Cape Cod Method

Cape Cod is often described as a bridge between chain-ladder and Bornhuetter-Ferguson. Like Bornhuetter-Ferguson, it uses an expected-loss view for the not-yet-emerged portion. Unlike Bornhuetter-Ferguson, it estimates that expected loss ratio from the triangle and premium base rather than selecting it entirely from outside.

That makes it useful when you want more stability than pure development but do not want to lean entirely on an externally selected expected loss ratio.

Suppose accident year A has reported loss 780 on premium 1,000 with 80% reported, and accident year B has reported loss 600 on premium 1,200 with 60% reported. The Cape Cod expected loss ratio is (780 + 600) / (0.80 x 1,000 + 0.60 x 1,200) = 1,380 / 1,520 = 0.9079.

For accident year B, the unreported share is 40%, so the indicated reserve is 0.40 x 0.9079 x 1,200 = 435.8. The implied ultimate for year B is 600 + 435.8 = 1,035.8.

That result shows the Cape Cod idea clearly: estimate an internal expected loss ratio, then use it to fill in the not-yet-reported portion rather than projecting everything from development alone.

Exam 5 includes Cape Cod because it gives a standard middle-ground reserving method. It is often attractive when the latest years are immature enough that chain-ladder feels too reactive, but you still want the expected-loss ratio to come from the portfolio experience rather than entirely from outside judgment.

It also forces good thinking about premium preparation, because the premium base used in Cape Cod usually needs to be adjusted and made comparable before the method is trusted.

A common mistake is treating Cape Cod as if it were free of premium assumptions. It is not. If the premium base is stale, off-level, or not appropriately matched to the loss experience, the method can look more objective than it really is.

Another mistake is forgetting the relationship to Bornhuetter-Ferguson. Cape Cod is not a completely different reserving philosophy. It is a way of generating the expected-loss anchor from the data.

The current outline explicitly lists Cape Cod among the unpaid-loss estimation techniques candidates should be able to calculate and evaluate. That puts it in the core reserving toolkit with chain-ladder and Bornhuetter-Ferguson.

It also creates a useful bridge between reserving and ratemaking pages because premium preparation and expected-loss reasoning matter on both sides of the exam.