Cape Cod Method - Explained
What is the Cape Cod Method?
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Table of ContentsWhat is the Cape Cod Method?How is the Cape Cod Method Used?Loss Reserving intheCape Cod MethodLimitations of the Cape Cod Method
What is the Cape Cod Method?
Cape Cod method, otherwise called the Stanard-Buhlmann method, is used in calculating ultimate losses in loss reserves. Losses are projected through the Cape Cod method by measuring both loss exposure and loss development that occur in a year. There are diverse volume measures that estimate the loss reserves for historical accident years. The Cape Cod method, however, uses peculiar volume measures to project ultimate losses for all accident years.
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How is the Cape Cod Method Used?
The Cape Cod method is identified as a framework or an extension under the Bornhuetter-Ferguson method. It is a method that projects loss development as well as patterns that signal ultimate losses in accident years. The Cape Cod method uses approaches that are more comprehensive than other methods, for example, many volume measures, even the Bornhuetter-Ferguson methods use external information to calculate loss reserves for accident years. The Cape Cod method , however, uses both internal and external information for ultimate loss calculations. The Cape Cod method calculates loss reverses by dividing the loss to date by exposure, then dividing it by the ultimate loss development. Cumulative losses are also estimated by the Cape Cod.
Loss Reserving intheCape Cod Method
The calculation of loss reserves using the Cape Cod method requires that consideration is given toweights proportional to loss exposure and weights inversely proportional to loss development. Loss reserving also entails that prior estimators of development patterns are identified and patterns of expected ultimate losses. The Bornhuetter-Ferguson framework contributed to the development of the Cape Cod method.
Limitations of the Cape Cod Method
There are certain limitations of the Cape Cod method, they are identified below;
- The Cape Cod method fails to give any regard to variability that is bound to occur in historical accidents years and historical loss estimates and other factors.
- The Cape Cod method cannot be used when estimating reported losses (IBNR), it is often used for the calculation of incurred losses.
- Another drawback of the Cape Cod method is that current experience has little weight as compared to historical experience which is accorded more importance.
Despite its shortcomings, when combined with the chain-ladder method and exposure-based method, Cape Cod method can achieve the best result.