Relationship Between Ratios 5 and 11
Could someone explain the rationale behind subtracting the 1-yr reserve development from the loss & LAE ratio component of Ratio 5 if Ratio 11 is in the unusual range?
I understand that a single year's reserve development resulting in an unusual Ratio 11 could be a fluke, but conversely, it could indicate the start of an ongoing problem with under-reserving. Wouldn't it be more conservative from the regulatory perspective to leave Ratio 5 as is and view it with the caveat that fluctuation in future years is more likely given an unusual Ratio 11? I would think that removing the impact of the 1-yr reserve development may give a more favorable view of the insurer's profitability than is warranted.
Comments
Overall, I agree with your assessment. There is also the viewpoint that doing so serves to better separate the indications of the two ratios. That is, if Ratio 11 is unusual, you avoid penalizing the profit ratio for the same reason. NAIC seems to have favored this line of thinking over yours in setting up this rule.