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SEVERITY, FREQUENCY &

SEVERITY, FREQUENCY & AGGREGATE Zero-Truncated Distributions Payment per Payment
AGGREGATE MODELS MODELS 1 𝑌𝑌 © : payment per payment
𝑝𝑝gá = 𝑝𝑝 , for 𝑛𝑛 = 1, 2, ⋯
1 − 𝑝𝑝B g E[𝑌𝑌 ö ]
Basic 1 E[𝑌𝑌 © ] = ; E[𝑌𝑌 ö ] = E[𝑌𝑌 © ] ⋅ 𝑆𝑆(𝑑𝑑)
E[(𝑁𝑁 á )G ] = E[𝑁𝑁 G ] 𝑆𝑆(𝑑𝑑)
CDFs, Survival Functions, and Hazard Functions 1 − 𝑝𝑝B With ordinary deductible 𝑑𝑑,
-
E[(𝑋𝑋 − 𝑑𝑑) • ]
𝐹𝐹(𝑥𝑥) = Pr(𝑋𝑋 ≤ 𝑥𝑥) = * 𝑓𝑓(𝑡𝑡) d𝑡𝑡 Zero-Modified Distributions 𝐸𝐸[𝑌𝑌 © ] = 𝑒𝑒(𝑑𝑑) = E[ 𝑋𝑋 − 𝑑𝑑 ∣ 𝑋𝑋 > 𝑑𝑑 ] =
./
1 − 𝑝𝑝Bä 𝑆𝑆(𝑑𝑑)
/
𝑆𝑆(𝑥𝑥) = Pr(𝑋𝑋 > 𝑥𝑥) = * 𝑓𝑓(𝑡𝑡) d𝑡𝑡 𝑝𝑝gä = 𝑝𝑝 , for 𝑛𝑛 = 1, 2, ⋯
1 − 𝑝𝑝B g Special Shortcuts for 𝑒𝑒(𝑑𝑑)
-
1 − 𝑝𝑝Bä
𝑓𝑓(𝑥𝑥) E[(𝑁𝑁 ä )G ] = E[𝑁𝑁 G ] 𝑒𝑒(𝑑𝑑)
ℎ(𝑥𝑥) = 1 − 𝑝𝑝B
𝑆𝑆(𝑥𝑥)
Exponential (𝜃𝜃) 𝜃𝜃
-
(𝑎𝑎, 𝑏𝑏, 0) Class Property 𝑏𝑏 − 𝑑𝑑
𝐻𝐻(𝑥𝑥) = * ℎ(𝑡𝑡) d𝑡𝑡 = − ln 𝑆𝑆(𝑥𝑥) ; 𝑆𝑆(𝑥𝑥) = 𝑒𝑒 .;(-) Uniform (𝑎𝑎, 𝑏𝑏)
./
𝑝𝑝g 𝑏𝑏 2
= 𝑎𝑎 + , for 𝑛𝑛 = 1, 2, ⋯ 𝜃𝜃 + 𝑑𝑑
𝑝𝑝g.I 𝑛𝑛 Pareto (𝛼𝛼, 𝜃𝜃)
Moments
/
Mixtures and Splices 𝛼𝛼 − 1
E[𝑔𝑔(𝑋𝑋)] = * 𝑔𝑔(𝑥𝑥) ⋅ 𝑓𝑓(𝑥𝑥) d𝑥𝑥 𝑑𝑑
./
Bernoulli Shortcut S-P Pareto (𝛼𝛼, 𝜃𝜃)
/ 𝑎𝑎, Probability = 𝑞𝑞 𝛼𝛼 − 1
= * 𝑔𝑔′(𝑥𝑥) ⋅ 𝑆𝑆(𝑥𝑥) d𝑥𝑥 If 𝑋𝑋 = ã , then:
𝑏𝑏, Probability = 1 − 𝑞𝑞 The Ultimate Formula for Insurance
B
Var[𝑋𝑋] = (𝑎𝑎 − 𝑏𝑏)M𝑞𝑞(1 − 𝑞𝑞) 𝑚𝑚 𝑑𝑑
𝑘𝑘 DE raw moment: 𝜇𝜇GH = E[𝑋𝑋 G ] ; 𝜇𝜇IH = 𝜇𝜇 E[𝑌𝑌 ö ] = 𝛼𝛼(1 + 𝑟𝑟) ™E ´𝑋𝑋 ∧ ≠ − E Æ𝑋𝑋 ∧ Ø∞
𝑘𝑘 DE central moment: 𝜇𝜇G = E[(𝑋𝑋 − 𝜇𝜇)G ] Poisson-Gamma Mixture 1 + 𝑟𝑟 1 + 𝑟𝑟
where
Var[𝑋𝑋] = 𝜎𝜎 M = 𝜇𝜇M If 𝑋𝑋 ∣ 𝜆𝜆 ∼ Poisson (𝜆𝜆) where 𝜆𝜆 ∼ Gamma (𝛼𝛼, 𝜃𝜃),
𝑑𝑑: deductible (set to 0 if not applicable)
Var[𝑔𝑔(𝑋𝑋)] = E[𝑔𝑔(𝑋𝑋)M] − E[𝑔𝑔(𝑋𝑋)]M then 𝑋𝑋 ∼ Neg. Binomial (𝑟𝑟 = 𝛼𝛼, 𝛽𝛽 = 𝜃𝜃).
𝑢𝑢: policy limit (set to ∞ if not applicable)
Covariance: Cov(𝑋𝑋, 𝑌𝑌) = E[𝑋𝑋𝑋𝑋] − E[𝑋𝑋]E[𝑌𝑌]
𝜎𝜎 Frailty Models 𝛼𝛼: coinsurance (set to 1 if not applicable)
Coefficient of variation: 𝐶𝐶𝐶𝐶 = ℎ( 𝑥𝑥 ∣ 𝛬𝛬 ) = 𝛬𝛬 ⋅ 𝑎𝑎(𝑥𝑥) 𝑟𝑟: inflation rate (set to 0 if not applicable)
𝜇𝜇 - 𝑢𝑢
𝜇𝜇_ 𝜇𝜇b 𝑚𝑚: maximum covered loss, which equals + 𝑑𝑑
Skewness = _ ; Kurtosis = b 𝑆𝑆(𝑥𝑥) = 𝑀𝑀ô [−𝐴𝐴(𝑥𝑥)], where 𝐴𝐴(𝑥𝑥) = * 𝑎𝑎(𝑡𝑡) d𝑡𝑡
𝜎𝜎 𝜎𝜎 ./
𝛼𝛼

