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The chain-ladder or developmenthttps://www.casact.org/library/studynotes/Friedland_estimating.pdf method is a prominent actuarial
loss reserving Loss reserving refers to the calculation of the required reserves for a tranche of general insurance business.Schmidt, K. D., Zocher, M.The Bornhuetter–Ferguson Principle Variance 2:1, 2008, pp. 85-110. It includes outstanding claims reserves. ...
technique. The chain-ladder method is used in both the property and casualtyhttps://www.casact.org/library/studynotes/Werner_Modlin_Ratemaking.pdf and
health insurance Health insurance or medical insurance (also known as medical aid in South Africa) is a type of insurance that covers the whole or a part of the risk of a person incurring medical expenses. As with other types of insurance, risk is shared among ma ...
fields. Its intent is to estimate incurred but not reported claims and project ultimate loss amounts. The primary underlying assumption of the chain-ladder method is that historical loss development patterns are indicative of future loss development patterns.


Methodology

According to Jacqueline Friedland's "Estimating Unpaid Claims Using Basic Techniques," there are seven steps to apply the chain-ladder technique: # Compile claims data in a development triangle # Calculate age-to-age factors # Calculate averages of the age-to-age factors # Select claim development factors # Select tail factor # Calculate cumulative claim development factors # Project ultimate claims Age-to-age factors, also called
loss development factor Loss development factors or LDFs are used in insurance pricing and reserving to adjust claims to their projected ultimate level. Insurance claims, especially in long-tailed lines such as liability insurance, are often not paid out immediately. Claim ...
s (LDFs) or link ratios, represent the ratio of loss amounts from one valuation date to another, and they are intended to capture growth patterns of losses over time. These factors are used to project where the ultimate amount losses will settle.


Example

Firstly, losses (either reported or paid) are compiled into a triangle, where the rows represent accident years and the columns represent valuation dates. For example, the entry '43,169,009' represents loss amounts related to claims occurring in 1998, valued as of 24 months. Next, age-to-age factors are determined by calculating the ratio of losses at subsequent valuation dates. From 24 months to 36 months, accident year 1998 losses increased from 43,169,009 to 45,568,919, so the corresponding age-to-age factor is 45,568,919 / 43,169,009 = 1.056. A "tail factor" is selected (in this case, 1.000) to project from the latest valuation age to ultimate. Finally, averages of the age-to-age factors are calculated. Judgmental selections are made after observing several averages. The age-to-age factors are then multiplied together to obtain cumulative development factors. The cumulative development factors multiplied by the reported (or paid) losses to project ultimate losses. Incurred but not reported can be obtained by subtracting reported losses from ultimate losses, in this case, 569,172,456 - 543,481,587 = 25,690,869. http://journals.cambridge.org/article_S0515036100015294


Limitations

The chain-ladder technique is only accurate when patterns of loss development in the past can be assumed to continue in the future. In contrast to other loss reserving methods such as the Bornhuetter–Ferguson method, it relies only on past experience to arrive at an incurred but not reported claims estimate. When there are changes to an insurer's operations, such as a change in claims settlement times, changes in claims staffing, or changes to case reserve practices, the chain-ladder method will not produce an accurate estimate without adjustments. The chain-ladder method is also very responsive to changes in experience, and as a result, it may be unsuitable for very volatile lines of business.


See also

* Incurred but not reported *
Loss reserving Loss reserving refers to the calculation of the required reserves for a tranche of general insurance business.Schmidt, K. D., Zocher, M.The Bornhuetter–Ferguson Principle Variance 2:1, 2008, pp. 85-110. It includes outstanding claims reserves. ...
* Bornhuetter–Ferguson method


References

{{reflist Actuarial science