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, and 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.
Methods
The most popular methods of claims reserving include the chain-ladder method and the Bornhuetter-Ferguson method.
The chain-ladder method, also known as the development method, assumes that past experience is an indicator of future experience. Loss development patterns in the past are used to estimate how claim amounts will increase (or decrease) in the future.
The Bornhuetter-Ferguson method uses both past loss development as well as an independently derived prior estimate of ultimate expected losses.[1]