2016 Fall #14b - Excess (deficiency) amount
This question does not explicitly state "for prior years in CY 2015" like it does in 2017 Spring #16. How do we know that we are supposed to exclude AY 2015 in calculations?
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This question does not explicitly state "for prior years in CY 2015" like it does in 2017 Spring #16. How do we know that we are supposed to exclude AY 2015 in calculations?
Comments
Excess & Deficiency always require a INITIAL reserve to compare to. There can be no reserve shortfall if no reserves are set.
Initial reserves for AY 2015 are set on Dec 31, 2015 and as such deficiency of said reserves = $0.
CY 2015 ends on Dec 31, 2015.
This makes sense, but then I don't understand why we should use AY 2015 reserve values in the calculation of investment income in part (a). Is it because we are assuming that average reserve for AY 2015 in CY 2015 is (0+5300)/2, so we can still earn income by investing this? And for the purposes of investment income we use all AYs, not just the ones that have excess/deficiency?
So the way I interpret this is we do earn investment income on reserve for AY 2015 even in CY 2015, but we don't include it in excess/deficiency calculation in part (b) because we don't use any information from AY 2015 in that calculation for CY 2015.
This is however isn't in line with the assumption that we only set the initial reserve at the end of the first year, because in this case we wouldn't have been able to earn any investment income on it in CY 2015.
There are 2 things going on here:
As you observed we can calculate investment income for CY2015 using the average UCAE across CY2015. It would be:
And you can use the excess (deficiency) formula to calculate an excess (deficiency) amount for AY2015 and CY2015 but the answer won't make sense. It would be:
= [ U(beg) - U(end) - Pd(All) + ii ]
= [0 - 5,300 - 5,000 + 132.5]
= -10,167.5
The reason it doesn't make sense (and why you exclude it from the calculation of excess (deficiency) in part(b) of the question) is that U(beg) or UCAE at the beginning of AY2015 for AY2015 has no meaning. Its value is 0 but that's because no claims have been reported and there's no way any could have been reported since the year just started. In other words, it doesn't make sense to talk about an excess or a deficiency at the start of the year.
Note that case reserves are set up over the course 2015 as claims are reported, but we don't have any of that information until the financial statements are published at the end of the year. So to calculate investment income for 2015, we assume the claims are evenly distributed over the whole year and that we've been earning investment income the whole time. That means we take the average of 0 and the year-end UCAE and multiply of the yield rate.
Then at the end of the first year, we can make our first calculation regarding the excess or deficiency of reserves for that year.