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Credibility Theory - Introduction

Credibility theory is a method used in insurance to estimate risk premiums and claim frequencies using a combination of data from the risk in question and similar risks. The basic credibility formula weights an observation and other collateral data using a credibility factor Z between 0 and 1. Full credibility is when Z=1 and only the risk's own data is used. Partial credibility uses Z<1 and combines the risk's data with collateral data. Practical considerations for using credibility theory include simplicity, accuracy, data sources and stability.

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sriram pv
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88 views

Credibility Theory - Introduction

Credibility theory is a method used in insurance to estimate risk premiums and claim frequencies using a combination of data from the risk in question and similar risks. The basic credibility formula weights an observation and other collateral data using a credibility factor Z between 0 and 1. Full credibility is when Z=1 and only the risk's own data is used. Partial credibility uses Z<1 and combines the risk's data with collateral data. Practical considerations for using credibility theory include simplicity, accuracy, data sources and stability.

Uploaded by

sriram pv
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Aum Sri Sairam

Credibility Theory - Introduction


Question 1. What is credibility theory?
Credibility theory is a collection of ideas and techniques for the systematic
adjustment of insurance premiums as claims experience is obtained.
Claim frequencies and risk premiums can be estimated using a combination
of direct data (ie data from the risk under consideration) and collateral
data (ie data from other similar, but not identical, risks).

Question 2. State the basic formula for calculating credibility-


weighted estimates and define any terms you use.
Credibility formula
Estimate = Z x (Observation) + (1 - Z) x (Other information)
where:
• Z is the credibility assigned to the observation (0 < Z < 1)
• 1-Z is the complement of credibility

Question 3. What is full credibility?


Full credibility of Z = 1 can assigned if sizable risk data experience is
available with us so that insurer can safely use risk data estimate X wholly
and ignore the collateral estimate µ.

Question 4. What is partial credibility?


Partial credibility is a special case of Credibility premium formula of Z < 1
In many practical situations, the experience is too small to assign full
credibility . Only partial credibility is possible . This can be determined as
using the formula Z = √ (n/nF)
where nF is the sample size required to produce a full credibility.

Question 5. What are the practical considerations when using


credibility theory?
Practical considerations when using credibility theory:
• Simplicity
• Visibility
• Goodness of fit - ie accuracy versus simplicity
• Level of grouping versus accuracy
• Source of data - more years / more locations / national data etc
• Stability of data - eg weightings based on numbers, not amounts
• Use of partial premiums
• Choice of credibility complement - accuracy, bias, etc
• Need to apply judgement- large claims, trends, etc

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