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
Liability insurance (also called third-party insurance) is a part of the general insurance system of risk financing to protect the purchaser (the "insured") from the risks of liabilities imposed by lawsuits and similar claims and protects the i ...
, are often not paid out immediately.
Claims adjuster
A claims adjuster, desk adjuster, field adjuster, or general adjuster (claim adjuster, claims handler, claim handler or loss adjuster in the United Kingdom, Ireland, Australia, South Africa, the Caribbean and New Zealand) investigates insurance cla ...
s set initial case reserves for claims; however, it is often impossible to predict immediately what the final amount of an insurance claim will be,
due to uncertainty around defense costs, settlement amounts, and trial outcomes (in addition to several other factors). Loss development factors are used by
actuaries
An actuary is a business professional who deals with the measurement and management of risk and uncertainty. The name of the corresponding field is actuarial science. These risks can affect both sides of the balance sheet and require asset man ...
,
underwriter
Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabilit ...
s, and other insurance professionals to "develop" claim amounts to their estimated final value. Ultimate loss amounts are necessary for determining an insurance company's carried reserves. They are also useful for determining adequate insurance premiums, when loss experience is used as a rating factor
Loss development factors are used in all triangular methods of
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.
Ty ...
,
such as the
chain-ladder method The chain-ladder or developmenthttps://www.casact.org/library/studynotes/Friedland_estimating.pdf method is a prominent actuarial loss reserving technique.
The chain-ladder method is used in both the property and casualtyhttps://www.casact.org/ ...
.
See also
Incurred but not reported
In insurance, incurred but not reported (IBNR) claims is the amount owed by an insurer to all valid claimants who have had a covered loss but have not yet reported it. Since the insurer knows neither how many of these losses have occurred, nor the ...
References
Further reading
*
*{{cite web, url=http://www.sigmaactuary.com/library/LDPrimer.pdf, title=The Insurance Professional's Loss Development Primer
Actuarial science