The Bornhuetter-Ferguson Technique: Definition, Application, and FAQs

The bornhuetter-ferguson technique, also known as the bornhuetter-ferguson method, is a widely used method for estimating an insurance company’s losses, particularly incurred but not yet reported (IBNR) losses for a given policy year. This technique was developed by two actuaries, bornhuetter and ferguson, and was first introduced in 1972.

The bornhuetter-ferguson technique is considered one of the most popular methods for calculating loss reserves, ranking second only to the chain-ladder method. It combines features of the chain ladder and expected loss ratio methods, assigning weights for the percentage of losses paid and losses incurred. Unlike the chain ladder method, which relies solely on past experience, the bornhuetter-ferguson technique incorporates the insurer’s exposure to loss.

There are two equivalent methods for calculating loss under the bornhuetter-ferguson technique. In the first approach, undeveloped reported (or paid) losses are added directly to expected losses, multiplied by an estimated percent unreported. In the second method, reported (or paid) losses are first developed to ultimate using a chain-ladder approach, then multiplied by an estimated percent reported. Finally, expected losses multiplied by an estimated percent unreported are added.

The chain ladder method focuses on examining reported or paid claims over a period of time to budget for future losses, while the bornhuetter-ferguson technique estimates IBNR by estimating ultimate losses for specific risk exposures and the percentage of those losses not reported at the time. Bornhuetter-ferguson is particularly useful in cases where actual reported losses do not accurately indicate IBNR, such as scenarios with low frequency but high severity losses.

IBNR stands for incurred but not reported losses, which refers to losses that have occurred but have not yet been reported to the insurance company.

The bornhuetter-ferguson technique was developed by actuaries bornhuetter and ferguson and was first presented in 1972.

The bornhuetter-ferguson technique is particularly useful in scenarios where actual reported losses do not accurately reflect IBNR, such as in cases of low frequency but high severity losses.

One limitation of the bornhuetter-ferguson technique is the need to estimate unreported losses, which can introduce uncertainty into the calculation. Additionally, the complexity of the method may require specialized expertise for accurate implementation.

While the bornhuetter-ferguson technique is commonly used in property and casualty insurance, it may not be suitable for all types of insurance. Its effectiveness depends on the nature of the risks being insured and the availability of reliable data for estimation.