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FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans

Which statement best describes why long-tail lines such as general liability and workers' compensation expose a property-casualty insurer to greater reserving risk than short-tail lines such as personal auto physical damage?

Long-tail lines carry more reserving risk because claims are reported and settled years after the premium is earned. Ultimate losses are therefore harder to estimate, and inflation or legal developments can make initial reserves inadequate. Short-tail lines settle quickly, leaving little time for estimates to prove wrong.

  1. AClaims on long-tail lines are reported and settled long after premiums are earned, so ultimate losses are more uncertain and reserves are more likely to prove inadequateCorrect
  2. BLong-tail lines have fixed premiums that cannot be repriced, whereas short-tail lines are repriced daily
  3. CLong-tail claims are always smaller in size, which makes reserve estimates less reliable
  4. DLong-tail lines are not subject to inflation in claim costs, so reserves are released early

Explanation

Long-tail claims develop over many years, so claim severity, inflation and legal changes can alter ultimate losses well after pricing. This makes reserve estimates uncertain. The other options misstate pricing, claim size or inflation effects.

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