Scribd
Upload
33 views6 pages

Empirical Bayes in Credibility Theory

This document discusses credibility theory, which combines multiple estimates to forecast uncertain future events. Specifically, it examines how credibility theory is used in insurance to determine premium values. The credibility premium formula weights an individual client's claims experience (x) and the overall claims experience (u) using a credibility factor (z) between 0 and 1. A higher credibility factor means more weight is given to the individual client's experience over the overall average when estimating their risk premium. The document also discusses how the credibility factor is calculated using maximum likelihood estimation and how classical credibility theory derives the risk premium as a weighted average of the individual and overall averages.

Uploaded by

Anonymous Reaper
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
33 views6 pages

Empirical Bayes in Credibility Theory

This document discusses credibility theory, which combines multiple estimates to forecast uncertain future events. Specifically, it examines how credibility theory is used in insurance to determine premium values. The credibility premium formula weights an individual client's claims experience (x) and the overall claims experience (u) using a credibility factor (z) between 0 and 1. A higher credibility factor means more weight is given to the individual client's experience over the overall average when estimating their risk premium. The document also discusses how the credibility factor is calculated using maximum likelihood estimation and how classical credibility theory derives the risk premium as a weighted average of the individual and overall averages.

Uploaded by

Anonymous Reaper
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

NAME : CAVIN POLSON KALLELY

CLASS : FY [Link]. ACTUARIAL SCIENCE


ROLL NO : 3713
CLG :THAKUR COLLEGE OF SCIENCE &
COMMERCE
SUBJECT: ACTUARIAL STATISTICS 2
TOPIC : THE EMPIRICAL BAYES’ APPROACH
TO CREDIBILITY THEORY
EXAM : CE 2
INDEX
 1) Intro to Credibility Theory (Bayes)
INTRODUCTION TO CREDIBILITY THEORY (BAYES)
Credibility theory is a form of statistical inference used to forecast an uncertain future event developed by Thomas Bayes. It is employed to
combine multiple estimates into a summary estimate that takes into account information on the accuracy of the initial estimates. This is
typically used by actuaries working for insurance companies when determining the premium values. For example, in group health
insurance an insurer is interested in calculating the risk premium, R P , (i.e. the theoretical expected claims amount) for a particular
employer in the coming year. The insurer will likely have an estimate of historic overall claims experience, x, as well as a more specific
estimate for the employer in question, y. Assigning a credibility factor, z , to the overall claims experience (and the reciprocal to employer
experience) allows the insurer to get a more accurate estimate of the risk premium in the following manner:
RP=xz+y(1−z).
The credibility factor is derived by calculating the maximum likelihood estimate which would minimise the error of estimate. Assuming
the variance of x and y are known quantities taking on the values u and v respectively, it can be shown that z should be equal to:
z=v/(u+v).
Therefore, the more uncertainty the estimate has, the lower is its credibility.

In Bayesian credibility, we separate each class (B) and assign them a probability (Probability of B). Then we find how likely our
experience (A) is within each class (Probability of A given B). Next, we find how likely our experience was over all classes (Probability of
A). Finally, we can find the probability of our class given our experience. So going back to each class, we weight each statistic with the
probability of the particular class given the experience.
CREDIBILITY PREMIUM FORMULA
(CREDIBILITY FACTOR)
x=Clients data mean
u= All Customer’s data
Formula ; (1 + t)[zx +(1-z)u] , t = theta

Weighted average of x &u


z = credibility factor
CREDIBILITY PREMIUM (RISK PREMIUM )

Credibility Premium (Risk Premium ) = zx+(1-x)u


In this Formula , z represents weights assigned to clients data only ,
Always 0<z>1
The Clients Data comprises of last few years loss date
The number of past years for which data are collected is denoted by
‘n’
Naturally ,as ‘n’ increases z also increases
CLASSICAL CREDIBILITY THEORY
In Classical Credibility Theory , the risk premium is
considered as the weighted average of clients average loss
& overall average loss .
The Weight assigned to the client’s average loss is known
as the Credibility Factor , it is denoted by Z , it lies
between 0 & 1 .
It is interesting to observe that when we use squared error
loss function , the bayes estimator which is mean of the
posterior distribution can be expressed as the credibility
premium formula (risk premium )

You might also like