namely the ‘percentile approach’ and the ‘cost-of-capital approach’. The ‘percentile approach’ is used to evaluate the adequacy of technical reserves for financial reporting purposes, while the ‘cost-of-capital approach’ is used as one of the inputs for regulatory reporting purposes. a. Percentile approach Under this methodology, reserves are held to be at least sufficient at the 75th percentile of the ultimate loss distribution. The first step in the process is to calculate a best-estimate reserve. Being a best-estimate, there is an equally likely chance that the actual amount needed to pay future claims will be higher or lower than this calculated value. The next step is to determine a risk margin. The risk margin is calculated such that there is now at least a 75% probability that the reserves will be sufficient to cover future claims. For more detail on the reserving techniques used in this approach, refer to note 38.2. b. Cost-of-capital approach The cost-of-capital approach to reserving is aimed at determining a market value for the liabilities on the statement of financial position. This is accomplished by calculating the cost of transferring the liabilities, including their associated expenses, to an independent third party. The cost of transferring the liabilities off the statement of financial position involves calculating a best-estimate of the expected future cost of claims, including all related run-off expenses, as well as a margin for the cost of capital that the independent third party would need to hold to back the future claims payments. Two key differences between the percentile and cost-of-capital approaches are that under the cost-of-capital approach, reserves must be discounted using a term-dependent interest rate structure and that an allowance must be made for unallocated loss adjustment expenses. The cost-of-capital approach will result in different levels of sufficiency per class underwritten so as to capture the differing levels of risk inherent within the different classes. This is in line with the principles of risk-based solvency measurement. The net claims ratio for the Group, which is important in monitoring short-term insurance risk is summarised below: Group 2022 2021 Loss history Net claims paid and provided % of net earned premiums 64.9% 55.3% Reinsurance Risk Management Reinsurance risk is the risk that the reinsurance cover placed is inadequate and/or inefficient relative to the Group’s risk management strategy and objectives. The Group obtains third-party short-term reinsurance cover to reduce risks from single events or accumulations of risk that could have a significant impact on the current year’s earnings or the Group’s capital. It is believed that the reinsurance programme suits the risk management needs of the business. The core components of the reinsurance programme comprise: • A Whole Account Clash & Catastrophe Excess of loss treaty with five layers. PPS Short-term Insurance ('PPS STI') retains the first R2.5 million of each and every claim, excluding reinstatement 39. Management of risks (continued) 39.2 Insurance product risk management (continued) 177 Notes to the Consolidated Financial Statements
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