The “Modified Bornhuetter-Ferguson” Approach to IBNR Allocation

1. The “Modified Bornhuetter-Ferguson” Approach to IBNR Allocation Trent Vaughn, Republic Insurance Phoebe Tinney, Towers Perrin

2. What makes a good IBNR allocation procedure? • Provide reasonable and stable results • Easy to automate • Explainable in “intuitive terms” • No need for “off-balance adjustment factor” • Allows for differences in a priori loss ratios

3. Why allocate IBNR? • Annual Statement requirements • Management reports • Reinsurance Accounting

4. Potential Pitfalls of IBNR Allocation • May imply degree of precision that does not exist • May be occasions when full reserve study is required instead of allocation

5. Two Common Methods for Allocating IBNR • Earned Premium Method • Weakness: Ignores differences in claim frequency and loss ratio by program • Case-Incurred Loss Method • Weakness: Often results in very unstable and unreliable allocations

6. “Modified BF Method” • Compromise between earned premium and case-incurred loss allocations • Relative weights assigned to each method vary by accident year • Immature Accident Years: Most of the weight goes to EP allocation • Older Accident Years: Most of the weight goes to Case Incurred Allocation • Numeric Example

7. Loss Projections & Earned Premium

8. Step 1: Earned Premium Method

9. Step 2: Case Incurred Loss Method

10. Step 3: Calculating Weights

11. Step 4: Weighted Average Allocation

12. Alternative: Expected Loss Method

13. Mature Accident Years • Modified BF Procedure may not work as well as simpler methods • Will allocate largely in accordance with case-incurred loss • May be more appropriate to allocate in proportion to open claims or case reserves

14. Negative IBNR amounts • “Implied LDF” in Modified BF weighting procedure will be less than unity • Thus, weight given to case-incurred allocation is greater than 1, weight given to EP allocation is negative • For negative IBNR, straight case-incurred allocation may be more appropriate