Intermediate Track II

September 2000
Minneapolis, Minnesota

2000 CLRS 1
 This Session Will Discuss

1. Bornhuetter-Ferguson Method

2. Average Hindsight Method

3. Average Incremental Paid Method

2000 CLRS 2
 BORNHUETTER-
FERGUSON
METHOD

2000 CLRS 3
 Bornhuetter-Ferguson Method

Summary:
Project IBNR based on expected losses and the
percentage of ultimate losses which are currently
unreported.

The Bornhuetter-Ferguson method is a combination of

Expected Loss Ratio Method
(loss ratio x premium)
Paid or Incurred Loss Development Method
(paid or incurred losses x loss
development factor)
2000 CLRS 4
 Bornhuetter-Ferguson Method

Steps to Project Ultimate Loss

(1) Calculate Expected Losses

(2) Calculate IBNR Factor
(3) Calculate IBNR Reserve
(4) Calculate estimated ultimate losses.

2000 CLRS 5
 Bornhuetter-Ferguson Method

Assumptions
Earned Premium = $1,250
Incurred Losses = $600
Expected Loss Ratio = 65%
CDF = 1.35
(derived from incurred loss development
triangle)

2000 CLRS 6
 Bornhuetter-Ferguson Method

Step 1 Calculate Expected Losses

= Expected Loss Ratio x Earned Premium

Earned Premium = $1,250

Expected Loss Ratio = 65%
Expected Losses = $813 (1,250 x 0.65)

[Expected losses may also be projected using

(pure premium x exposure) OR
(frequency x severity x exposure) ]
2000 CLRS 7
 Bornhuetter-Ferguson Method

Step 2 Calculate IBNR Factor

[IBNR Factor is the percent of ultimate losses still left to be reported]

= IBNR / Ultimate Losses

= Ultimate Loss - Incurred to Date
Ultimate Loss
= 1.000 - (Incurred to Date / Ultimate)
= 1.000 - [1.000/(CDF)]

CDF = 1.350
IBNR Factor = [1 - 1/1.350] = 26%

2000 CLRS 8
 Bornhuetter-Ferguson Method

Step 3 Calculate IBNR Reserve

= IBNR Factor x Expected Losses

Expected Losses = $813

IBNR Factor = [1 - 1/1.350] = 26%
IBNR Reserve = [$813 x 26%] = $211

2000 CLRS 9
 Bornhuetter-Ferguson Method

Step 4 Calculate Estimated Ultimate Losses

= Incurred Losses + IBNR Reserve

Incurred Losses = $600

IBNR Reserve = [$813 x 26%] = $211
Ultimate Losses = [$600 + $211] = $811

2000 CLRS 10
 Bornhuetter-Ferguson Method

Advantages

Easy to use
Compromises between loss development and expected
loss ratio methods
Avoid overreaction - doesnt apply development factors
to an unusual claim occurrence
Suitable for new or volatile lines of business
Can be used with no internal loss history
Can also be used with paid data

2000 CLRS 11
 Bornhuetter-Ferguson Method

Disadvantages

Highly dependent on expected loss ratio or pure

premium
Requires development factors

2000 CLRS 12
 Bornhuetter-Ferguson Method

Comparison of Methods

Given:
Earned Premium = $2,000
Expected Loss Ratio = 70 %
Incurred Losses to Date = $750
Development Factor = 2.00

2000 CLRS 13
 Bornhuetter-Ferguson Method

1) Expected Loss Ratio Method

=Earned Premium x Expected Loss Ratio
=$2,000 x 70%
=$1,400

2) Loss Development Method

=Incurred to Date x Development Factor
=$750 x 2.00
=$1,500

3) Bornhuetter Ferguson Method

= Incurred to Date + Expected Losses x (1-1/Dev. Factor)
=$750 + $1,400 x [1 - 1/2.00]
=$750 + $700
=$1,450

2000 CLRS 14
 Bornhuetter-Ferguson Method

Comparison of Methods:
Illustration of Tempering Effect

Given:
One additional large claim of $150
Incurred Losses to Date = $900

2000 CLRS 15
 Bornhuetter-Ferguson Method

1) Expected Loss Ratio Method

=Earned Premium x Expected Loss Ratio
=$2,000 x 70%
=$1,400

2) Loss Development Method

=Incurred to Date x Development Factor
=$900 x 2.00
=$1,800

3) Bornhuetter Ferguson Method

= Incurred to Date + Expected Losses x (1-1/Dev. Factor)
=$900 + $1,400 x [1 - 1/2.00]
=$900 + $700
=$1,600

2000 CLRS 16
 AVERAGE
HINDSIGHT
METHOD

2000 CLRS 17
 Average Hindsight Method

Summary:

Estimate the expected ultimate losses for recent

accident years based on hindsight average paid
values per claim for more mature accident years.