Moment and Probability Generating Functions Aggregate Loss Models

Insurance Applications Collective Risk Model
𝑀𝑀d (𝑧𝑧) = E[𝑒𝑒 fd ]
(g) (g) 𝑌𝑌 ö : payment per loss If 𝑆𝑆 = ∑µ
¥∂I 𝑋𝑋¥ for independent 𝑁𝑁 and 𝑋𝑋, then:
𝑀𝑀d (0) = E[𝑋𝑋 g ] where 𝑀𝑀d is the 𝑛𝑛 DE derivative

(𝑧𝑧) d ] Policy Limits, 𝑢𝑢 • E[𝑆𝑆] = E[𝑁𝑁]E[𝑋𝑋]

𝑃𝑃d = E[𝑧𝑧
(g) 𝑋𝑋, 𝑋𝑋 < 𝑢𝑢 • Var[𝑆𝑆] = E[𝑁𝑁]Var[𝑋𝑋] + Var[𝑁𝑁]E[𝑋𝑋]M
𝑃𝑃d (1) = E[𝑋𝑋(𝑋𝑋 − 1) ⋯ (𝑋𝑋 − 𝑛𝑛 + 1)] 𝑌𝑌 ö = 𝑋𝑋 ∧ 𝑢𝑢 = ù
(g) 𝑢𝑢, 𝑋𝑋 ≥ 𝑢𝑢 Impact of Deductibles on Claim Frequency
where 𝑃𝑃d is the 𝑛𝑛 DE derivative E[(𝑌𝑌 ö )G ]
= E[(𝑋𝑋 ∧ 𝑢𝑢) G ]

ü For 𝑣𝑣 = Pr(𝑋𝑋 > 𝑑𝑑),
Conditional Distributions = * 𝑥𝑥 G 𝑓𝑓(𝑥𝑥) d𝑥𝑥 + 𝑢𝑢 G ⋅ 𝑆𝑆(𝑢𝑢) 𝑵𝑵 𝑵𝑵′
Pr(𝐴𝐴 ∩ 𝐵𝐵) Pr(𝐵𝐵 ∣ 𝐴𝐴) Pr(𝐴𝐴) B
Pr(𝐴𝐴 ∣ 𝐵𝐵) = = ü
Poisson 𝜆𝜆 𝑣𝑣𝑣𝑣
Pr(𝐵𝐵) Pr(𝐵𝐵) = * 𝑘𝑘𝑥𝑥 G.I𝑆𝑆(𝑥𝑥) d𝑥𝑥
𝑓𝑓d (𝑥𝑥) B
𝑓𝑓d∣rsdsG (𝑥𝑥) = , where 𝑗𝑗 < 𝑥𝑥 < 𝑘𝑘 E[𝑋𝑋 ∧ 𝑢𝑢]
Pr(𝑗𝑗 < 𝑋𝑋 < 𝑘𝑘) Binomial 𝑚𝑚, 𝑞𝑞 𝑚𝑚, 𝑣𝑣𝑣𝑣
Increased Limit Factor: 𝐼𝐼𝐼𝐼𝐼𝐼 =
E[𝑋𝑋 ∧ 𝑏𝑏]
Law of Total Probability Neg.
• 𝑏𝑏: original limit 𝑟𝑟, 𝛽𝛽 𝑟𝑟, 𝑣𝑣𝑣𝑣
Pr(𝑋𝑋 = 𝑥𝑥) = Ew [Pr(𝑋𝑋 = 𝑥𝑥 ∣ 𝑌𝑌)] Binomial
• 𝑢𝑢: increased limit
Law of Total Expectation
Negative Binomial/Exponential Compound Models
Deductibles, 𝑑𝑑
Ed [𝑋𝑋] = Ew xEd [𝑋𝑋 ∣ 𝑌𝑌]y 𝑁𝑁 ∼ Neg. Binomial (𝑟𝑟, 𝛽𝛽)
Ordinary deductible: ã π
Law of Total Variance 0, 𝑋𝑋 < 𝑑𝑑 𝑋𝑋 ∼ Exponential (𝜃𝜃)
𝑌𝑌 ö = (𝑋𝑋 − 𝑑𝑑)• = ã
Vard [𝑋𝑋] = Ew xVard [ 𝑋𝑋 ∣ 𝑌𝑌 ]y + Varw xEd [𝑋𝑋 ∣ 𝑌𝑌]y 𝑋𝑋 − 𝑑𝑑, 𝑋𝑋 ≥ 𝑑𝑑 ⇕
E[𝑌𝑌 ö ] = E[(𝑋𝑋 − 𝑑𝑑)• ] = E[𝑋𝑋] − E[𝑋𝑋 ∧ 𝑑𝑑] 𝛽𝛽
Independence E[(𝑌𝑌 ö )G ] = E[(𝑋𝑋 − 𝑑𝑑)G• ] 𝑁𝑁 ∼ Binomial ™𝑟𝑟, ∞
ª 1 + 𝛽𝛽 º
/
For independent 𝑋𝑋 and 𝑌𝑌, 𝑋𝑋 ∼ Exponential (𝜃𝜃[1 + 𝛽𝛽])
• Pr(𝑋𝑋 = 𝑥𝑥, 𝑌𝑌 = 𝑦𝑦) = Pr(𝑋𝑋 = 𝑥𝑥) ⋅ Pr(𝑌𝑌 = 𝑦𝑦) = * (𝑥𝑥 − 𝑑𝑑)G 𝑓𝑓(𝑥𝑥) d𝑥𝑥
¶
• E[𝑔𝑔(𝑋𝑋) ⋅ ℎ(𝑌𝑌)] = E[𝑔𝑔(𝑋𝑋)] ⋅ E[ℎ(𝑌𝑌)] / Compound Poisson Models
= * 𝑘𝑘(𝑥𝑥 − 𝑑𝑑)G.I𝑆𝑆(𝑥𝑥) d𝑥𝑥 A collective risk model where the frequency
Parametric Distributions ¶ follows a Poisson distribution.
Special Distribution Shortcuts E[𝑋𝑋 ∧ 𝑑𝑑]
Loss eliminiation ratio: 𝐿𝐿𝐿𝐿𝐿𝐿 =
E[𝑋𝑋]
𝑿𝑿 𝑿𝑿 − 𝒅𝒅 ∣ 𝑿𝑿 > 𝒅𝒅

