Bornhuetter-Ferguson Initial Expected Loss Ratio Working Party Paper

“The Actuary and IBNR” was published in 1972 by Ronald Bornhuetter and Ronald Ferguson. The methodology from this paper has exploded into a veritably universal methodology used by actuaries and commonly referred to as the “Born Ferg” or “BF” method. The technique and its application are included in the syllabus for the CAS actuarial exams and the use of the technique is pervasive in both the reserving and pricing worlds.

The method involves the selection of an “Initial Expected Loss Ratio” or “IELR” for which the selection criteria varies greatly and a great degree of latitude is permitted to the practitioner for “actuarial judgment.” Given the widespread use of this method and its impact on financial reporting, the Bornhuetter Ferguson Initial Expected Loss Ratio Working Party set out to glean an understanding of general industry practices surrounding the selection of the IELR used in this method.

A survey was conducted across the CAS membership and the results of that survey are presented in this paper.

Along with the survey, the paper also explores several alternative methods to selecting the initial expected loss ratios, their relative strengths and weaknesses and their relative predictive value when applied to historical data. Carried reserves versus the outcome of several alternative methods for selecting the IELR are also explored to determine the effectiveness of industry practices.

Keywords: ratemaking; risk pricing and risk evaluation models; aggregation methods