, Fall 2000
• NAIC INT 99-23: Disclosure of Premium Deficiency Reserves (nullified by SSAP No. 53)
• Deloitte DART, ASC 944 Financial Services: Insurance