What Is the Bornhuetter-Ferguson Technique?
The Bornhuetter-Ferguson technique is a method for calculating an estimate of an insurance policy company’s losses. The Bornhuetter-Ferguson technique, regularly referred to as the Bornhuetter-Ferguson method, estimates incurred alternatively not however reported (IBNR) losses for a protection year. The program was once as soon as created by means of two actuaries, Bornhuetter and Ferguson, and was once as soon as first presented in 1975.
Key Takeaways
- The Bornhuetter-Ferguson technique is a method of estimating incurred alternatively not however reported (IBNR) losses for insurers.
- That is most probably one among the freshest methods for calculating loss reserves, 2d best to the chain-ladder method.
- The Bornhuetter-Ferguson technique combines choices of the chain ladder and expected loss ratio methods and assigns weights for the share of losses paid and losses incurred.
- The technique may be when losses are low frequency alternatively top severity.
How the Bornhuetter-Ferguson Technique Works
Bornhuetter-Ferguson is one of the maximum most often used loss reserve valuation methods, 2d best to the chain-ladder method. It combines choices of the chain ladder and expected loss ratio methods and assigns weights for the share of losses paid and losses incurred. By contrast to the chain ladder method, which builds a method in keeping with earlier enjoy, the Bornhuetter-Ferguson technique builds a method in keeping with the insurer’s exposure to loss.
There are two algebraically an an identical methods for calculating loss, consistent with the Bornhuetter-Ferguson technique. Throughout the first way, undeveloped reported (or paid) losses are added immediately to expected losses (in keeping with an a priori loss ratio), multiplied by means of an estimated percent unreported.
BF = L + ELR * Exposure * (1 – w)
In the second calculation method, reported (or paid) losses are first complicated to ultimate using a chain-ladder way and applying a loss building factor (LDF). Next, the chain-ladder ultimate is multiplied by means of an estimated percent reported. In any case, expected losses multiplied by means of an estimated percent unreported are added (as throughout the first way).
BF = L * LDF * w + ELR * Exposure * (1 – w)
The estimated percent reported is the reciprocal of the loss building factor. IBNR claims are then figured by means of subtracting reported losses from the Bornhuetter-Ferguson ultimate loss estimate.
Bornhuetter-Ferguson Technique vs. Chain Ladder Approach
The chain ladder method examines the aim over a length in time through which a claim is reported or paid. Insurers use this to “budget” for longer term losses, with the sum of all the longer term losses equaling the IBNR. Claim estimates from earlier time periods are made concrete, in keeping with loss enjoy. As a result of this the actuary swaps earlier estimates with actual claims.
The Bornhuetter-Ferguson technique estimates IBNR right through a time period by means of estimating the ultimate loss needless to say risk exposures and then estimating the percent of this ultimate loss that was once as soon as not reported at the time. Bornhuetter-Ferguson calculates the estimated loss since the sum of reported loss plus IBNR, with IBNR calculated since the estimated ultimate loss multiplied by means of the share of loss that is unreported. Loss estimates use priori loss estimates.
Bornhuetter-Ferguson may be some of the useful in instances where actual reported losses do not provide a good indicator of IBNR. This is in all probability when losses are low frequency alternatively top severity, a combination that makes it more difficult to provide right kind estimates. It is easier for an insurer to be expecting what will happen with top frequency, low severity claims.
