WHAT ARE 'Priori Loss Estimates'

Priori loss estimates refer to a technique used by insurance companies to calculate loss reserves. A priori is Latin for “from the former,” and refers to the development of an estimate using past experiences.

BREAKING DOWN 'Priori Loss Estimates'

Priori loss estimates are used to determine expected ultimate losses from exposures.

When an insurance company underwrites a new policy and accepts a premium, the company is taking on an obligation. The insurer is required to indemnify the policyholder for claims covered in the policy language. While the insurer can use a portion of the premium revenue to invest in profit-making activities, the company is also required to set aside a portion to cover potential claims in what is known as loss revenue. State insurance regulators help define how much an insurer has to set aside in the loss reserve.

Insurers can use a variety of different estimation techniques to determine what to set aside in loss revenue. Some of these methods include the Cape Cod, and Bonhuetter-Ferguson reserve development methods. The Cape Cod method, for example, uses priori losses to develop ratios for paid losses and incurred losses. Both methods are used to calculate the ultimate loss.

How the Techniques Work

Loss reserve techniques often require a basic set of data, including information on incurred losses, earned premiums, and priori losses. Each data point requires accompanying origin information, such as the accident year, policy year, or similar time frame.

The Cape Cod 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 also referred to as the Stanard-Buhlmann method, and it differs from the Bornhuetter-Ferguson method in that the Cape Cod method creates ultimate loss estimates using both internal and external information.

Insurers will also compare priori losses to earned premiums, creating the a priori loss ratio. This is calculated as the priori loss divided by the earned premium. This ratio can be multiplied by the origin, such as a calendar year, to come up with a loss reserve estimate.

Insurance companies develop loss reserves using approaches that mix loss development methods with priori loss methods Determining priori loss estimates works best when companies can use all accident years to develop a given estimate for any one year, and when they give added weight to estimates from years close to the year being estimated.

RELATED TERMS
  1. Policy Year Experience

    Policy year experience describes the relationship between the ...
  2. Loss Reserve

    Loss reserve is an estimate of an insurer’s liability from future ...
  3. Converted Losses

    Converted Losses are the total amount of claims incurred multiplied ...
  4. Ultimate Net Loss

    Ultimate net loss is a party's total financial obligation when ...
  5. Loss Cost

    Loss cost is the amount of money an insurer must pay to cover ...
  6. Loss Ratio

    Loss ratio is the ratio of losses to gains such as the ratio ...
Related Articles
  1. Investing

    Methods of Handling Risk: A Quick Guide

    Discover the five methods to manage pure risk, and learn how they can be implemented to mitigate risk with health and life insurance.
  2. Insurance

    Insurance: A Common Personal Finance Pitfall

    Making decisions about insurance can be challenging. But declining coverage altogether comes with it's own risks, and costs.
  3. Insurance

    How To Value An Insurance Company

    In the insurance space, accurate predictions of metrics such as ROE are important, and paying a low P/B can help put the odds in investors' favor.
  4. Insurance

    How To Invest In Insurance Companies

    Knowing the special circumstances that insurance companies operate under helps in evaluating whether or not a listed insurance company is a good investment and whether the economic environment ...
  5. Insurance

    Behind the Law of Large Numbers in the Insurance Industry

    Discover how the law of large numbers helps insurance companies cope with risk, and why the theory does not always live up to reality.
  6. Insurance

    The History of Insurance in America

    Insurance was a latecomer to the American landscape, largely due to the country's unknown risks.
  7. Investing

    You Need to Cut Your Losses in Investing

    It's more important to reduce the percentage of potential loss than to try to beat the market.
  8. Insurance

    For Life Insurers, Making Money Is A Numbers Game

    Life insurance is a data-driven industry that relies on complex financial models to predict future expenses and income from premiums and investments.
  9. Investing

    Limiting Losses

    It is impossible to avoid losses completely, but there is a systematic method you can use to control them.
  10. Tech

    How Big Data Has Changed Insurance

    No longer confined to technology, big data has become integral to providing solutions to the insurance industry's long standing challenges.
RELATED FAQS
  1. Loss Ratio vs Combined Ratio

    Learn about the loss ratio and combined ratio, what the two ratios measure and the main difference between the two. Read Answer >>
  2. What is the expense ratio in the insurance industry?

    Understand the two different methods of calculating expense ratio and find out how it can be used to compare insurance companies ... Read Answer >>
Hot Definitions
  1. 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 ...
  2. Portfolio

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

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

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

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center