Part I

Severity, Frequency, and

Aggregate Loss
1 Basic Probability
Raw moments µ0n = E[X n ]
Central moments µn = E[(X − µ)n ]
Skewness γ1 = µ3 /σ 3
Kurtosis γ2 = µ4 /σ 4
Coefficient of variation CV = σ/µ
Covariance Cov[X, Y ] = E[(X − µX )(Y − µY )] = E[XY ] − E[X] E[Y ]
Correlation ρXY = Cov[X, Y ]/(σX σY )
MGF MX (t) = E[etX ]
PGF PX (t) = E[tX ] = MX (log t)
(n)
Moments via MGF MX (0) = E[X n ]
(n)
Moments via PGF PX (1) = E[X(X − 1) . . . (X − n + 1)]
Conditional mean E[X] = EY [EX [X|Y ]]

2 Variance
" n
#
1X Var[X]
Sample variance Var[X̄] = Var Xi =
n i=1 n
Xn
Mixtures F (x) = wi FXi (x), w1 + w2 + · · · + wn = 1
i=1
Bernoulli shortcut Var[Y ] = (a − b)2 q(1 − q)

3 Conditional Variance
Conditional variance Var[X] = Var[E[X|I]] + E[Var[X|I]]

1
4 Expected Values
Z ∞ Z ∞
Payment per loss with E[(X − d)+ ] = (x − d)f (x) dx = S(x) dx
deductible d d
Z d Z d
Payment per loss with E[X ∧ d] = xf (x) dx + dS(d) = S(x) dx
claims limit/Limited ex- 0 0

pected value
Decomposition relation E[X] = E[(X − d)+ ] + E[X ∧ d]
E[(X − d)+ ]
Payment per payment e(d) = E[X − d|X > d] =
1 − F (d)
event/mean residual life
Z d
LEV higher moments E[(X ∧ d)k ] = kxk−1 S(x) dx
0
Deductible + Limit E[Y L ] = E[X ∧ u] − E[X ∧ d]
(max. payment = u − d)

5 Parametric Distributions
Tail weight:
1. Compare moments More moments =⇒ less tail weight
2. Density ratios Low ratio =⇒ numerator has less tail weight
3. Hazard rate Increasing hazard rate =⇒ less tail weight
4. Mean residual life Decreasing MRL =⇒ less tail weight

6 Lognormal Distribution
Continuously compounded growth rate α
Continuously compounded dividend return δ
Volatility σv
Lognormal parameters µ = (α√ − δ − 21 σv2 )t
σ = σv t
Asset price at time t St = S0 exp(µ + Zσ)
Strike price K
European call (option to buy) C = max{0, ST − K}
European put (option to sell) C = max{0, K − ST }
American options exercise at any time up to T
Black-Scholes −dˆ1 = (log(K/S0 ) − µ − σ 2 )/σ
−dˆ2 = (log(K/S0 ) − µ)/σ
Cumulative distribution Pr[St < K] = Φ(−dˆ2 )
Φ(−dˆ1 )
Limited expected value E[St |St < K] = S0 e(α−δ)t
Φ(−dˆ2 )
Φ(dˆ1 )
E[St |St > K] = S0 e(α−δ)t
Φ(dˆ2 )

2
7 Deductibles, LER, Inflation
Loss elimination ratio LER(d) = E[X ∧ d]/ hE[X] i
d
Inflation if Y = (1 + r)X E[Y ∧ d] = (1 + r) E X ∧ 1+r

8 Other Coverage Modifications

With deductible d, maximum covered loss u, coinsurance α, policy limit/maximum
payment L = α(u − d):
Payment per loss E[Y L ] = α(E[X ∧ u] − E[X ∧ d])
Second moment of per-loss E[(Y L )2 ] = E[(X ∧ u)2 ] − E[(X ∧ d)2 ] − 2d E[Y L ]

9 Bonuses
With earned premium P , losses X, proportion of premiums r:
Bonus B = c(rP − X)+

10 Discrete Distributions
pk b
(a, b, 0) recursion =a+
pk−1 k
pn
zero-truncated relation pT0 = 0, pTn =
1 − p0
1 − pM
0
zero-modified relation pM
n = pn
1 − p0

11 Poisson/Gamma
If S = X1 + X2 + · · · + XN , where X ∼ Gamma(α, θ), N ∼ Poisson(λ) where λ
varies by X, then S ∼ NegBinomial(r = α, β = θ).