2000 CLRS 18
 Average Hindsight Method

Data Needed

Cumulative Paid Loss Triangle

Cumulative Closed (Paid) Claim Count Triangle

2000 CLRS 19
 Average Hindsight Method

Steps to project Accident Year 1997 Ultimate Loss

(1) Project ultimate losses for AYs 1993-1996 using
paid loss development method
(2) Project ultimate claim counts for all AYs using
claim count development
(3) Calculate projected payment per claim from 36
months to ultimate
(4) Calculate total future payments for AY 1997
(5) Calculate estimated ultimate losses for AY 1997

2000 CLRS 20
 Average Hindsight Method

Accident Year 1997 - Step 1

Project ultimate losses for AYs 1993-1996 using

paid loss development method

2000 CLRS 21
 Average Hindsight Method

XYZ Auto Insurance Company

Cumulative Paid Losses ($000)

Accident Months of Development

Year 12 24 36 48 60 72 84
1993 $50.0 $80.0 $98.2 $107.8 $113.2 $117.2 $119.7
1994 60.2 97.0 118.5 130.7 136.6 141.0
1995 75.5 120.1 147.0 162.4 171.0
1996 91.9 147.1 180.2 197.0
1997 115.0 184.1 226.4
1998 146.5 233.4
1999 181.1

2000 CLRS 22
 Average Hindsight Method
XYZ Auto Insurance Company
Development of Paid Losses

Months of Development
Acc Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult
1993 1.600 1.228 1.098 1.050 1.035 1.021 1.000
1994 1.611 1.222 1.103 1.045 1.032
1995 1.591 1.224 1.105 1.053
1996 1.601 1.225 1.093
1997 1.601 1.230
1998 1.593

3 year avg 1.598 1.226 1.100 1.049 1.034 1.021 1.000

Selected 1.050 1.035 1.020 1.000
CDF 1.108 1.056 1.020 1.000

Diagonal 197.0 171.0 141.0 119.7

Ultimate 218.4 180.5 143.8 119.7

2000 CLRS 23
 Average Hindsight Method

XYZ Auto Insurance Company

Cumulative Paid Losses ($000)

Accident Months of Development

Year 12 24 36 48 60 72 84 Ultimate
1993 $50.0 $80.0 $98.2 $107.8 $113.2 $117.2 $119.7 $119.7
1994 60.2 97.0 118.5 130.7 136.6 141.0 143.8
1995 75.5 120.1 147.0 162.4 171.0 180.5
1996 91.9 147.1 180.2 197.0 218.4
1997 115.0 184.1 226.4 *
1998 146.5 233.4 *
1999 181.1 *

Ultimate losses from Slide 23

2000 CLRS 24
 Average Hindsight Method

Accident Year 1997 - Step 2

Project ultimate claim counts for all AYs using

claim count development

2000 CLRS 25
 Average Hindsight Method

XYZ Auto Insurance Company

Cumulative Number of Closed Claims

Accident Months of Development

Year 12 24 36 48 60 72 84
1993 50 75 88 94 97 99 100
1994 55 83 97 104 107 109
1995 63 94 110 118 122
1996 70 105 123 131
1997 80 120 141
1998 93 139
1999 105

2000 CLRS 26
 Average Hindsight Method
XYZ Auto Insurance Company
Development of Closed Claims

Months of Development
Acc Year 12-24 24-36 36-48 48-60 60-72 72-84 84-Ult
1993 1.500 1.173 1.068 1.032 1.021 1.010 1.000
1994 1.509 1.169 1.072 1.029 1.019
1995 1.492 1.170 1.073 1.034
1996 1.500 1.171 1.065
1997 1.500 1.175
1998 1.495

3 year avg 1.498 1.172 1.070 1.032 1.020 1.010 1.000

Selected 1.500 1.172 1.070 1.032 1.020 1.010 1.000
CDF 2.000 1.333 1.138 1.063 1.030 1.010 1.000

