What is 'Cape Cod Method'

Cape Cod method is used to calculate loss reserves, which use weights proportional to loss exposure and inversely proportional to loss development. The Cape Cod (CC) method operates under the assumption that premiums or other volume measures are known for historical accident years, and that ultimate loss ratios are identical for all accident years. The Cape Cod method is sometimes called the Stanard-Buhlmann method.

Next Up

BREAKING DOWN 'Cape Cod Method'

The Cape Cod method is based off of the framework created by the Bornhuetter-Ferguson method of loss development, which also serves as the framework for the chain-ladder method and additive method. The primary difference between the Cape Cod and Bornhuetter-Ferguson methods is that the Cape Cod method creates ultimate loss estimates using both internal and external information.

In the Cape Cod method, loss reserves are calculated as the loss to date, divided by the exposure divided by the ultimate loss development factor. Both the loss to date and exposure are adjusted for trend. Cumulative losses are calculated using a run-off triangle, which contains losses for the current year as well as premiums and prior loss estimators. This creates a series of weights that are proportional to exposures and inversely proportional to loss development.

Loss Reserving in the Cape Cod Method

The process of arranging known methods of loss reserving, under the umbrella of the extended Bornhuetter-Ferguson method, of which Cape Cod Method is a part, requires the identification of prior estimators of the development pattern and the expected ultimate losses. This process can be reversed by combining components of different methods to obtain new versions of the extended Bornhuetter-Ferguson method. The Bornhuetter-Ferguson principle proposes the simultaneous use of various versions of the extended Bornhuetter-Ferguson method and a comparison of the resulting predictors in order to select best predictors and to determine prediction ranges.

Limitations of the Cape Cod Method

The Cape Cod method has does have its drawbacks. For instance, it does not take into account variability in both historical loss estimates and loss development factors, and the loss exposure is assumed to be constant over time. This method can understand incurred but not reported (IBNR) losses if the insurer is underwriting the same policies at lower rates over time. The method also provides greater weight to historical experience over recent experience, since more mature accident years are closer to the ultimate loss. A best practice for actuaries is to use a loss reserving method that combines the chain-ladder method with an exposure-based method, such as the Cape Cod method.

RELATED TERMS
1. Priori Loss Estimates

Priori loss estimates are techniques used by insurance companies ...
2. Cash on Delivery (COD)

Cash on delivery is a type of transaction in which payment for ...
3. Previous Balance Method

The previous balance method is an accounting method where interest ...
4. Average Cost Method

The average cost method is an inventory costing method in which ...
5. Adjusted Balance Method

The adjusted balance method is a method of accounting for financing ...
6. Percentage Of Completion Method

The percentage of completion method is an accounting method in ...
Related Articles
1. Investing

Activision: More Wall Street Firms Express Concern

Concerns over Activision's Call of Duty franchise prompted yet another Wall Street downgrade.
2. Investing

Introduction To Bonds

Find out how this method of debt investment is used to finance various levels of government and private companies.
3. Investing

Why the Stock Bubble Will Burst Quickly: Yale's Shiller

Nobel Laureate Robert Shiller warns that stocks could tumble suddenly and unexpectedly.
4. Investing

Discounted Cash Flow (DCF)

Discover how investors can use this valuation method to determine the intrinsic value of a stock.
5. Investing

Value at Risk (VaR)

Value at risk, often referred to as VaR, measures the amount of potential loss that could happen in an investment or a portfolio of investments over a given time period.
6. Investing

What Is Contrarian Investing?

Learn the method and reasoning behind this contradictory investment strategy.
7. Investing

An Introduction To Depreciation

Companies make choices and assumptions in calculating depreciation, and you need to know how these affect the bottom line.
8. Investing

Snyder's-Lance Plummets on Weak Preliminary Earnings, CEO Retires (LNCE)

The Kettle Brand and Cape Cod chip maker warns of weakness ahead, promising to accelerate zero-based budgeting plans as it instates an interim CEO.
9. Investing

An Introduction to Value at Risk (VAR)

Volatility is not the only way to measure risk. Learn about the "new science of risk management".

Understanding Internal Rate Of Return

Internal rate of return, or IRR, is one of the most popular methods of evaluating potential projects. Learn more about this important metric.
RELATED FAQS
1. How does accrual accounting differ from cash basis accounting?

The accrual and cash-basis methods recognize revenue and expenses at different times. In this article, we analyze the advantages ... Read Answer >>
2. When do you use installment sales method vs. the cost recovery method?

Take a deeper look at the installment sales method and the cost recovery method of recognizing business sales revenue and ... Read Answer >>
3. What are the differences between percentage of completion and the completed contract ...

Learn the advantages and disadvantages businesses face when using either the percentage-of-completion or completed contract ... Read Answer >>
4. What are the differences between the installment method and percentage of completion ...

Learn how businesses recognize revenues and report them under the installment method and percentage-of-completion method, ... Read Answer >>
Hot Definitions

The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
2. Futures Contract

An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
3. Yield Curve

A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
4. Portfolio

A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
5. Gross Profit

Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
6. Diversification

Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...