CLRS 2014: Correlations vs Common Accident Year and Calendar Year Drivers

We discuss three types of relationships between long tail LOBs; process or volatility correlation, parameter correlation and similar trend structure, equivalently common drivers. Two LOBs or segments have common calendar (accident) year drivers if calendar (accident) year trends change in the same way in the same years. Common drivers are the strongest type of relationships.

Process correlation between two LOBs is spurious unless for each LOB the identified (optimal) model measures the trends in the three directions.Common drivers by accident (underwriting) year have major implications for pricing future accident (underwriting) years.

The single identified (optimal) composite model projects log-normal distributions for each cell in each LOB including correlations between LOBs and within LOBs yielding a wealth of metrics. It facilitates the computation of the Economic Balance Sheet, SII one-year risk horizon metrics including SCR, Technical Provisions and Risk Margins, and variation in mean ultimates on year hence.

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