12 Frequency Distributions—Exposure and Cov-

erage Modifications
Model Original Exposure mod. Coverage mod.
Exposure n1 n2 n1
Pr[X > 0] 1 1 υ
Poisson λ (n2 /n1 )λ υλ
Binomial m, q (n2 /n1 )m, q m, υq
Neg. Binomial r, β (n2 /n1 )r, β r, υβ

3
13 Aggregate Loss Models: Approximating Dis-
tribution
Compound variance Var[S] = Var[X] E[N ] + E[X]2 Var[N ]

14 Aggregate Loss Models: Recursive Formula

Frequency pn = Pr[N = n]
Severity fn = Pr[X = n]
Aggregate loss gn = Pr[S = n] = fS (n)
k  
1 X bj
(a, b, 0) recursion gk = a+ fj gk−j
1 − af0 j=1 k

15 Aggregate Losses—Aggregate Deductible

dd/he−1
X
E[S ∧ d] = d(1 − F (d)) + hjghj
j=0

16 Aggregate Losses—Misc. Topics

1
If X ∼ Exponential(θ), N ∼ Geometric(β), then FS (x) = 1+β [x = 0] +
β 0
1+β FX (x),
0 where X ∼ Exponential(θ(1 + β)).
If S = X1 + · · · + Xn , then S ∼ Gamma(α = n, θ).
Method of rounding: pk = FX (k + 1/2) − FX (k − 1/2)

17 Ruin Theory
Ruin probability, discrete, finite horizon ψ̃(u, t)
Survival probability, continuous, infinite horizon φ(u)

4
Part II
Empirical Models
18 Review of Mathematical Statistics
Bias Biasθ̂ (θ) = E[θ̂ − θ|θ]
Consistency lim Pr[|θ̂n − θ| < δ] = 1, ∀δ > 0
n→∞
Mean square error MSEθ̂ (θ) = E[(θ̂ − θ)2 |θ]
n
1 X
Sample variance s2 = (xi − x̄)2
n−1
k=1
Variance of s2 σ 2 /n
MSE/Bias relation MSEθ̂ (θ) = Var[θ̂] + Biasθ̂ (θ)2

19 Empirical Distribution for Complete Data

Total number of observations n
Observations in j-th interval nj
Width of j-th interval cj − cj−1
nj
Empirical density fn (x) =
n(cj − cj−1 )

20 Variance of Empirical Estimators with Com-

plete Data
Empirical variance d n (x)] = Sn (x)(1 − Sn (x))/n = nx (n − nx )/n3
Var[S

21 Kaplan-Meier and Nelson Åalen Estimators

Risk set at time yj rj
Loss events at time yj sj
j−1
Y 
si
Kaplan-Meier product-limit estimator Sn (t) = 1− , yj−1 ≤ t < yj
i=1
ri
j−1
X si
Nelson-Åalen cumulative hazard Ĥ(t) = , yj−1 ≤ t < yj
i=1
ri

22 Estimation of Related Quantities

Exponential extrapolation: fit Sn (yk ) = exp(−yk /θ), and solve for the parame-
ter θ.

5
23 Variance of Kaplan-Meier and Nelson-Åalen
Estimators
j
d n (yj )] = Sn (yj )2
X si
Greenwood’s approximation Var[S
ri (ri − si )
for KM i=1
j
X si
Greenwood’s approximation Var[
d Ĥ(yj )] =
r2
i=1 i
for NÅ q  
Var[S zα/2
d n (t)]
100(1−α)% log-transformed (Sn (t)1/U , Sn (t)U ), U = exp  
Sn (t) log Sn (t)
confidence interval for KM q
 
zα/2 Var[
d Ĥ(t)]
100(1−α)% log-transformed (Ĥ(t)/U, Ĥ(t)U ), U = exp  
confidence interval for NÅ Ĥ(t)

24 Kernel Smoothing
1
Uniform kernel density , y − b ≤ x ≤ y + b
ky (x) = 2b
 0, x<y−b
x−(y−b)
Uniform kernel CDF Ky (x) = 2b , y−b≤x≤y =b
1, y+b<x

Triangular kernel density height = 1/b, base = 2b
Empirical probability at yi pn (yi )
n
X
Fitted density fˆ(x) = pn (yi )kyi (x)
i=1
Xn
Fitted distribution F̂ (x) = pn (yi )Kyi (x)
i=1
Use conditional expectation formulas to find moments of kernel-smoothed
distributions; condition on the empirical distribution.

25 Approximations for Large Data Sets

Right/upper endpoint of j-th interval cj
Number of new entrants in [cj , cj+1 ) dj
Number of withdrawals in (cj , cj+1 ] uj
Number of events in (cj , cj+1 ] sj
Risk set for the interval (cj , cj+1 ] rj
Conditional mortality rate in (cj , cj+1 ] qj
j−1
X
Population at time cj Pj = di − ui − si
i=0
Generalized relation rj = Pj + αdj − βuj
UD of entrants/withdrawals α = β = 1/2

6
Part III
Parametric Models
26 Method of Moments
For a k-parameter distribution, match the first k empirical moments to the fitted
distribution:
n
X
E[X m ] = (xi − x̄)m
i=1

