LAT – Liability Adequacy Test

LAT – Liability Adequacy Test

International Financial Reporting Standard 4 required liability adequacy testing (LAT). In non-life insurance, the most important components of
LAT are run off analysis for claims provisions and unexpired risk reserve (URR) calculation. URR is defined as a prospective assessment of the
amount that needs to be set aside in orders to provide for the claims and expenses which will emerge from unexpired risks and which is over and
above the unearned premium reserve pertaining to the same risk as at the same valuation date.

In algebraic form: URR = max {(E[Claims] + E[Expenses] + DAC – UPR); 0}, where E[Claims] and E[Expenses] are claims and expenses expected to be incurred after valuation date on policies with unexpired exposure periods as the valuation date, DAC are deferred acquisition costs and UPR is unearned premium reserve as at valuation date.

In some countries, insurance regulator requires increasing modeled URR by some risk margin. In the near future, Solvency II will bring some changes – unearned premium reserve will be calculated on different way, URR will be calculated similar to current approach, except URR would be smaller due to effect of discounting.

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