Diagonal 105 139 141 131 122 109 100

Ultimate 210 185 160 139 126 110 100

2000 CLRS 27
 Average Hindsight Method

XYZ Auto Insurance Company

Cumulative Number of Closed Claims

Accident Months of Development

Year 12 24 36 48 60 72 84 Ultimate
1993 50 75 88 94 97 99 100 100
1994 55 83 97 104 107 109 110
1995 63 94 110 118 122 126
1996 70 105 123 131 139
1997 80 120 141 160
1998 93 139 185
1999 105 210

Ultimate claim counts from Slide 27

2000 CLRS 28
 Average Hindsight Method

Accident Year 1997 - Step 3

Calculate projected payment per claim from 36

months to ultimate

2000 CLRS 29
 Average Hindsight Method

XYZ Auto Insurance Company

Calculation of Future Payment per Claim - 36 Months to Ultimate

Estimated Number of Number

Estimated Paid Estimated Ultimate Closed to Settle Average
Accident Ultimate Losses at Future Number Claims at Beyond Future
Year Losses 36 Months Payments of Claims 36 Months 36 Mos Payment
(1) (2)=Slide 24 (3)=Slide 24 (4)=(2)-(3) (5)=Slide 28 (6)=Slide 28 (7)=(5)-(6) (8)=(4)/(7)
1993 $119,700 $98,200 $21,500 100 88 12 $1,792
1994 143,820 118,500 25,320 110 97 13 1,934
1995 180,525 147,000 33,525 126 110 16 2,137
1996 218,372 180,200 38,172 139 123 16 2,345

Fitted forecasted value for AY 1997 $2,561

2000 CLRS 30
 Average Hindsight Method

Accident Year 1997 - Steps 4 & 5

Calculate total future payments for AY 1997

Calculate estimated ultimate losses for AY 1997

2000 CLRS 31
 Average Hindsight Method

XYZ Auto Insurance Company

Estimated Ultimate Losses: Accident Year 1997

(1) Forecasted Average Future Payment [Slide 30] $2,561

(2) Number of Future Claims to Settle [Slide 28]
(Ultimate - Closed Claims) = 160 - 141 19
(3) Estimated Future Loss Payments [ (1) x (2) ] $49,693
(4) Paid Losses to Date [Slide 24] $226,400
(5) Estimated Ultimate Losses [ (3) + (4) ] $276,093

2000 CLRS 32
 Average Hindsight Method

Steps to Project Accident Year 1998 Ultimate Loss

(1) Calculate projected payment per claim from 24 mos. to

ultimate (using results from AY 1997 projection)
(2) Calculate total future payments for AY 1998
(3) Calculate estimated ultimate losses for AY 1998

2000 CLRS 33
 Average Hindsight Method

Accident Year 1998 - Step 1

Calculate projected payment per claim from 24 mos. to

ultimate (using results from AY 1997 projection)

2000 CLRS 34
 Average Hindsight Method
XYZ Auto Insurance Company
Calculation of Future Payment per Claim - 24 Months to Ultimate

Estimated Number of Number

Estimated Paid Estimated Ultimate Closed to Settle Average
Accident Ultimate Losses at Future Number Claims at Beyond Future
Year Losses 24 Months Payments of Claims 24 Months 24 Mos Payment
(1) (2)=see below (3)=Slide 24 (4)=(2)-(3) (5)=Slide 28 (6)=Slide 28 (7)=(5)-(6) (8)=(4)/(7)
1994 $143,820 $97,000 $46,820 110 83 27 $1,728
1995 180,525 120,100 60,425 126 94 32 1,907
1996 218,372 147,100 71,272 139 105 34 2,079
1997 276,093 184,100 91,993 160 120 40 2,277

Fitted forecasted value for AY 1998 $2,497

(2) 1994-1996 ultimates from Slide 24, 1997 ultimate from Slide 32

2000 CLRS 35
 Average Hindsight Method

Accident Year 1998 - Steps 2 & 3

Calculate total future payments for AY 1998

Calculate estimated ultimate losses for AY 1998

2000 CLRS 36
 Average Hindsight Method

XYZ Auto Insurance Company

Estimated Ultimate Losses: Accident Year 1998

(1) Forecasted Average Future Payment [Slide 35] $2,497

(2) Number of Future Claims to Settle [Slide 28]
(Ultimate - Closed Claims) = 185 - 139 46
(3) Estimated Future Loss Payments [ (1) x (2) ] $115,684
(4) Paid Losses to Date [Slide 24] $233,400
(5) Estimated Ultimate Losses [ (3) + (4) ] $349,084