27 Percentile Matching
Interpolated k-th order statistic xk+w = (1 − w)xk + wxk+1 , 0<w<1
Smoothed empirical 100p-th πp = xp(n+1)
percentile

28 Maximum Likelihood Estimators

n
Y
Likelihood function ~ =
L(θ) ~
Pr[X ∈ Xi |θ]
i=1
Loglikelihood l = log L
Xi are the observed events—each is a subset of the sample space. Maximize l
∂l
by finding θ~ such that = 0 for each parameter in the fitted distribution.
∂θi

29 MLEs—Special Techniques
Exponential MLE = sample mean
Gamma (fixed α) MLE = method of moments
Normal MLE(µ) = sample mean, MLE(σ 2 ) = population variance
Poisson MLE = sample mean
Neg. Binomial MLE(rβ) = sample mean
Lognormal take logs of sample, then use Normal shortcut

Censored exponential MLE–Take each observation (including censored ones)

and subtract the deductible; sum the result and divide by the number of uncen-
sored observations.

7
30 Estimating Parameters of a Lognormal Dis-
tribution
31 Variance of MLEs
For n estimated parameters θ~ = (θ1 , θ2 , . . . , θn ), the estimated variance of a
function of MLEs is computed using the delta method: 2 
σ1 σ12 · · · σ1n
 σ21 σ22 · · · σ2n 
Covariance matrix Σ(θ)~ =  .. .. ..

.. 
 . . . . 
σn1 σn2 · · · σn2
 > X  
~ ∂g ~ ∂g
Delta method Var[g(θ)] = (θ)
~
"∂ θ # ∂ θ~
2 ~
∂ l(θ)
Fisher’s information I(θrs ) = − E
∂θs ∂θr
Covariance-information relation ~ θ)
Σ(θ)I( ~ = In

32 Fitting Discrete Distributions

To choose which (a, b, 0) distribution to fit to a set of data, compute the empirical
mean and variance. Then note
Binomial E[N ] > Var[N ]
Poisson E[N ] = Var[N ]
Negative Binomial E[N ] < Var[N ]

33 Cox Proportional Hazards Model

Hazard class i/Covariate zi
logarithm of proportionality constant for class i βi
Proportionality constant/relative risk c = exp(β1 z1 + β2 z2 + · · · + βn zn )
Baseline hazard H0 (t)
Hazard relation H(t|z1 , . . . , zn ) = H0 (t)c

34 Cox Proportional Hazards Model: Partial

Likelihood
Number at risk at time y k
Proportionality constants of members at risk {c1 , c2 , . . . , ck }
Failures at time y {j1 , j2 , . . . , jd }
d k
!−d
Y X
Breslow’s partial likelihood exp(βji ) exp(βi )
i=1 i=1

8
35 Cox Proportional Hazards Model: Estimat-
ing Baseline Survival
Risk set at time yj R(yj )
Proportionality constants for the ci
members of risk set R(yj )
X sj
Baseline hazard rate Ĥ0 (t) = P
yj ≤t i∈R(yj ) ci

36 The Generalized Linear Model

37 Hypothesis Tests: Graphic Comparison
f (x)
Adjusted fitted density f ∗ (x) =
1 − F (d)
∗ F (x) − F (d)
Adjusted fitted distribution F (x) =
1 − F (d)
D(x) plot D(x) = Fn (x) − F ∗ (x)
empirical observations x1 , x2 , . . . , xn
p-p plot (Fn (xj ), F ∗ (xj ))
Normal probability plot (xj , F ∗−1 (Fn (x)))
Where the p-p plot has slope > 1, then the fitted distribution has more weight
than the empirical distribution; where the slope < 1, the fitted distribution has
less weight.

38 Hypothesis Tests: Kolmogorov-Smirnov

Komolgorov-Smirnov statistic D = max |Fn (x) − F ∗ (x; θ̂)|
KS-statistic is the largest absolute difference between the fitted and empirical
distribution. Should be used on individual data, but bounds on KS can be
established with grouped data. Fitted distribution must be continuous. Uniform
weight across distribution. Lower critical value for fitted parameters and for
more samples.

39 Hypothesis Tests: Anderson-Darling

u
(Fn (x) − F ∗ (x))2 ∗
Z
Anderson-Darling statistic A2 = n f (x) dx
t F ∗ (x)(1 − F ∗ (x))
AS-statistic used only on individual data. Heavier weight on tails of distribution.
Critical value independent of sample size, but decreases for fitted parameters.