Pareto (𝛼𝛼, 𝜃𝜃) Pareto (𝛼𝛼, 𝜃𝜃 + 𝑑𝑑) Franchise deductible:

0, 𝑋𝑋 < 𝑑𝑑
Exponential (𝜃𝜃) Exponential (𝜃𝜃) 𝑌𝑌 ö = ã
𝑋𝑋, 𝑋𝑋 ≥ 𝑑𝑑
Uniform (𝑎𝑎, 𝑏𝑏) Uniform (0, 𝑏𝑏 − 𝑑𝑑) E[𝑌𝑌 ö ] = E[(𝑋𝑋 − 𝑑𝑑)• ] + 𝑑𝑑 ⋅ 𝑆𝑆(𝑑𝑑)

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Risk Measures Choosing from (𝑎𝑎, 𝑏𝑏, 0) Class 𝐷𝐷(𝑥𝑥) Plot
Value-at-Risk (VaR) Two methods to fit data to an (𝑎𝑎, 𝑏𝑏, 0) class Graph the difference between empirical CDF and
VaRæ (𝑋𝑋) = 𝐹𝐹d.I(𝑝𝑝) distributions: fitted CDF


• Method 1: Compare 𝑥𝑥̅ and 𝑠𝑠 M
Tail-Value-at-Risk (TVaR) Gg
TVaRæ (𝑋𝑋) = Ex𝑋𝑋 ∣ 𝑋𝑋 > VaRæ (𝑋𝑋)y • Method 2: Observe the slope of ‹
g‹›À
= VaRæ (𝑋𝑋) + 𝑒𝑒xVaRæ (𝑋𝑋)y

Distribution Method 1 Method 2
TVaRæ (𝑋𝑋) Poisson 𝑥𝑥̅ = 𝑠𝑠 M 0
𝜙𝜙¬𝑧𝑧æ √ Binomial M
𝑥𝑥̅ > 𝑠𝑠 Negative
Normal 𝜇𝜇 + 𝜎𝜎 ¿ ƒ
1 − 𝑝𝑝 Neg. Binomial 𝑥𝑥̅ < 𝑠𝑠 M Positive
Φ¬𝜎𝜎 − 𝑧𝑧æ √

Lognormal E[𝑋𝑋] ⋅ ¿ ƒ Variance of MLE

1 − 𝑝𝑝 Fisher’s Information
One Parameter:


Coherence
𝐼𝐼(𝜃𝜃) = −Ed [𝑙𝑙′′(𝜃𝜃)] Peak: 𝐷𝐷(𝑥𝑥) = 𝐹𝐹g ¬𝑥𝑥r √ − 𝐹𝐹∗ ¬𝑥𝑥r √
𝜌𝜌(𝑋𝑋) is coherent if it satisfies the properties below:
Varx𝜃𝜃”y = [𝐼𝐼(𝜃𝜃)].I
• Translation invariance: 𝜌𝜌(𝑋𝑋 + 𝑐𝑐) = 𝜌𝜌(𝑋𝑋) + 𝑐𝑐
Valley: 𝐷𝐷(𝑥𝑥) = 𝐹𝐹g ¬𝑥𝑥r.I √ − 𝐹𝐹 ∗¬𝑥𝑥r √
• Positive homogeneity: 𝜌𝜌(𝑐𝑐𝑐𝑐) = 𝑐𝑐 ⋅ 𝜌𝜌(𝑋𝑋) Two Parameters:

H (𝛼𝛼, 𝑝𝑝-𝑝𝑝 Plot

• Subadditivity: 𝜌𝜌(𝑋𝑋 + 𝑌𝑌) ≤ 𝜌𝜌(𝑋𝑋) + 𝜌𝜌(𝑌𝑌) 𝑙𝑙fiHH (𝛼𝛼, 𝜃𝜃) 𝑙𝑙fi,— 𝜃𝜃) 𝑗𝑗
• Monotonicity: 𝜌𝜌(𝑋𝑋) ≤ 𝜌𝜌(𝑌𝑌), if Pr(𝑋𝑋 ≤ 𝑌𝑌) = 1 𝐼𝐼(𝛼𝛼, 𝜃𝜃) = −Ed ¿ H ƒ Coordinate: Ó𝐹𝐹g ¬𝑥𝑥r √, 𝐹𝐹 ∗¬𝑥𝑥r √Ô where 𝐹𝐹g ¬𝑥𝑥r √ =
𝑙𝑙fi,— (𝛼𝛼, 𝜃𝜃) 𝑙𝑙—HH (𝛼𝛼, 𝜃𝜃) 𝑛𝑛 + 1
VaR is not coherent because it fails subaddivity. Var[𝛼𝛼÷] Covx𝛼𝛼÷, 𝜃𝜃”y

TVaR is coherent. [𝐼𝐼(𝛼𝛼, 𝜃𝜃)].I = fl ‡ Hypothesis Tests: Chi-Square Goodness-of-Fit

Covx𝛼𝛼÷, 𝜃𝜃”y Varx𝜃𝜃”y Chi-Square Goodness-of-Fit Test
Tail Weight
G M
1. Fewer positive raw moments ⟹ heavier tail Delta Approximation ¬𝐸𝐸r − 𝑂𝑂r √
  (-) Õ (-) One-Variable: Test statistic: 𝜒𝜒M = Ò where
2. If lim À(-) = ∞ or lim À(-) = ∞, then numerator 𝐸𝐸r
M r∂I
-→/  Ã -→/ ÕÃ 𝑑𝑑
has a heavier tail. Varx𝑔𝑔¬𝜃𝜃”√y ≈ Æ 𝑔𝑔(𝜃𝜃)Ø Varx𝜃𝜃”y • 𝑘𝑘: # of groups
𝑑𝑑𝑑𝑑
3. ℎ(𝑥𝑥) decreases with 𝑥𝑥 ⟹ heavy tail • 𝐸𝐸r : expected # of observations in group 𝑗𝑗
4. 𝑒𝑒(𝑑𝑑) increases with 𝑑𝑑 ⟹ heavy tail Two-Variable: • 𝑂𝑂r : actual # of observations in group 𝑗𝑗
Varx𝑔𝑔¬𝛼𝛼÷, 𝜃𝜃”√y ≈ (𝑔𝑔fiH )M Var[𝛼𝛼÷] + 2𝑔𝑔fiH 𝑔𝑔—H Covx𝛼𝛼÷, 𝜃𝜃”y Degrees of freedom = 𝑘𝑘 − 1 − 𝑟𝑟 where
+(𝑔𝑔—H )MVarx𝜃𝜃”y • 𝑟𝑟: # of estimated parameters
CONSTRUCTION AND SELECTION OF
CONSTRUCTION AND SELECTION OF