2000 CLRS 37
 Average Hindsight Method

Steps to Project Accident Year 1999 Ultimate Loss

(1) Calculate projected payment per claim from 12 mos. to

ultimate (using results from AYs 1997 & 1998 projections)
(2) Calculate total future payments for AY 1999
(3) Calculate estimated ultimate losses for AY 1999

2000 CLRS 38
 Average Hindsight Method

Accident Year 1999 - Step 1

(1) Calculate projected payment per claim from 12 mos. to

ultimate (using results from AYs 1997 & 1998 projections)

2000 CLRS 39
 Average Hindsight Method

XYZ Auto Insurance Company

Calculation of Future Payment per Claim - 12 Months to Ultimate

Estimated Number of Number

Estimated Paid Estimated Ultimate Closed to Settle Average
Accident Ultimate Losses at Future Number Claims at Beyond Future
Year Losses 12 Months Payments of Claims 12 Months 12 Mos Payment
(1) (2)=see below (3)=Slide 24 (4)=(2)-(3) (5)=Slide 28 (6)=Slide 28 (7)=(5)-(6) (8)=(4)/(7)
1995 $180,525 $75,500 $105,025 126 63 63 $1,675
1996 218,372 91,900 126,472 139 70 69 1,826
1997 276,093 115,000 161,093 160 80 80 2,004
1998 349,084 146,500 202,584 185 93 92 2,194

Fitted forecasted value for AY 1999 $2,399

(2) 1995-1996 ultimates from Slide 24, 1997 from Slide 32, 1998 from Slide
37
2000 CLRS 40
 Average Hindsight Method

Accident Year 1999 - Steps 2 & 3

Calculate total future payments for AY 1999

Calculate estimated ultimate losses for AY 1999

2000 CLRS 41
 Average Hindsight Method

XYZ Auto Insurance Company

Estimated Ultimate Losses: Accident Year 1999

(1) Forecasted Average Future Payment [Slide 40] $2,399

(2) Number of Future Claims to Settle [Slide 28]
(Ultimate - Closed Claims) = 210 - 105 105
(3) Estimated Future Loss Payments [ (1) x (2) ] $251,902
(4) Paid Losses to Date [Slide 24] $181,100
(5) Estimated Ultimate Losses [ (3) + (4) ] $433,002

2000 CLRS 42
 Average Hindsight Method

Advantages
Relatively unaffected by changes in case reserving
practices
Can easily adjust trend assumptions
Allows separate analysis of frequency and severity

Disadvantages
Sensitive to payment pattern shifts
Averages highly variable when only a few claims
May be insufficient if business has significantly changed
(i.e. retentions dramatically increase)
Too formula-driven
2000 CLRS 43
 AVERAGE
INCREMENTAL
PAID
METHOD

2000 CLRS 44
 Average Incremental Paid Method

Summary:
Estimate the expected ultimate losses for recent
accident years based on average incremental paid
values per claim.

2000 CLRS 45
 Average Incremental Paid Method

Data Needed:

Ultimate Claim Counts

Incremental Paid Loss Triangle

2000 CLRS 46
 Average Incremental Paid Method

XYZ Auto Insurance Company

Cumulative Number of Closed Claims

Accident Months of Development

Year 12 24 36 48 60 72 84 Ultimate
1993 50 75 88 94 97 99 100 100
1994 55 83 97 104 107 109 110
1995 63 94 110 118 122 126
1996 70 105 123 131 139
1997 80 120 141 160
1998 93 139 185
1999 105 210

Ultimate claim counts derived in average hindsight method -

Slide 28
2000 CLRS 47
 Average Incremental Paid Method

XYZ Auto Insurance Company

Incremental Paid Losses ($000)

Accident Months of Development

Year 0-12 12-24 24-36 36-48 48-60 60-72 72-84
1993 $50.0 $30.0 $18.2 $9.6 $5.4 $4.0 $2.5
1994 60.2 36.8 21.5 12.2 5.9 4.4
1995 75.5 44.6 26.9 15.4 8.6
1996 91.9 55.2 33.1 16.8
1997 115.0 69.1 42.3
1998 146.5 86.9
1999 181.1

12-24 column = Slide 24, column 3 (24 mos) - column 2 (12 mos)

2000 CLRS 48
 Average Incremental Paid Method

Steps to Project Ultimate Loss

(1) Create triangle of incremental paid losses per ultimate claim

(2) Calculate incremental payment trend factors and select
projected trend factor
(3) Calculate on-level incremental payments
(4) Project future payment amounts
(5) Calculate estimated ultimate losses

