What Is the Chain Ladder Method?

The Chain Ladder Method (CLM) is a method for computing the claims reserve requirementꦫ in an insurance company’s financial statement. The chain ladder method is used by insurers to forecast the amount of reserves that must be established in order to cover projected future claims by projecting past claims experience into the future. CLM therefore only works when prior patterns of losses are assumed to persist in the future🧸. When insurer’s current claims experience changes for some reason, the chain-ladder method will not produce an accurate estimate without proper adjustments.

This actuarial method is one of the most popular reserve methods used by insurance companies. The chain ladder method can be compared with the 澳洲幸运5官方开奖结果体彩网:Bornhuetter-Ferguson Technique and 澳洲幸运5官方开奖结果体彩网:Expected Loss Ratio (ELꦚR) method for calculating insurance company reserves.

Chain Ladder Method

The chain ladder method calculates 澳洲幸运5官方开奖结果体彩网:incurred but not reported (IBNR) loss estimates, using run-off triangles of paid losses and incurred losses, representing the sum of paid losses and case reserves. Insurance companies are required to set aside a portion of the premiums they receive from their 澳洲幸运5官方开奖结果体彩网:underwriting activities to pa𝐆y for claims that may be filed in the future. The accuracy of claims forecasts and reserving has a big impact on an insurance company's financial situation.

Run-off triangles (or delay triangles) are two-dimensional matrices that are generated by accumulating claim data over a period of time. The claim data is run through a stochastic process to create the run-off matrices after allowing for many degrees of freedom✃.

Key Assumptions

At its core, the chain ladder method operates under the assumption th﷽at patterns in claims activities in the past will continue to be seen in the future. In order for this assumption to hold, data from past loss experiences must be accurate. Several factors can impact accuracy, including changes to the product offerings, regulatory and legal changes, periods of high severity claims, and changes in the claims settlement process. If the assumptions built into the model differ from observed claims, insurers may have to make adjustments to the model.

Creating estimations can be difficult because random fluctuations in claims data and a small data set can result in forecasting errors. To smooth over these problems, insurers combine both company claims data with data from the industry in gen🦹eral.

Steps for Applying Chain Ladder Method

According to Jacqueline Friedland's "Estimating Unpaid Claims Using Basic Techniques," the seven steps to applying the chain-ladder method are:

1. Compile claims data in a development triangle
2. Calculate age-to-age factors
3. Calculate averages of the age-to-age factors
4. Select claim development factors
5. Select tail factor
6. Calculate cumulative claim development factors
7. Project ultimate claims

Age-to-age factors, also called 澳洲幸运5官方开奖结果体彩网:loss development factors (LDFs) or link ratios, represent the ratio of loss amoꦗunts 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 ultimate amount of losses will settle.