What is a “Reasonable” Range?
Outline
• Range of what?
• For what purpose/use –
• Whose range?
• Transparent disclosure
• Uncertainty, conservatism and bias
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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Range of what?
Major issues in this area
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Outcomes vs. estimates?
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If estimates, what’s the measurement basis?
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Speculative outcomes
•
Range endpoints
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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”.
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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Measurement basis
What is a best estimate?
“Best estimate” of what?
• Mean?
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•
•
•
•
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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?)
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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Range Endpoints
“Reasonable” is not a black and white standard
This implies that the endpoints of a reasonable range
are not exact or firm.
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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For What Purpose/use?
The desired range may vary (or even be dictated)
by the purpose/use.
(I.e., your options may be limited.)
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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?
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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Whose range?
Some choices
Reserving actuary’s
Management’s
Auditor’s
The role of the range depends on whose range it is.
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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.)
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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.
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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Transparent disclosure – a few other suggestions
Be clear as to what kind of range it is
Outcome? Estimates? Estimates of what?
Be clear as to how reliable it is
Be ready for outcomes outside your previous range
May want to disclose that possibility in advance.
Be ready for misinterpretations (innocent and otherwise)
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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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.
2006 CLRS
What is a “Reasonable” Range – R. Blanchard
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