2000 CLRS 49
 Average Incremental Paid Method

Step 1

Create triangle of incremental paid losses per ultimate claim

2000 CLRS 50
 Average Incremental Paid Method

XYZ Auto Insurance Company

Incremental Paid Losses per Ultimate Claim (Actual)

Accident Months of Development

Year 0-12 12-24 24-36 36-48 48-60 60-72 72-84
1993 500 300 182 96 54 40 25
1994 547 334 195 111 54 40
1995 601 355 214 123 68
1996 660 396 238 121
1997 717 431 264
1998 791 469
1999 862

Slide 48 (incremental paid losses) / Slide 47 (ultimate claims counts)

2000 CLRS 51
 Average Incremental Paid Method

Step 2

Calculate incremental payment trend factors and select projected

trend factor.

2000 CLRS 52
 Average Incremental Paid Method

XYZ Auto Insurance Company

Incremental Paid Losses per Ultimate Claim (Actual)

Accident Months of Development

Year 0-12 12-24 24-36 36-48 48-60 60-72 72-84
1994/93 9.4% 11.4% 7.3% 15.4% -0.8% -0.1%
1995/94 9.9% 6.2% 9.6% 10.6% 27.7%
1996/95 9.8% 11.7% 11.0% -1.6%
1997/96 8.7% 8.7% 11.0%
1998/97 10.3% 8.8%
1999/98 9.1%

Select 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0%

6.2% = 355 / 334 - 1

= Slide 51 (1995) / Slide 51 (1994) - 1

2000 CLRS 53
 Average Incremental Paid Method

Step 3

Calculate on-level incremental payments

[Trend all incremental paid amounts to current (2000) level]

2000 CLRS 54
 Average Incremental Paid Method

XYZ Auto Insurance Company

Incremental Paid Losses per Ultimate Claim (On-Level)

Accident Months of Development

Year 0-12 12-24 24-36 36-48 48-60 60-72 72-84
1993 503 280 136 70 48 27
1994 514 276 144 64 44
1995 501 277 146 75
1996 513 282 131
1997 512 287
1998 511
1999
Select N/A 510 280 140 70 46 27

514 = 334 x (1.09) ^ 5

= Slide 51 * (Slide 53) ^ number of years

2000 CLRS 55
 Average Incremental Paid Method

Step 4

Project future payment amounts

[Fill-in the triangle]

2000 CLRS 56
 Average Incremental Paid Method
XYZ Auto Insurance Company
Incremental Paid Losses per Ultimate Claim (Projected)

Accident Months of Development

Year 0-12 12-24 24-36 36-48 48-60 60-72 72-84 Total
1993 0
1994 27 27
1995 46 29 75
1996 70 50 32 152
1997 140 76 55 35 306
1998 280 153 83 60 38 613
1999 510 305 166 91 65 42 1,179

Slide 55, Selected

83 = 70 x (1.09) ^ 2
= 1996 value x (Slide 53 ^ number of years)
Total = Sum across row (projected future severity)

2000 CLRS 57
 Average Incremental Paid Method

Step 5

Calculate estimated ultimate losses.

2000 CLRS 58
 Average Incremental Paid Method

XYZ Auto Insurance Company

Projected Ultimate Losses

Projected
Paid Loss Projected Projected Projected Ultimate
Accident Per Ult. Claim Future Average Ultimate Losses
Year as of 12/99 Severity Severity Claims (000's)
(1) (2)=see below (3)=Slide 57 (4)=(2)+(3) (5)=Slide 47 (6)=(4)x(5)
1993 $1,197 $0 $1,197 100 $119.7
1994 1,281 27 1,308 110 144.0
1995 1,361 75 1,436 126 180.5
1996 1,414 152 1,567 139 218.2
1997 1,411 306 1,717 160 275.5
1998 1,259 613 1,873 185 347.1
1999 862 1,179 2,041 210 428.6
(2) = Slide 51, summed across
row
2000 CLRS 59
 Average Incremental Paid Method

Advantages
Allows separate analysis of frequency and severity trends
Can be modified to account for changes affecting accident
year severity (e.g. deductibles, benefit changes)
Model can accommodate different trends by accident year,
calendar year or development age.

Disadvantages
Very dependent upon estimate of future inflation rates
Less accurate for low frequency lines of business
Could be distorted if payout patterns change

2000 CLRS 60