PARAMETRIC MODELS Confidence Interval Chi-Square Goodness-of-Fit Test Properties

PARAMETRIC MODELS
• Individual and grouped data
 x𝜃𝜃”y
𝜃𝜃” ± 𝑧𝑧(I•æ)/M‰Var
Maximum Likelihood Estimators • Continuous and discrete fit

Steps to Calculating MLE Hypothesis Tests • No adjustments to critical value for censored
1. 𝐿𝐿(𝜃𝜃) = ∏ 𝑓𝑓(𝑥𝑥) –
3. 𝑙𝑙H (𝜃𝜃) = 𝑙𝑙(𝜃𝜃) 𝐻𝐻B : null hypothesis data
2. 𝑙𝑙(𝜃𝜃) = ln 𝐿𝐿(𝜃𝜃) –—
H (𝜃𝜃) 𝐻𝐻I : alternative hypothesis • If parameters are estimated, critical value is
4. Set 𝑙𝑙 = 0 automatically adjusted via degrees of freedom
Reject 𝐻𝐻B when test statistic > critical value
Incomplete Data • No change for critical value if sample size is
𝑯𝑯𝟎𝟎 is true 𝑯𝑯𝟎𝟎 is false large
Left-truncated at 𝑑𝑑 𝑓𝑓(𝑥𝑥)⁄𝑆𝑆(𝑑𝑑) • Data needs to be grouped according to 𝐸𝐸r
Type I Correct
Right-censored at 𝑢𝑢 𝑆𝑆(𝑢𝑢) Reject 𝑯𝑯𝟎𝟎
Error Decision • More weights on intervals with poor fit
Grouped data on interval
Pr(𝑎𝑎 < 𝑋𝑋 ≤ 𝑏𝑏) Fail to reject Correct Type II Hypothesis Tests: Likelihood Ratio
(𝑎𝑎, 𝑏𝑏]
𝑯𝑯𝟎𝟎 Decision Error Test statistic: 𝑇𝑇 = 2[𝑙𝑙(𝜃𝜃I ) − 𝑙𝑙(𝜃𝜃B )]
Special Cases
Degrees of freedom = # of free parameters in 𝐻𝐻I
Hypothesis Tests: Kolmogorov-Smirnov
Distribution Shortcuts Empirical Distribution − # of free parameters in 𝐻𝐻B

Gamma, 𝑥𝑥̅ Equal probability for each observation Score-Based Approaches

𝜃𝜃” = # of observations ≤ 𝑥𝑥 Two types of criteria:
fixed 𝛼𝛼 𝛼𝛼 𝐹𝐹g (𝑥𝑥) =
𝜇𝜇̂ = 𝑥𝑥̅
𝑛𝑛 • Schwarz Bayesian Criterion (SBC), a.k.a.

Kolmogorov-Smirnov Test Bayesian Information Criterion (BIC)

Normal ∑ g
¥∂I 𝑥𝑥¥
M
𝜎𝜎÷ M = − 𝜇𝜇̂ M Test statistic: 𝐷𝐷 = max x𝐷𝐷r y where • Akaike Information Criterion (AIC)
𝑛𝑛 ÍÎÎ r

∑g¥∂I ln 𝑥𝑥¥ 𝐷𝐷r = max¬Ï𝐹𝐹g ¬𝑥𝑥r √ − 𝐹𝐹 ∗¬𝑥𝑥r √Ï, Ï𝐹𝐹g ¬𝑥𝑥r.I√ − 𝐹𝐹∗ ¬𝑥𝑥r √Ï√ 𝑟𝑟
SBC/BIC 𝑙𝑙 − ln 𝑛𝑛
𝜇𝜇̂ = If data is truncated at 𝑑𝑑, then 2
𝑛𝑛
Lognormal

𝐹𝐹(𝑥𝑥) − 𝐹𝐹(𝑑𝑑)
g
∑¥∂I(ln 𝑥𝑥¥ ) M AIC 𝑙𝑙 − 𝑟𝑟
𝜎𝜎÷ M = − 𝜇𝜇̂ M 𝐹𝐹 ∗(𝑥𝑥) = , for 𝑥𝑥 ≥ 𝑑𝑑
𝑛𝑛 1 − 𝐹𝐹(𝑑𝑑)

where
Poisson 𝜆𝜆◊ = 𝑥𝑥̅ Kolmogorov-Smirnov Test Properties 𝑙𝑙: log-likelihood
𝑥𝑥̅ • Individual data only 𝑟𝑟: # of estimated parameters
Binomial,
𝑞𝑞÷ = • Continuous fit only 𝑛𝑛: sample size
fixed 𝑚𝑚 𝑚𝑚
• Lower critical value for censored data Select model with the highest SBC or AIC value.
Neg. Binomial, 𝑥𝑥̅ • If parameters are estimated, critical value
𝛽𝛽◊ =
fixed 𝑟𝑟 𝑟𝑟 should be adjusted

Zero-Truncated Distribution: • Lower critical value if sample size is large

• Match E[𝑋𝑋 á ] to 𝑥𝑥̅ • No discretion
Zero-Modified Distribution: • Uniform weight on all parts of distribution
• Match 𝑝𝑝Bä to the proportion of zero observations
• Match E[𝑋𝑋 ä ] to 𝑥𝑥̅
Uniform Distribution on (0, 𝜃𝜃):
• 𝜃𝜃” = max(𝑥𝑥I, 𝑥𝑥M, … , 𝑥𝑥g )

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CREDIBILITY CREDIBILITY Bühlmann As Least Squares Estimate of Exact Credibility

