A Priori Loss Estimates
Insurance companies provide the backstop for bad stuff happening. A chunk of the international space station breaks off, falls to Earth, and lands on your house. You need $50,000 to fix the damages. You don't want to call the insurance agent and have them shrug, "Sorry, we're out of cash...try again next week."
As such, insurance companies have to keep a sufficient cash around to pay claims as they come in. This amount is known as the firm's loss reserve. Simple enough. Insurance companies need some cash to fulfill their commitments. However, the process of figuring out how much the reserve should be gets pretty complicated pretty fast.
Remember: an insurance company can't know when claims are coming in. Bad stuff happens to people randomly. The firm can only estimate on a broad scale the amounts it will have to pay out during any interval of time.
Meanwhile, the company wants to invest as much of its money as possible. It takes all those premium checks you and your fellow customers send and puts that cash to work. The insurance company wants the reserve as small as possible, that way it can maximize its investment return (and its overall profit). So the insurance company is looking to optimize the reserve. It needs to have a safe amount, so it can cover space debris crashing through a client's ceilings. But it wants as much of that money as possible to invest.
The a priori loss estimate comes into play for some of the methods for calculating loss reserves.
If you've taken an intro-level philosophy course, you've encountered the term "a priori" before. For those of you who have avoided Plato and Kant thus far, the term refers to any conclusion you reach through theoretical deduction rather than experience. Like...your brother has the a priori conclusion that ladies will love that paisley shirt he bought. Then experience teaches him that it belongs in the closet. Waaaaay in the back of the closet.
In calculating loss reserves, the a priori loss estimate is a building block of two main models: the Bornhuetter-Fergusson method and the loss ratio method. In both, the a priori loss estimate is a starting point for calculating reserves. It's the projected loss ratio the company calculates based on the available data ahead of time. Think of it as the best-guess starting point. From there, the company can use its actual experience to refine the estimate.