G.4 Cape Cod Method

Question 1

Cape Cod Formula for Estimated Ultimate Claims

Answer 1

CC Ultimate =

Reported + On-Level EP x ECR x % Unreported

Question 2

How to calculate the Cape Cod ECR

Answer 2

First adjust reported claims to be at common trend levels
and tort reform levels, and adjust earned premium to be at current rate level and a common premium trend level. Then using all years of data (including latest):
Cape Cod ECR = sum (Reported Claims) /
sum (On-Level Earned Premium x % Reported)

Question 3

Main assumption of Cape Cod Method

Answer 3

Unreported claims will develop based on expected claims, and expected claims are derived using reported claims and earned premium.

Question 4

Advantages of the Cape Cod Method

Answer 4

The key innovation and advantage of the Cape Cod method is that the ECR is estimated from historical data rather than being judgmentally selected.

Another advantage compared to the development method is that random fluctuations at early maturities do not significantly distort estimates.

Question 5

Disadvantages of the Cape Cod Method

Answer 5

-Cape Cod can’t be used for a new line of business since there is no data to calculate the ECR.
-Cape Cod estimates are highly dependent on the
appropriate on-leveling of premium, and this can be
difficult (especially for older years).
-When data is thin or volatile, the Cape Cod ECR will not be reliable, and B-F may perform better.

Question 6

How speedups or slowdowns in settlement impact

the Cape Cod method

Answer 6

Cape Cod estimates will be accurate since reported claims are unaffected by a change in settlement rates.

Question 7

How changes in case reserve adequacy impact the

Cape Cod method

Answer 7

The Cape Cod method will overestimate when there has been an increase in case reserve adequacy and will underestimate when there has been a decrease in case reserve adequacy. The error will be larger in magnitude than the B-F method, but not as large as the Development method.

Question 8

How changes in claim ratios impact the Cape Cod

method

Answer 8

The Cape Cod method is more responsive to changing claim
ratios than the B-F method since it calculates the ECR using the most recent exposure periods. However, it is still not fully responsive (like the Development method). As such, for increasing claim ratios, Cape Cod will understate estimates, but not by as much as the B-F method.

Question 9

How exposure growth impacts the Cape Cod method

Answer 9

The Cape Cod method is unaffected by exposure growth on its own. However, if there are changes in the average accident date because of the exposure growth, then the Cape Cod method will be affected in the same direction but not to the same extent as the Development technique. For example, if the book of business is growing causing the average accident date to be later in more recent years, then the Cape Cod method will underestimate ultimate claims.

Question 10

How mix of business changes impact the Cape Cod

method

Answer 10

When you have a changing mix of business, the Cape Cod method will be inaccurate if either of the following are true:
-The segments of the business that are changing have
different development patterns.
-The segments of the business that are changing have
different expected claim ratios.