Bayesian Bayesian estimate = Bühlmann estimate
Classical Credibility M
Minimize ∑ÍÎÎ - ´𝑝𝑝- ¬𝑌𝑌- − 𝑌𝑌”- √ ≠ where • Poisson/Gamma
a.k.a. Limited Fluctuation Credibility
• Binomial/Beta
𝑌𝑌- : Bayesian estimate given 𝑋𝑋I = 𝑥𝑥
Full Credibility • Exponential/Inv. Gamma
# of exposures needed for full credibility, 𝑛𝑛ı : 𝑌𝑌”- : Bühlmann estimate given 𝑋𝑋I = 𝑥𝑥

• Normal/Normal
Full credibility of aggregate claims: Properties of a Bayesian/Bühlmann graph

𝑧𝑧(I•æ)⁄M M • Bühlmann estimates are on a straight line Empirical Bayes Non-Parametric Methods
𝑛𝑛ı = ´ ≠ (𝐶𝐶𝑉𝑉 M) • Bayesian estimates are within the range of Uniform Exposures
𝑘𝑘

hypothetical means ∑!¥∂I ∑gr∂I 𝑥𝑥¥r

# of claims needed for full credibility, 𝑛𝑛ˆ : 𝜇𝜇̂ =
Full credibility of aggregate claims: • There are Bayesian estimates above and below
𝑟𝑟 ⋅ 𝑛𝑛
M
𝑧𝑧(I•æ)⁄M M 𝜎𝜎µM the Bühlmann line ! g
∑¥∂I ∑r∂I¬𝑥𝑥¥r − 𝑥𝑥̅ ¥ √
𝑛𝑛ˆ = ´ ≠ fl + 𝐶𝐶𝑉𝑉dM‡ • Bühlmann estimates are between the sample 𝑣𝑣÷ =
𝑘𝑘 𝜇𝜇µ 𝑟𝑟(𝑛𝑛 − 1)
mean and theoretical mean

• Full credibility of claim frequency: set 𝐶𝐶𝑉𝑉dM = 0

!
∑¥∂I(𝑥𝑥̅ ¥ − 𝑥𝑥̅ ) M
𝑣𝑣÷
˜ Ã̄ Conjugate Priors 𝑎𝑎÷ = −
• Full credibility of claim severity: set = 0 𝑟𝑟 − 1 𝑛𝑛
˘¯ Poisson/Gamma
𝑛𝑛ˆ Non-uniform Exposures
𝑛𝑛ˆ = 𝑛𝑛ı ⋅ 𝜇𝜇µ ; 𝑛𝑛ı = • Model: Poisson (𝜆𝜆)
𝜇𝜇µ • Prior: Gamma (𝛼𝛼, 𝜃𝜃) ∑!¥∂I ∑gr∂I
"
𝑚𝑚¥r 𝑥𝑥¥r

𝜇𝜇̂ =
Partial Credibility 𝑚𝑚
( 𝜆𝜆 ∣ data ) ∼ Gamma (𝛼𝛼 ∗, 𝜃𝜃 ∗)

M
Credibility premium: 𝑃𝑃˙ = 𝑍𝑍𝑥𝑥̅ + (1 − 𝑍𝑍)𝑀𝑀
g
∑!¥∂I ∑r∂I"
𝑚𝑚¥r ¬𝑥𝑥¥r − 𝑥𝑥̅ ¥ √
= 𝑀𝑀 + 𝑍𝑍(𝑥𝑥̅ − 𝑀𝑀) Posterior • 𝛼𝛼 ∗ = 𝛼𝛼 + ∑g¥∂I 𝑥𝑥¥ 𝑣𝑣÷ =
∑!¥∂I(𝑛𝑛¥ − 1)
where I .I
• 𝜃𝜃 ∗ = Ó + 𝑛𝑛Ô

𝑀𝑀: manual premium — ∑!¥∂I 𝑚𝑚¥ (𝑥𝑥̅ ¥ − 𝑥𝑥̅ )M − 𝑣𝑣÷(𝑟𝑟 − 1)

𝑎𝑎÷ =
𝑍𝑍: credibility factor/credibility Predictive Neg. Binomial (𝑟𝑟 = 𝛼𝛼 ∗, 𝛽𝛽 = 𝜃𝜃 ∗) 𝑚𝑚 − 𝑚𝑚 .I ∑!¥∂I 𝑚𝑚¥M

𝑛𝑛 𝑛𝑛′
Balancing the Estimators
Square Root Rule: 𝑍𝑍 = ¸ =¸ Binomial/Beta ∑!¥∂I 𝑍𝑍¥ 𝑥𝑥̅ ¥
𝑛𝑛ı 𝑛𝑛ˆ
• Model: ( 𝑋𝑋 ∣ 𝑞𝑞 ) ∼ Binomial (𝑚𝑚, 𝑞𝑞) Estimate EHM as: 𝜇𝜇̂ = !
where ∑¥∂I 𝑍𝑍¥
• Prior: 𝑞𝑞 ∼ Beta (𝑎𝑎, 𝑏𝑏, 1)
𝑛𝑛: actual # of exposures
Empirical Bayes Semi-Parametric Methods
𝑛𝑛′: actual # of claims ( 𝑞𝑞 ∣ data ) ∼ Beta (𝑎𝑎∗ , 𝑏𝑏 ∗, 1)

To estimate 𝑣𝑣÷:
Posterior • 𝑎𝑎∗ = 𝑎𝑎 + ∑g¥∂I 𝑥𝑥¥

Bayesian Credibility Model 𝒗𝒗
%
Model Distribution • 𝑏𝑏 ∗ = 𝑏𝑏 + [𝑛𝑛(𝑚𝑚) − ∑g¥∂I 𝑥𝑥¥ ]
Poisson (𝜆𝜆) 𝑥𝑥̅
Distribution of model conditioned on a parameter Predictive - Neg. Binomial (𝑟𝑟, 𝛽𝛽) 𝑥𝑥̅ (1 + 𝛽𝛽)
Model density function: 𝑓𝑓( 𝑥𝑥 ∣ 𝜃𝜃 )
Gamma (𝛼𝛼, 𝜃𝜃) 𝑥𝑥̅ 𝜃𝜃

Exponential/Inv. Gamma
Prior Distribution
• Model: ( 𝑋𝑋 ∣ 𝜃𝜃 ) ∼ Exponential (𝜃𝜃) To estimate 𝜇𝜇̂ and 𝑎𝑎÷, use the non-parametric
Initial distribution of the parameter
Prior density function: 𝜋𝜋(𝜃𝜃) • Prior: 𝜃𝜃 ∼ Inv. Gamma (𝛼𝛼, 𝛽𝛽) method formulas shown above.

