On the Savety Loading for Chain Ladder Estimates: A Monte Carlo Simulation Study

TL;DR

This paper develops a Monte Carlo simulation method to determine the appropriate safety loading for Chain Ladder reserves, accounting for risk and bias, to improve insurance loss reserving accuracy.

Contribution

It introduces a simulation-based approach to quantify safety loading and bias in Chain Ladder estimates, enhancing risk management practices.

Findings

Safety loading depends on claim number and size distribution.

Chain Ladder estimator bias varies with distribution parameters.

Monte Carlo simulation effectively assesses reserve risk and bias.

Abstract

A method for analysing the risk of taking a too low reserve level by use of Chain Ladder method is developed. We give an answer to the question of how much safety loading in terms of the Chain Ladder standard error has to be added to the Chain Ladder reserve in order to reach a specified security level in loss reserving. This is an important question in the framework of integrated risk management of an insurance company. Furthermore we investigate the relative bias of Chain Ladder estimators. We use Monte Carlo simulation technique as well as the collective model of risk theory in each cell of run-off table. We analyse deviation between Chain Ladder reserves and Monte Carlo simulated reserves statistically. Our results document dependency on claim number and claim size distribution types and parameters.