Estimation of liability for outstanding claims.1

1. A public sector company offers various general insurance products such as, Fire, Marine, Transit, Motor, Personal Accident, etc. One of the policies underwritten by the company is Motor Third Party Insurance under which legal liability suffered by the insured on account of injuries/death, caused to the public as well as property damage suffered by the public resulting from collision with the insured’s vehicle, is indemnified by the company. The querist had obtained the Opinion of the Expert Advisory Committee earlier on the facts contained in the following paragraphs. The same has been published in the Compendium of Opinions, Volume XXII, Query No.29.

2. The accounts of the company are prepared on mercantile basis and the losses reported but not settled at the year end are provided for. Generally, the outstanding losses in the case of policies other than Motor Third Party are provided for on the basis of survey reports given by surveyors quantifying the loss. As per the querist, these estimates are by and large realistic and can be easily verified by the auditors. However, Motor Third Party losses are broadly divided into four categories, viz., death, grievous injury, minor injury and third party property damage. The liability is estimated on the basis of certain criteria, such as, age of the person, number of dependent family members, income of the person, etc. According to the querist, the compensation awarded by the Motor Accident Claims Tribunals (MACT) varies from tribunal to tribunal as the compensation is not fully structured under the Motor Vehicles Act and certain element of subjectivity is involved in the awards pronounced by the judges.

3. Till the year 2000-01, the company was providing for outstanding Motor Third Party claims based on the above factors. However, the company observed, at the time of finalisation of accounts for the year 2001-02, that these claims have not been adequately provided for in the light of actual awards given by the MACT during the year 2001-02. Hence, the company conducted an exercise to arrive at the average amount paid per Third Party claim by each region during the year 2001-02 and compared the same with the average amount provided for outstanding claims by their Operating Offices as on 31.3.2002. This study established the fact that the claims were underprovided since average amount provided per claim by their Operating Offices was considerably short of the average amount paid per claim by the regions. Accordingly, the company provided an additional amount of Rs.308 crore at Head Office on account of its Operating Offices before finalising their accounts for the year 2001-02.

4. The change in the method of estimating the liability from ‘case to case method’ to the ‘trends in settlement method’ was referred by the company to two firms of chartered accountants for their opinion and advice. They concurred with the action and opined that there is nothing wrong in estimating the liability on the basis of ‘trends in settlement method’ which reflected a more realistic picture of the liability. The matter was also referred to the appointed actuary who also agreed with the change and certified the additional liability provided at the Head Office. The querist had provided the opinions of the firms mentioned above and the certificate of the actuary for the reference of the Expert Advisory Committee.

5. The querist had sought the opinion of the Expert Advisory Committee as to whether the action of changing the method of estimation of outstanding liabilities from ‘case to case method’ to ‘trends in settlement method’ in case of Motor Third Party claims was justified and would not be construed as ad hoc. The Committee had opined that it is for the management to decide and for the auditor to comment upon whether the ‘trends in settlement method’ provides the best estimate of the expenditure required to settle the claims. In general, the ‘case to case method’, which also takes into consideration the trends in settlement in similar circumstances, is likely to provide a better estimate compared to an over-all region-wise averaging under the ‘trends in settlement method’.

6. The querist has now informed that for the year 2002-03, statistics similar to the statistics collected for the year 2001-02 was collected from the Regions, category-wise, i.e., fatal cases, grievous injuries, minor injuries and property damage and excess/under-provisioning category-wise and region-wise was worked out, in accordance with the opinion of the Expert Advisory Committee obtained by the querist earlier. The querist is of the view that this is a better method over the overall average method adopted by the company in the year 2001-02 in view of disparities in the amount of compensation awarded by MACT in different regions and further because category-wise composition of claims paid and claims outstanding is different for fatal, grievous injury, minor injury and property damage. The querist has stated that for instance, the average amount paid per fatal claim is Rs.2,67,057 in the case of New Delhi RO II as against Rs.1,19,254 in the case of Patna RO. Similarly, fatal cases account for 29.02% of the number of claims settled during the year whereas only 24.45% of the outstanding claims is made up of fatal cases. In the method adopted for the year 2002-03 weightage is given for these two factors, which have a bearing on the net under-provisioning of outstanding claims of the company as a whole.

7. The querist has informed that if the excess/under-provisioning is netted out category-wise and region-wise, the net under-provisioning works out to Rs.64.48 crore. However, if the excess/under-provisioning is netted out for each category separately, i.e., by netting the effect of excess/under- provisioning taking into account all regions for each category separately; in other words, if excess provisioning under one category like ‘fatal cases’ is not set off against under-provisioning in another category, for instance, net excess provision of Rs.9,14,27,276 under ‘fatal cases’ is not set off against under-provisioning of Rs.74,36,40,318 in ‘grievous injuries cases’, the net under-provisioning works out to Rs.77.18 crore.

B . Query

8. The querist has sought the opinion of the Expert Advisory Committee on the issue as to whether under/excess-provision is to be netted off category- wise and region-wise or only category-wise.

C. Points Considered by the Committee

9. The Committee notes from the facts of the case that the company is estimating the liability for outstanding claims at the regional level and is applying the ‘trends in settlement’ method at the head-office level. The Committee also notes from the facts of the case that the ‘trend in settlement’ is determined by the company for each category region-wise, by averaging the actual amount paid by the region under that category during the year 2002-03.

10. The Committee reiterates its view that generally the case-to-case method, which also takes into consideration the trends in settlement in similar circumstances, is likely to provide a better estimate of the liability for outstanding claims since such a method would take into account the peculiarities and circumstances of the individual cases. In this context, the Committee is of the view that the ‘trend’ should be based on the past atleast 3 to 5 years’ data. Thus, ‘trend’ cannot be determined by merely averaging the actual claims paid in the past one year as the company is doing; instead, it should be determined as to whether there is an increasing trend or a decreasing trend for different classes of claims within a particular category, viz., classes determined on the basis of age, earnings, dependants, etc., in respect of each region and based on such a trend, make the estimate. In other words, it is preferred that the liability for outstanding claims should be estimated at the regional level by applying the trend in settlement in similar cases within that region taking into consideration other factors on a case-to- case basis.

11. The Committee is further of the view that when the amount of provision for outstanding claims is determined after taking into account the trend in settlement of similar cases, there will be no need to provide for any additional amounts at the Head Office level. Thus, the question of netting off any under/excess-provision category-wise and/or region-wise would not arise. However, if it is considered that the best estimate of the provision can be arrived at the Head Office level by adjusting the estimates made by the regional offices, by applying the trend based on the past 3 to 5 years’ data, netting off of under/excess-provision between different categories should not be done. In other words, netting off can be done within the same category in respect of under/excess-provision pertaining to different regions. For example, excess provision under the category of fatal cases can not be adjusted against the under-provision under the category of grievous injury, whereas, an under-provision of region ‘X’ can be adjusted against the excess provision of region ‘Y’ within the category of grievous injury. The Committee is further of the view that the excess/under-provision made at the Head Office level should be reflected in the accounts of the regions also so that their performance is reflected in a true and fair manner.

D. Opinion

12. On the basis of the above, the Committee is of the opinion that under/ excess provisioning should not be netted off either category-wise and region- wise or only category-wise. The provision should be made in accordance with paragraphs 10 and 11 above.

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1 Opinion finalised by the Committee on 28.10.2003.

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