For most lines of insurance, there is some delay between when a loss event actually occurs and when it's reported to the insurance company.

But this creates a problem for the insurance company because they need to calculate their claims expense based on the total amount of incurred claims, but they don't know with absolute certainty what loss events have actually occurred. Well, the way that insurance companies deal with this is to include in their reserves an estimate of the amount of claims which have been incurred but not yet reported to the insurance company, and those claims are referred to as incurred but not reported, or IBNR claims. Now, the claims reserves therefore show the amount of claims reported plus the IBNR claims, less amounts paid to policyholders. And the sum of the reported claims plus the IBNR claims are therefore the incurred claims.

Now, insurance companies spend a great deal of time analyzing how the reporting of claims and the payment of them develop over time, and there's really three key reasons why this is so important to them.

Now, the first is that it will help to identify if claims are likely to be higher or lower than their initial estimations, as they will see the claims development deviate from their expectations over time rather than waiting until all the claims are received.

Secondly, it will help to make a more accurate estimate of how long it takes for claims to be reported and therefore a more accurate estimate of the IBNR claims. Now, finally, it will also help them by tracking how claims are actually paid over time, which will help them to predict the amount of funds available to invest before the claims are actually paid.

Now, this chart shows an example of how claims for a two-year policy might develop over time. And you can see at the bottom, the dark blue blocks, they're the reported claims.

The light blue blocks, they're the IBNR claims.

And then the dark blue line which runs over the top, that's the total incurred claims. And then the red line shows you the total amount of claims paid. Now, it's important to note that this claims development data is given on a cumulative basis. So if for this policy, the initial premium was 100, you can see that the claims level off by year three or four at 80. So the ultimate loss ratio on this policy is 80%.

Now you can see that during the coverage period, the IBNR claims are a very large part of the incurred claims, but this reduces rapidly once the coverage period finishes, and that's because the anticipated claims are actually reported. Now, you can see that the red line sits well below the top of the dark blue block, and that shows that there is a lag between the claims being reported and when they're paid.

And this is because it takes time for losses to be agreed and settled.

Now this lag, it really depends on the complexity of the claims.

It's typically much longer for commercial insurance, where it can take many months for the claims to be agreed and then settled, whereas it's typically much shorter in autos insurance, where it takes just a matter of days or weeks for the claims to be agreed and settled.