[[Actuarial Notes Wiki|Wiki]] / [[Exam 5 (CAS)]] / **Expected Loss Method** ## Definition ==Expected Loss Method== is a reserving technique that uses an a priori expected loss ratio applied to earned premium to estimate ultimate losses, ignoring actual reported losses entirely. ## Formula ``` Ultimate Losses = Expected Loss Ratio × Earned Premium IBNR = Ultimate - Reported Losses Where Expected Loss Ratio from: - Pricing assumptions - Budget - Industry benchmarks - Historical average ``` ## Characteristics ### Completely A Priori - Does not use actual reported losses - Based solely on expected losses - Most stable method - Least responsive to actual experience ### Appropriate Use Cases ``` Use when: - Very immature data (first few months) - No credible loss history - New product or coverage - Known large operational changes - Actual emergence not yet credible ``` ## Example ``` AY 2024 @ 6 months: Earned Premium: $2,000,000 Reported Losses: $250,000 (very immature) Expected Loss Ratio: 68% Expected Loss Method: Ultimate = $2,000,000 × 0.68 = $1,360,000 IBNR = $1,360,000 - $250,000 = $1,110,000 Chain Ladder (6-Ult CDF = 6.500): Ultimate = $250,000 × 6.500 = $1,625,000 IBNR = $1,375,000 Expected Loss gives more stable estimate for very immature AY ``` ## Comparison to Other Methods | Method | Weight to Actual | Weight to Expected | Best For | |--------|------------------|-------------------|----------| | Expected Loss | 0% | 100% | Very immature | | Bornhuetter-Ferguson | Partial | Partial | Immature | | Chain Ladder | 100% | 0% | Mature | ## Advantages - Very stable - Not affected by random reporting - Works for new products - Simple to apply ## Disadvantages - Ignores actual experience - Not responsive to changes - Requires credible expected loss ratio - May miss emerging trends ## Related Concepts - [[Bornhuetter-Ferguson Method#Definition]] - [[Cape Cod Method#Definition]] - [[Chain Ladder Method#Definition]] ## References - Friedland, Chapter 5