Loss reserving
Loss reserving or Outstanding claims reserves refers to the calculation of the required reserves for a tranche of general insurance business.[1]
Typically, the claims reserves represent the money which should be held by the insurer so as to be able to meet all future claims arising from policies currently in force and policies written in the past.
Methods of calculating reserves in general insurance are different from those used in life insurance, pensions and health insurance since general insurance contracts are typically of a much shorter duration. Most general insurance contracts are written for a period of one year. Typically there is only one payment of premium at the start of the contract in exchange for coverage over the year.
Reserves are calculated differently from contracts of a longer duration with multiple premium payments since there are no future premiums to consider in this case. The reserves are calculated by forecasting future losses from past losses.
The more popular statistical methods in claims reserving are the Chain Ladder Method and the Bornhuetter Ferguson Method.
The Chain Ladder Method uses data in a two dimensional array representing occurrence and development of claims. The upper left of this matrix contains known values (in the past) which are used to estimate the remaining figures (i.e. arising in the future).
The Bornhuetter Ferguson Method is a Bayesian technique. This means that it incorporates both an independently derived prior estimate of ultimate expected losses as well as estimates generated by the same kind of matrix described above. These are weighted by what is called a credibility factor, ideally giving preference to the more reliable projection, but taking both into consideration.[1]