Loss development factors or LDFs are used in insurance pricing and reserving to adjust claims to their projected ultimate level i.e to Ultimate Claims. Insurance claims, especially in long-tailed lines such as liability insurance or Motor TP, are often not paid out immediately. Claims adjusters set initial case reserves for claims; however, it is often impossible to predict immediately what the final amount of an insurance claim will be and in Indian scenario in cases like Motor TP, the legal and defense costs and trial outcomes may strech to years to value it completely.
Due to uncertainty around defense costs, settlement amounts, and trial outcomes (in addition to several other factors). Loss development factors are used by actuaries, underwriters, and other insurance professionals to “develop” claim amounts to their estimated final value. Ultimate loss amounts are necessary for determining an insurance company’s carried reserves. They are also useful for determining adequate insurance premiums, when loss experience is used as a rating factor.
Loss development factors are used in all triangular methods (run off triangles) of loss reserving, such as the chain ladder method, Bornheutter Ferguson, IELM and more