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IAI Actuarial Core Principles · Economic Modelling · Run-off triangles

Compared with the basic chain ladder method, why is the Bornhuetter-Ferguson method often preferred for the most recent, immature accident year?

BF is preferred for immature years because it uses an a priori expected ultimate for the part of claims not yet emerged, so the reserve is not distorted by volatile early experience that the chain ladder would scale up by a large factor.

  1. AIt ignores the a priori estimate and uses only the development factors
  2. BIt requires no assumption about the development pattern
  3. CIt guarantees that the reserve equals the chain ladder reserve
  4. DIt makes the ultimate proportional to the small amount of claims so far, which gives stability
  5. It limits the effect of volatile early claims experience by using an a priori ultimate for the unreported partCorrect

Explanation

For immature years the cumulative claims are small and volatile, and grossing them up by a large factor magnifies random fluctuation. BF uses the a priori ultimate for the outstanding portion, so the reserve is not driven by the early noise. Option 3 describes the chain ladder weakness.

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