Posterior Distribution ( 𝜃𝜃 ∣ data ) ∼ Inv. Gamma (𝛼𝛼 ∗, 𝛽𝛽 ∗ )

Revised distribution of the parameter Posterior • 𝛼𝛼 ∗ = 𝛼𝛼 + 𝑛𝑛
Posterior density function: 𝜋𝜋(𝜃𝜃 ∣ data) • 𝛽𝛽 ∗ = 𝛽𝛽 + ∑g¥∂I 𝑥𝑥¥
𝑓𝑓( data ∣ 𝜃𝜃 ) ⋅ 𝜋𝜋(𝜃𝜃)
𝜋𝜋(𝜃𝜃 ∣ data) = / Predictive Pareto (𝛼𝛼 = 𝛼𝛼 ∗, 𝜃𝜃 = 𝛽𝛽 ∗ )
∫./ 𝑓𝑓( data ∣ 𝜃𝜃 ) ⋅ 𝜋𝜋(𝜃𝜃) d𝜃𝜃

Normal/Normal
Predictive Distribution
Revised unconditional distribution (w.r.t. model) • Model: ( 𝑋𝑋 ∣ 𝜃𝜃 ) ∼ Normal (𝜃𝜃, 𝑣𝑣)
of the model • Prior: 𝜃𝜃 ∼ Normal (𝜇𝜇, 𝑎𝑎)

Predictive density function: 𝑓𝑓(𝑥𝑥 ∣ data) ( 𝜃𝜃 ∣ data ) ∼ Normal (𝜇𝜇∗ , 𝑎𝑎∗ )
Predictive Mean = Bayesian Premium
Posterior • 𝜇𝜇∗ = 𝑍𝑍𝑥𝑥̅ + (1 − 𝑍𝑍)𝜇𝜇
Bühlmann Credibility • 𝑎𝑎∗ = (1 − 𝑍𝑍)𝑎𝑎
Expected Hypothetical Mean (EHM):
𝜇𝜇 = ExE[𝑋𝑋 ∣ 𝜃𝜃]y Predictive Normal (𝜇𝜇 = 𝜇𝜇 ∗, 𝜎𝜎 M = 𝑣𝑣 + 𝑎𝑎∗ )

Expected Process Variance (EPV):
Uniform/S-P Pareto
𝑣𝑣 = ExVar[𝑋𝑋 ∣ 𝜃𝜃]y
• Model: ( 𝑋𝑋 ∣ 𝜃𝜃 ) ∼ Uniform (0, 𝜃𝜃)
Variance of Hypothetical Mean (VHM): • Prior: 𝜃𝜃 ∼ S-P Pareto (𝛼𝛼, 𝛽𝛽)
𝑎𝑎 = VarxE[𝑋𝑋 ∣ 𝜃𝜃]y
𝑣𝑣 ( 𝜃𝜃 ∣ data ) ∼ S-P Pareto (𝛼𝛼 ∗, 𝛽𝛽 ∗ )
Bühlmann 𝑘𝑘: 𝑘𝑘 =
𝑎𝑎 Posterior
𝑛𝑛 • 𝛼𝛼 ∗ = 𝛼𝛼 + 𝑛𝑛
Bühlmann Credibility Factor: 𝑍𝑍 = • 𝛽𝛽 ∗ = max(𝛽𝛽, 𝑥𝑥I, … , 𝑥𝑥g )
𝑛𝑛 + 𝑘𝑘
Bühlmann Credibility Premium: Predictive -
𝑃𝑃˙ = 𝑍𝑍𝑥𝑥̅ + (1 − 𝑍𝑍)𝜇𝜇
= 𝜇𝜇 + 𝑍𝑍(𝑥𝑥̅ − 𝜇𝜇)

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 SHORT-TERM INSURANCES Expenses and Profit
SHORT-TERM INSURANCES SHORT-TERM INSURANCES Expenses and Profit 𝐸𝐸ä

Variable Expense Ratio: 𝑉𝑉𝐸𝐸= ä
Insurance Coverages Variable Expense Ratio: 𝑉𝑉 = 𝑃𝑃
Insurance Coverages 𝑃𝑃ç
𝐸𝐸
Homeowners Coinsurance
Homeowners Coinsurance 𝐼𝐼 Fixed Expense Ratio: 𝐹𝐹𝐸𝐸= ç
𝐼𝐼 Fixed Expense Ratio: 𝐹𝐹 = 𝑃𝑃
min 0𝐼𝐼, ⋅ 𝐿𝐿7 , 𝐼𝐼 < 𝑐𝑐𝑐𝑐 𝑃𝑃
Permissible Loss Ratio: PLR = 1 − 𝑉𝑉 − 𝑄𝑄 ,
Compensation: 𝑃𝑃 = min / 0𝐼𝐼, 𝐿𝐿7 , 𝐼𝐼 < 𝑐𝑐𝑐𝑐
⋅𝑐𝑐𝑐𝑐 Permissible Loss Ratio: PLR = 1 − 𝑉𝑉 − 𝑄𝑄ë , ë
Compensation: 𝑃𝑃 = / 𝑐𝑐𝑐𝑐 where 𝑄𝑄ë is the target profit and contingencies ratio
min(𝐼𝐼, 𝐿𝐿) , 𝐼𝐼 ≥ 𝑐𝑐𝑐𝑐 where 𝑄𝑄 is the target profit and contingencies ratio
min(𝐼𝐼, 𝐿𝐿) , 𝐼𝐼 ≥ 𝑐𝑐𝑐𝑐
ë

