Adjusting for Changes in Loss Development

There is a considerable volume of actuarial research and literature devoted to answering the question: “How do we react to changes in loss development patterns?”  If development patterns never changed, we’d all just use the chain-ladder methods and go home early.

There are no shortage of approaches.  How does the actuary best choose the right approach, given all of the options?  How can the actuary be sure that the approach is appropriate to the scenario?  This is a crucial question to answer, because the consequences for choosing the wrong method can be severe.

B-F and B-S potholes

One of my actuarial heroes, Jerry Degerness, once famously said,

“The road to insolvency is paved with Bornehuetter-Ferguson and Berquist-Sherman calculations.”

By way of explanation, he later added, “The B-F pothole is sustained embrace of progressively inadequate expected loss ratio assumptions and the B-S pothole is overly optimistic adjustments based on the promise of better claim processing and settlement practices or revised coverage terms.”

It’s not that the Berquist-Sherman method is flawed per se, it’s the fact that it can mask loss ratio deterioration if used inappropriately. And by used inappropriately, I mean that it is used to mask underlying change, despite emerging evidence to the contrary. Consider this scenario:

  1. There is an undetected mix shift into a class of business which has 10% higher severity
  2. The claim department implements a new system that starts under-reserving case reserves by about 10%

Looking at the paid and incurred loss triangles, the actuary sees heavier (earlier) paid loss development, but little or no change on the incurred side. “What’s causing this?” asks the actuary. Hypothesis: with the switch to a new claims system, the payment pattern must be changing. So, armed with Berquist-Sherman, the actuary adjusts the historic paid loss triangle to match the new payment pattern. The end result is a reserve estimate consistent with past estimates, effectively masking the increasing loss ratio.

It would be better, instead, to identify that different types of business have different expected frequencies and severities, and different paid and incurred development patterns. The trick is identifying which are the key types, and then quantifying those differences.  Armed with this knowledge, the actuary would be able to anticipate how observed development patterns should be changing, given observed mix changes on the exposure side.

Where there is mix shift, there will be changes in development. And there is always mix shift.

Armed with the knowledge of what’s really happening in the book, the actuary can correctly identify the change in paid loss development is being driven by mix shift, and can also identify (and quantify) the change in case reserve adequacy. Ideally, all of this happens independently of the claim department’s case reserving process.

Enter the Actuarial Case Reserve

In his March 2020 webinar, Chris Gross discussed Actuarial Case Reserves, an independent and unbiased case reserve set by the actuary for purposes of more accurate price and reserve estimates:

“Case reserves currently serve two primary roles – to facilitate the appropriate settlement of each claim, and to provide financial information. These goals are intrinsically at odds with each other. As a profession, we need to move beyond the use of subjectively determined case reserves to using case reserves that are more appropriate for loss reserving, that we have constructed directly, using objective claim and exposure information.”

The Actuarial Case Reserve, he says, can be thought of as an extension of the Berquist-Sherman idea — that is, adjusting the historic triangle to account for identified changes. In this case, we are adjusting the incurred triangle by replacing all of the claim department’s case reserve estimates with an independent and unbiased Actuarial Case Reserve, based not just on accident period and development age, but all available exposure and claim characteristics as well.

Developing the Actuarial Case Reserve

It’s difficult — maybe impossible — to accurately identify the impact of various mix changes by studying paid and incurred triangles. The analyst would have to correctly intuit the important segmentations needed (geography, class of business, size of risk, etc) and then study triangles for all of these segments. Are there differences between these triangles? Are the differences statistically significant? Are the segments large enough to be credible? What about interaction effects: We’re growing in state X, but that’s where our growth in small business is coming from.

This is where the Claim Life Cycle Model (CLCM) approach proves useful. (For an introduction to CLCM, see CLCM In a Nutshell.)

A CLCM analysis assumes that the loss triangles are an artifact of the claims process, not a description of the claims process itself. The claims process is a series of events in the life cycle of a policy: Will there be a claim? How many claims? What are the claim severities? When will the claims be reported? When will payments be made? When will the claims close? Will any claims re-open?

Each of these events is itself a simple model, based on the segmentations that are significant and credible to that event. Perhaps report lag is not sensitive to geography, but claim severity is. If mix is shifting from one state to another, the severity model will catch this.

The end result is an estimate of future payments, by claim and by policy (for IBNR claims) that reflects all historic mix shifts to the extent that they are statistically significant and credible. In other words, an Actuarial Case Reserve.

It is important to emphasize that there is no implication that the claim department’s case reserve is wrong! As Chris reiterates, the primary purpose of the traditional case reserve is to “facilitate the appropriate settlement of each claim.” In contrast, the development of the Actuarial Case Reserve gives the actuary an estimate which aligns more closely with the actuary’s goals: more accurate loss reserves and risk pricing.

For more discussion on topics like these, and some free Continuing Ed credit, join us each month for our MuSigma Webinar Series.  Sign up at

If you’re an actuary about to start a pricing, reserving, or claims modeling project, you should absolutely look into CLCM as one of your core strategies. Compared to more traditional approaches, the benefits and capabilities CLCM provides are transformational.

Want to accelerate your implementation of CLCM? Actuaries at Gross Consulting are now helping carriers stand up a multi-line CLCM process in three months or less using our Comprehensive Insurance Review (CIR) engagement. Please reach out to me with comments or questions at

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