Chain Ladder Method
The chain ladder method estimates ultimate claims cost by projecting historical development patterns from a claims triangle onto the as-yet unresolved accident years.
Concept
The chain ladder method is the most widely used actuarial technique for estimating ultimate claims cost, deriving development factors from the historical development pattern of a claims triangle and applying them to accident years that are not yet fully developed.
Approach
Development factors (age-to-age factors) are calculated for each development period from the cumulative claims amounts of successive development periods in the claims triangle, expressing the average ratio of the claims amount in one period to the preceding period; the future development factors still missing for a given accident year are applied multiplicatively to the most recently observed claims amount to derive the estimated ultimate claims amount.
Assumptions and Limitations
The chain ladder method assumes that the historical development pattern can be projected into the future and remains stable across all accident years; changes in the business (such as new products, revised claims handling processes, or regulatory changes) as well as a small number of observations for young accident years can make the method unstable and unreliable, which is why it is frequently combined in practice with other methods such as the Cape Cod method or the Bornhuetter-Ferguson technique.