Disappearing Deductible Premium
Disappearing Deductible Premium
Deductible decreases linearly over a specific range:
Deductible decreases linearly over a specific range:
𝑑𝑑, 𝑋𝑋 ≤ 𝑎𝑎
𝑑𝑑, 𝑋𝑋 ≤ 𝑎𝑎 Premium
𝑏𝑏 − 𝑋𝑋
𝐷𝐷 = =𝑏𝑏𝑑𝑑 − 0 𝑋𝑋 7 , 𝑎𝑎 < 𝑋𝑋 ≤ 𝑏𝑏
𝐷𝐷 = =𝑑𝑑 0 𝑏𝑏 − 7 ,𝑎𝑎 𝑎𝑎 < 𝑋𝑋 ≤ 𝑏𝑏
𝑏𝑏 − 𝑎𝑎0, 𝑋𝑋 > 𝑏𝑏
Claim Payment: 0, 𝑋𝑋 > 𝑏𝑏 Aggregation Current Rate Level
Claim Payment: 0, 𝑋𝑋 ≤ 𝑑𝑑
⎧ 0, 𝑋𝑋 ≤ 𝑑𝑑 • Calendar Year (CY) • Extension of Exposures
⎪ 𝑋𝑋 𝑋𝑋
⎧ − 𝑑𝑑, 𝑑𝑑 < 𝑋𝑋 ≤ 𝑎𝑎
− 𝑑𝑑, 𝑑𝑑 < 𝑋𝑋 ≤ 𝑎𝑎 • Policy Year (PY) Method
𝑌𝑌⎪= 𝑏𝑏 − 𝑋𝑋 • Parallelogram Method
𝑌𝑌 = ⎨ 𝑋𝑋 − 𝑏𝑏𝑑𝑑 − 0 𝑋𝑋 7 , 𝑎𝑎 < 𝑋𝑋 ≤ 𝑏𝑏
⎨ 𝑋𝑋⎪− 𝑑𝑑 0 𝑏𝑏 −7 ,𝑎𝑎 𝑎𝑎 < 𝑋𝑋 ≤ 𝑏𝑏
⎪ ⎩ 𝑏𝑏 − 𝑋𝑋,𝑎𝑎 𝑋𝑋 > 𝑏𝑏
⎩ 𝑋𝑋, 𝑋𝑋 > 𝑏𝑏

Loss Reserving Premium at Current Rates
Loss Reserving
Expected Loss Ratio Method
Expected Loss Ratio Method
1. 𝐿𝐿KLMN. = 𝑃𝑃P ⋅ 𝐸𝐸𝐸𝐸𝐸𝐸
Unearned premium for CY 𝑖𝑖:
1. 𝐿𝐿KLMN. = 𝑃𝑃KPLMN. ⋅ 𝐸𝐸𝐸𝐸𝐸𝐸 Unearned premium for CY 𝑖𝑖:
2. 𝑅𝑅 K= 𝐿𝐿 − 𝐿𝐿S 𝑃𝑃í = 𝑃𝑃ì − 𝑃𝑃P + í
í 𝑃𝑃Us\
2. 𝑅𝑅 = 𝐿𝐿LMN. − 𝐿𝐿S 𝑃𝑃Uí =U 𝑃𝑃Uì −U 𝑃𝑃UP +U 𝑃𝑃Us\

Chain-Ladder Method
Extension of Exposures Method
Chain-Ladder Method Extension of Exposures Method
a.k.a. Loss Development Triangle Method Recalculates the premiums of historical policies under the current rate level
a.k.a. Loss Development Triangle Method Recalculates the premiums of historical policies under the current rate level

1.LMN.𝑓𝑓ULMN. =X∏X WYZ[\ 𝑓𝑓W
1. 𝑓𝑓U = ∏WYZ[\ 𝑓𝑓W Parallelogram Method
Parallelogram Method

2. K
𝐿𝐿 LMN.
= 𝐿𝐿 ⋅ 𝑓𝑓ULMN. Calculates average factors to be applied to the aggregate historical premiums
2. 𝐿𝐿KLMN.
U =U
𝐿𝐿 U,Z ⋅ U,ZLMN.
𝑓𝑓 U Calculates average factors to be applied to the aggregate historical premiums
3. 𝑅𝑅 K= KLMN. − S to make them on-level
LMN.𝐿𝐿 S 𝐿𝐿

3. 𝑅𝑅 = 𝐿𝐿 − 𝐿𝐿 to make them on-level

Bornhuetter-Ferguson Method

Ratemaking
Bornhuetter-Ferguson Method Ratemaking
1 Loss Ratio Method
𝑅𝑅 = 𝐿𝐿KLMN. 01 − 1 7 where Loss Ratio Method 𝐿𝐿𝐿𝐿 + 𝐹𝐹
𝑅𝑅 = 𝐿𝐿KLMN. 01 − LMN.𝑓𝑓7LMN. where Indicated Avg. Rate Change =𝐿𝐿𝐿𝐿 + 𝐹𝐹 − 1
K LMN. 𝑓𝑓 Indicated Avg. Rate Change = 1 − 𝑉𝑉 − 𝑄𝑄− 1
• 𝐿𝐿 is calculated based on the expected loss ratio method 1 − 𝑉𝑉 − 𝑄𝑄ë ë
• 𝐿𝐿KLMN. is calculated based on the expected loss ratio method

• 𝑓𝑓 LMN. is calculated based on the chain-ladder method

𝐿𝐿𝑅𝑅U
• 𝑓𝑓 LMN. is calculated based on the chain-ladder method Indicated Relativity = Current Relativity 𝐿𝐿𝑅𝑅 ⋅ U
Alternatively, Indicated RelativityU = UCurrent RelativityU ⋅ U 𝐿𝐿𝑅𝑅òôöõ
Alternatively, 1

𝐿𝐿𝑅𝑅òôöõ
1 + Indicated Avg. Rate Change
𝑅𝑅 = 𝑤𝑤 ⋅ 𝑅𝑅 + (1 − 𝑤𝑤) ⋅ 𝑅𝑅gi where 𝑤𝑤 =1 LMN.

Indicated Base Rate = Current Base Rate 1+ ⋅ Indicated Avg. Rate Change
𝑅𝑅 = 𝑤𝑤 ⋅ 𝑅𝑅fg +fg(1 − 𝑤𝑤) ⋅ 𝑅𝑅gi where 𝑤𝑤 = LMN.𝑓𝑓 Indicated Base Rate = Current Base Rate ⋅ Off-Balance Factor
𝑓𝑓
Indicated Avg. RelativityOff-Balance Factor

Frequency-Severity Method

Frequency-Severity Method Off-Balance FactorIndicated Avg.

