1What is a “Reasonable” Range – R. Blanchard2006 CLRS

What is a “Reasonable” Range?

Outline

• Range of what?

• For what purpose/use –

• Whose range?

• Transparent disclosure

• Uncertainty, conservatism and bias

2What is a “Reasonable” Range – R. Blanchard2006 CLRS

Range of what?

Major issues in this area

• Outcomes vs. estimates?

• If estimates, what’s the measurement basis?

• Speculative outcomes

• Range endpoints

3What is a “Reasonable” Range – R. Blanchard2006 CLRS

Outcomes vs. Estimates (part 1 - outcomes)

Range of “reasonable outcomes”

• “Reasonable outcome” = “Reasonably likely”?

• If so, this implies a confidence interval,

• implies a distribution,

• but not necessarily a complete distribution

Focuses on the middle of the distribution, not the tail, and middle should be more quantifiable

4What is a “Reasonable” Range – R. Blanchard2006 CLRS

Outcomes vs. Estimates (part 2 – estimates)

Range of estimates

• Implies different opinions of what is likely

• Not necessarily compatible to “confidence interval” presentation

• Doesn’t require a distribution

Not “what could happen”, but “what is reasonable to expect”.

5What is a “Reasonable” Range – R. Blanchard2006 CLRS

Measurement basis

What is a best estimate?

“Best estimate” of what? • Mean? • Mode? • Median? • Central tendency?• 75th percentile? • PML?• Mean plus one standard deviation

Could be any of the above, but does your audience know which one you’re estimating? Do you?

(Communication opportunity?)

6What is a “Reasonable” Range – R. Blanchard2006 CLRS

Speculative Outcomes

What is speculation?

• If I can reliably quantify it, it isn’t speculation

• Just because I can come up with a value, doesn’t mean it isn’t speculation.

N = N* × fp × fpm × ne × ng × fi × fc × fl × fm × fj × fme

“Drake’s Equation”

Key is reliable estimation.

• Speculative outcomes may not be appropriate for inclusion in estimate

Common rule – book estimates, disclose but don’t book speculation

7What is a “Reasonable” Range – R. Blanchard2006 CLRS

Range Endpoints

“Reasonable” is not a black and white standard

This implies that the endpoints of a reasonable range are not exact or firm.

8What is a “Reasonable” Range – R. Blanchard2006 CLRS

For What Purpose/use?

The desired range may vary (or even be dictated)

by the purpose/use.

(I.e., your options may be limited.)

9What is a “Reasonable” Range – R. Blanchard2006 CLRS

For What Purpose/use? – Part 1

Internal communication• No “a priori” limitations• Find out what is expected

SEC filing

• Range of reasonable estimates

How much are current earnings a function of judgment?

• Range of outcomes

How much are future earnings at risk?

10What is a “Reasonable” Range – R. Blanchard2006 CLRS

For What Purpose/use? – Part 2

Merger/acquistion• Buyer/seller may want to know many different things

• Expected payments?• Worst case payouts?• Possible one year development?• other?

• Find out what your audience wants

Commutation work

• See Merger/acquisition discussion above

11What is a “Reasonable” Range – R. Blanchard2006 CLRS

Whose range?

Some choices

Reserving actuary’s

Management’s

Auditor’s

The role of the range depends on whose range it is.

12What is a “Reasonable” Range – R. Blanchard2006 CLRS

Whose range? – Reserving actuary’s?

Range of estimates

• Aids management in determining their best estimate

• Should include discussion of drivers for various pts in range

• Possible input for appointed actuary’s analysis

Range of outcomes

Part of risk analysis

13What is a “Reasonable” Range – R. Blanchard2006 CLRS

Whose range? – Management’s? Auditor’s

Management’s range• Used for determining what to book

Auditor’s range

• Used for determining reasonableness of management’s estimate (i.e., what was booked)

Concern is not whether management is continually booking near

the low or the high of their range

Concern is instead whether they are moving around in their range

from year to year.

(Note: Moving around in auditor’s range is not the same thing.)

14What is a “Reasonable” Range – R. Blanchard2006 CLRS

Transparent Disclosure – 4 major rules

1. Know your audience !

2. Know your audience !!

3. Know your audience !!!

4. Your audience may not be fellow actuaries.

15What is a “Reasonable” Range – R. Blanchard2006 CLRS

Transparent disclosure – a few other suggestions

Be clear as to what kind of range it isOutcome? Estimates? Estimates of what?

Be clear as to how reliable it is

Be ready for outcomes outside your previous rangeMay want to disclose that possibility in advance.

Be ready for misinterpretations (innocent and otherwise)

16What is a “Reasonable” Range – R. Blanchard2006 CLRS

Uncertainty, Conservatism & Bias

With all this uncertainty, shouldn’t I be a bit conservative in my numbers, and include a margin for adverse deviation in my range?

Are you adjusting for bias? Or adding bias?

Proposed GAAP – “this framework does not include prudence or conservatism as

desirable qualities of financial reporting information.”

Current GAAP thinking clearly favors neutrality (lack of bias)

over conservatism

17What is a “Reasonable” Range – R. Blanchard2006 CLRS

Uncertainty, Conservatism & Bias – part 2

Existing U.S. Stat.

(NAIC’s Emerging Accounting Issues Working Group – INT 01-28: Margin for Adverse Deviation in Claim Reserve)

“The working group reached a consensus that the concept of conservatism is inherent to the estimation of reserves and as such should not be specifically prohibited in the consideration of management’s best estimate. On the other hand, the working group does not believe there should be a specific requirement to include a provision for adverse deviation in claims as the application of estimates varies greatly from company to company and requires the careful judgement of management.”

Conclusion: GAAP intends to prohibit any “bias”,

Stat. allows but doesn’t require upward bias.