DEFINITION of 'Priori Loss Estimates'

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

BREAKING DOWN 'Priori Loss Estimates'

When an insurance company underwrites a new policy and accepts a premium it 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, it also is required to set aside a portion to cover potential claims. This portion set aside is the loss reserve. State insurance regulators help define how much the insurer has to set aside in the loss reserve.

Insurers can use a variety of different estimation techniques, including the chain ladder, 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. Each method is used to calculate the ultimate loss.

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.

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.

An actuarial best practice is to develop loss reserves using approaches that mix loss development methods with priori loss methods, such as the Cape Cod and Bonhuetter-Ferguson methods. Determining priori loss estimates is best when all accident years are used to develop the estimate for any one year, and when added weight is given to years close to the year being estimated.

RELATED TERMS
  1. Losses Incurred

    Losses incurred refers to benefits paid to policyholders during ...
  2. Losses and Loss-Adjustment Expense

    Losses and loss-adjustment expense is the portion of an insurance ...
  3. Policy Year Experience

    The premiums and losses associated with insurance policies that ...
  4. Loss Constant

    An amount added to an insurance policy with a low premium designed ...
  5. Ultimate Net Loss

    Ultimate net loss is a party's total financial obligation when ...
  6. Chain Ladder Method (CLM)

    The Chain Ladder Method (CLM) calculates the claims reserve requirement ...
Related Articles
  1. Investing

    Elements of Insurable Risks: A Quick Guide

    Explore the elements of insurable risk: due to chance, measurable and definite, predictability, noncatastrophic, random selection and large loss exposure.
  2. Small Business

    Explaining Cash On Delivery

    Cash on delivery, also referred to as COD, is a method of shipping goods to buyers who do not have credit terms with the seller.
  3. Insurance

    Deducting Disaster: Casualty And Theft Losses

    If you've been a victim, your losses may be deductible. Find out how.
  4. 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.
  5. 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.
  6. 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 ...
  7. 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.
  8. Insights

    Is the CAPE Ratio Predicting an Era of Low Returns?

    When the the CAPE ratio is high, as it is now, it can indicate a bubble economy nearing its peak. Are we headed towards another bust?
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?

    Learn about the expense ratio for insurance companies and the different methods of calculating it. Read Answer >>
Hot Definitions
  1. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  2. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  3. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  4. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  5. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  6. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
Trading Center