= Relativity
Alternate Method: Off-Balance Factor = Current Avg. Relativity
Alternate Method: Current Avg. Relativity
1. Apply the chain-ladder method to frequency and severity separately
Pure Premium Method
1. Apply the chain-ladder method to frequency and severity separately
2. 𝐿𝐿KLMN. k=LMN.𝑁𝑁 k LMN. LMN.
K ⋅ 𝑋𝑋
K LMN. Pure Premium Method
𝐿𝐿† + 𝐸𝐸†ç
2. 𝐿𝐿KLMN. = 𝑁𝑁 LMN. ⋅ 𝑋𝑋 S
3. 𝑅𝑅 K= K
𝐿𝐿 − 𝐿𝐿 Indicated Avg. Rate =𝐿𝐿† + 𝐸𝐸†ç
3. 𝑅𝑅 = 𝐿𝐿LMN. − 𝐿𝐿S Indicated Avg. Rate = 1 − 𝑉𝑉 − 𝑄𝑄

Closure Method:

1 − 𝑉𝑉 − 𝑄𝑄ë ë
Closure Method:

Avg. RateU
Frequency Avg. Relativity Avg. = RateU
Frequency Avg. RelativityU = U Base Rate
1. 𝑐𝑐U,W = lkm,n
lm,n

Base RateU U
1. 𝑐𝑐U,W = ompqr. som,ntu 𝐿𝐿
𝐿𝐿U U

o kmpqr. so
kULMN. − 𝑁𝑁U,Ws\z Adj. 𝐿𝐿† =
Adj. 𝐿𝐿†U = U Avg. RelativityU ⋅ Exposure
m,ntu
2. 𝑛𝑛wU,W = 𝑐𝑐̂kWLMN. y𝑁𝑁
2. 𝑛𝑛wU,W = 𝑐𝑐̂W y𝑁𝑁U − 𝑁𝑁U,Ws\z
Avg. RelativityU ⋅ ExposureU U
Aggregate
Adj. 𝐿𝐿†U
Aggregate Indicated Relativity =Adj. 𝐿𝐿†U
|1. 𝑙𝑙|U,W = 𝑛𝑛wU,W ⋅ 𝑥𝑥wU,W Indicated RelativityU = U Adj. 𝐿𝐿†òôöõ

1. 𝑙𝑙U,W = 𝑛𝑛wU,W ⋅ 𝑥𝑥wU,W
2. 𝑅𝑅 = ∑U[WÄ 𝑙𝑙|U,W , where 𝑦𝑦 is the valuation CY
Adj. 𝐿𝐿†òôöõ
2. 𝑅𝑅 = ∑U[WÄ 𝑙𝑙|U,W , where 𝑦𝑦 is the valuation CY
Indicated Avg. Rate
Indicated Base Rate =Indicated Avg. Rate

Data Preparation Indicated Base Rate = Indicated Avg. Relativity
Data Preparation Indicated Avg. Relativity
Losses

Losses


Credibility-Weighted Relativities
Credibility-Weighted Relativities
Losses New Relativity = 𝑍𝑍(Indicated Relativity) + (1 − 𝑍𝑍)(Current Relativity)
New Relativity
= 𝑍𝑍(Indicated Relativity) + (1 − 𝑍𝑍)(Current Relativity)

Other Topics
Other Topics
Increased Limit Factor
Increased Limit Factor
𝐿𝐿𝐿𝐿𝐿𝐿(𝑢𝑢) + 𝑅𝑅𝐿𝐿ß
Aggregation Develop to Trending
𝐼𝐼𝐼𝐼𝐼𝐼𝐿𝐿𝐿𝐿𝐿𝐿(𝑢𝑢)
= + 𝑅𝑅𝐿𝐿ß
• Calendar Year (CY) Ultimate • Trend Period 𝐼𝐼𝐼𝐼𝐼𝐼 =
𝐿𝐿𝐿𝐿𝐿𝐿(𝑏𝑏) + 𝑅𝑅𝐿𝐿
𝐿𝐿𝐿𝐿𝐿𝐿(𝑏𝑏) + 𝑅𝑅𝐿𝐿® ®
• Accident Year (AY) • Loss Development • Trend Factor • 𝑏𝑏: original limit
• 𝑏𝑏: original limit
• Policy Year (PY) Factors • 𝑢𝑢: increased limit
• 𝑢𝑢: increased limit
Rate of policy variation with limit 𝑢𝑢 = 𝐼𝐼𝐼𝐼𝐹𝐹ß ⋅ Indicated Base Rate
Rate of policy variation with limit 𝑢𝑢
= 𝐼𝐼𝐼𝐼𝐹𝐹ß ⋅ Indicated Base Rate

Loss Elimination Ratio
Loss Elimination Ratio
𝐿𝐿𝐿𝐿𝐿𝐿(𝑑𝑑) − 𝐿𝐿𝐿𝐿𝐿𝐿(𝑏𝑏)
Projected Losses
𝐿𝐿𝐿𝐿𝑅𝑅 𝐿𝐿𝐿𝐿𝐿𝐿(𝑑𝑑)
= − 𝐿𝐿𝐿𝐿𝐿𝐿(𝑏𝑏)
𝐿𝐿𝐿𝐿𝑅𝑅© =© 𝑥𝑥̅ − 𝐿𝐿𝐿𝐿𝐿𝐿(𝑏𝑏)
𝑥𝑥̅ − 𝐿𝐿𝐿𝐿𝐿𝐿(𝑏𝑏)

Incurred losses for CY 𝑖𝑖: 𝐿𝐿É = 𝐿𝐿S + 𝑅𝑅 − 𝑅𝑅 • 𝑏𝑏: original deductible
Incurred losses for CY 𝑖𝑖: 𝐿𝐿ÉU = U𝐿𝐿SU +U 𝑅𝑅U − U𝑅𝑅Us\ Us\ • 𝑏𝑏: original deductible
where 𝑅𝑅U is the reserves at the end of CY 𝑖𝑖 • 𝑢𝑢: increased deductible
where 𝑅𝑅U is the reserves at the end of CY 𝑖𝑖 • 𝑢𝑢: increased deductible

Rate of policy variation with deductible 𝑑𝑑 = (1 − 𝐿𝐿𝐿𝐿𝑅𝑅 ) ⋅ Indicated Base Rate

Incurred losses for AY or PY 𝑖𝑖: 𝐿𝐿É = 𝐿𝐿S + 𝑅𝑅 Rate of policy variation with deductible 𝑑𝑑 = (1 − 𝐿𝐿𝐿𝐿𝑅𝑅© ) ⋅©Indicated Base Rate
Incurred losses for AY or PY 𝑖𝑖: 𝐿𝐿ÉU = U𝐿𝐿SU +U 𝑅𝑅U U
where 𝑅𝑅U is the reserves as of the valuation date
where 𝑅𝑅U is the reserves as of the valuation date

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