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STAT 3908: Credibility Theory and Loss

Distributions
Limited Fluctuation Credibility Theory

Tutorial 1

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Review

Two approaches deciding the pure premiums


I Sample mean: X = X1 ++X
n
n
, where X1 , . . . , Xn are past
experiences (number of claims, amount of claim, et al.) on
the individual;
I Manual premium: M, which totally ignores the past
experiences.

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Review

Full credibility approach


The premium will be charged by
I X , if the standard for full credibility is satisfied;
I M, if not satisfied.

Partial credibility approach


The premium will be charged by Z X + (1 Z )M, where Z is the
credibility factor.

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Full credibility

Standard of full credibility


Full credibility will be assigned if

P(|X | r ) p,

for some predetermined r > 0, 0 < p < 1 and = E[X ]. In


general, r is small but p is large (e.g., r = 0.05, p = 0.9).

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Full credibility: X denotes claim amount

Standard of full credibility


In this case, the standard of full credibility reduces to
 2
Var [X ]
n 0 = 0 ,
(E[X ])2

where
- n is the number of past observations
- Var [X ] = 2 , E[X ] =
- coefficient of variation =
n   o
- yp = miny P |X |
y p
/ n
- 0 = (yp /r )2 (remember this!)

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Full credibility: X denotes claim amount

Calculation of 0
Upon using the Central Limit Theorem (CLT), we have
 
1 p + 1
yp = .
2

Furthermore,  y 2
p
0 = .
r
Specifically, if we take p = 0.9, r = 0.05, then

yp = 1.645, 0 = 1082.41.

q Pn
2
i=1 (Xi X )
Estimating , : = X and = n1

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Full credibility: X denotes claim count

I If we define N := X be the Poisson random variable with


parameter , the standard of full credibility can be rewritten as

Var [N] 0
n 0 2
= ,
(E[N])
or
n 0 ,
where n is the number of exposure units, and n is the
expected number of claims.
If = n1 ni=1 Ni , an estimator of , then the standard of full
P
I
credibility is
Xn
n = Ni 0 .
i=1

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Full credibility: X denotes compound Poisson claim
amounts

In year i, the number of claims Ni is assumed to be Poisson


random variable with parameter , and the severity of the j-th
claim is denoted as Yi,j . Then, the total claim amounts in year i is

Ni
X
Xi = Yij , i = 1, 2, . . . , n.
j=1

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(i) Standard of full credibility: numbers of exposure periods
"  #
Y 2

Var [X ] 0
n 0 = 1+
(E[X ])2 Y

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(ii) Standard of full credibility: number of claims
"  2 #
Y
n 0 1 + .
Y
Given real data, check that
n
"  2 #
X Y
Ni 0 1 + .
Y
i=1

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(iii) Standard of full credibility: total amount of claims

Y2
 
nY 0 Y + .
Y
Given real data, check that
n
Y2
X  
Xi 0 Y + .
Y
i=1

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One typo on Page 8 of lecture notes
By the formula n E[Y ] 5412.05, which means that the total
amount of claims should be larger than 5412.05. Therefore, it
should be said that the number 5412.05 (not 5142) satisfies with
the standard!

Figure 1: Corresponding place

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Problem 1
Determine the number of claims required for full credibility, given
the following information,
I the number of claims (N) is Poisson distributed;
I the severity distribution (Y ) has mean 1000 and variance
2700000; and
I the full credibility standard is to be 90% certain that the total
claim amount is within 5% of the true mean.

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Solution 1
In this compound Poisson model, the full credibility standard is
"  #
Y 2

n 0 1 + .
Y

Hence the number of claims required is


"  #
Y 2
  
2700000
0 1 + = 1082.41 1 + = 4004.92,
Y 10002

i.e. we need at least 4005 claims.

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Problem 2
Suppose that the total claim amount is compound Poisson
distributed. Let A be the number of claims needed for full
credibility, if the estimate of the total claim amount is to be within
5% of the true value with a 90% probability. Let B to be the
similar number using 10% rather than 5%. What is the ratio of
A/B?

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Solution 2
In this compound Poisson model, the full credibility standard is
"  2 #  "  2 #
 y 2 y 2
p p
A= 1+ = 1+ .
r 0.05

Similarly, "
 y 2  2 #
p
B= 1+ .
0.1
Hence  2
A 0.1
= = 4.
B 0.05

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Problem 3
You have determined that 2670 claims are necessary for full
credibility on the total claim amount under a compound Poisson
model with constant severity C . If severities are log-normal
distributed with mean 1000 and variance 1500000, how many
claims are needed for full credibility?

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Solution 3
In the compound Poisson model, the full credibility standard is
"  #
Y 2

n 0 1 + .
Y

Therefore, we have
"  2 # "  2 #
Y 0
2670 = 0 1 + = 0 1+ ,
Y C

which indicates
0 = 2670.

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When severities are log-normal distributed with mean 1000 and
variance 1500000, we have
"  #
Y 2
   
1500000
n 0 1 + = 2670 1 + = 6675.
Y 10002

We need at least 6675 claims.

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