At a basic level a premium deficiency exists when unearned premium and expected future premium are not sufficient to cover future estimated losses, loss adjustment expenses, policy acquisition costs and maintenance costs. In other words, a premium deficiency reserve is required if you expect a net loss in future periods for the particular policy, line of business, segment or company that has already been written.
Divergence in practice have evolved regarding at what level one should apply their analysis and which method should be used to calculate any resulting reserve. Should one look to the policy level, and perform a review of multiple contracts or do one high level review? Once you determine you have a premium deficiency how should you calculate the premium deficiency reserve?
To answer these questions we first have to understand the theory and guidance relative to premium deficiency reserves. We will also look quickly at how practices have evolved over time in different segments of the insurance industry
Guidance on Premium Deficiency Reserves
Generally Accepted Accounting Principles (GAAP) and Statutory Accounting Principles (SAP) are fairly consistent in their definitions of premium deficiency reserves. The general premise is that a premium deficiency