9
40 Hypothesis Tests: Chi-square
Total number of observations n
Hypothetical probability X is in j-th group pj
Number of observations in j-th group nj
k
X (nj − Ej )2
Chi-square statistic Q= Ej = n j pj
j=1
Ej

Degrees of freedom df = total number of groups, minus number of estimated

parameters, minus 1 if n is predetermined

41 Likelihood Ratio Algorithm, Schwarz Bayesian

Criterion
Likelihood Ratio—compute loglikelihood for each parametric model. Twice the
difference of the loglikelihoods must be greater than 100(1 − α)% percentile
of chi-square with df = difference in the number of parameters between the
compared models.
Schwarz Bayesian Criterion—Compute loglikelihoods and subtract 2r log n,
where r is the number of estimated parameters in the model and n is the sample
size of each model.

Part IV
Credibility
42 Limited Fluctuation Credibility—Poisson Fre-
quency
Poisson frequency of claims λ
Margin of acceptable fluctuation k
Confidence of fluctuation being within k P
Severity CV CVs2 = σs2 /µ2s
 −1 1+P
2
Φ 2
n0 n0 =
k
Credibility for Frequency Severity Aggregate
n0 n0 n0
CVs2 1 + CVs2


Exposure units eF
λ λ λ
Number of claims nF n0 n0 CVs2 n0 (1 + CVs2 )
Aggregate losses sF n0 µs n0 µs CVs2 n0 µs (1 + CVs2 )

10
43 Limited Fluctuation Credibility: Non-Poisson
Frequency
Credibility for Frequency Severity Aggregate !
σf2 σ2 n0 σf2 σ2
Exposure units eF n0 2 n0 s 2 + s2
µf µf µs µf µf µs
!
σf2 σs2 2
σf σs2
Number of claims nF n0 n0 n0 + 2
µf µ2s µf µs
!
σf2 σs2 σf2
σs2
Aggregate losses sF n0 µs n0 n0 µs + 2
µf µs µf µs

Poisson group frequency is the special case µf = σf2 = λ. If a compound Poisson

frequency model is used, you cannot use the Poisson formula—you must use the
mixed distribution (e.g., Poisson/Gamma mixture is Negative Binomial).

44 Limited Fluctuation Credibility: Partial Cred-

ibility
p p p
Credibility factor Z= n/nF = e/eF = s/sF
Manual premium (presumed M
value before observations)
Observed premium X̄
Credibility premium PC = Z X̄ + (1 − Z)M

45 Bayesian Estimation and Credibility—Discrete

Prior
Constructing a table: First row is the prior probability, the chance of member-
ship in a particular class before any observations are made. Second row is the
likelihood function of the observation(s) given the hypothesis of membership in
that particular class. Third row is the joint probability, the product of Rows
1 and 2. Row 4 is the posterior probability, which is Row 3 divided by the
sum of Row 3. Row 5 is the hypothetical mean or conditional probability, the
expectation or probability of the desired outcome given that the observations
belong that that class. Row 6 is the expectation, Bayesian premium, or ex-
pected probability, the desired result given the observations, and is the sum of
the products of Rows 4 and 5.

11
46 Bayesian Estimation and Credibility—Continuous
Prior
Observations ~x = (x1 , x2 , . . . , xn )
Prior density π(θ)
Model density f (~x|θ)
Joint density Z f (~x|θ)π(θ)
f (~x, θ) =
Unconditional density f (~x) = f (~x, θ) dθ
f (~x, θ)
Posterior density π(θ|x1 , . . . , xn ) =
Z f (~x)
Predictive density f (xn+1 |~x) = f (xn+1 |θ)π(θ|~x) dθ
Loss function minimizing MSE posterior mean E[Θ|~x]
Loss function minimizing abso- posterior median
lute error
Zero-one loss function posterior mode
A conjugate prior is the prior distribution when the prior and posterior distri-
butions belong to the same parametric family.

47 Bayesian Credibility: Poisson/Gamma

With Poisson frequency with mean λ, where λ is Gamma distributed with pa-
rameters α, θ,
Number of claims x
Number of exposures n
Average claims per exposure x̄ = x/n
Conjugate prior parameters α, γ = 1/θ
Posterior parameters α∗ = α + x
γ∗ = γ + n
Credibility premium PC = α∗ /γ∗

48 Bayesian Credibility: Normal/Normal

With Normal frequency with mean θ and fixed variance v, where θ is Normal
with mean µ and variance a,
vµ + nax̄
Posterior parameters µ∗ =
v + na
va
Posterior variance a∗ =
v + na
n
Credibility factor Z=
n + v/a
Credibility premium µ∗

12
49 Bayesian Credibility: Binomial/Beta
With Binomial frequency with parameters M , q, where q is Beta with parame-
ters a, b,
Number of trials m
Number of claims in m trials k
Posterior parameters a∗ = a + k
b∗ = b + m − k
Credibility premium PC = a∗ /(a∗ + b∗ )

50 Bayesian Credibility: Exponential/Inverse Gamma

With exponential severity with mean Θ, where Θ is inverse Gamma with pa-
rameters α, β,
Posterior parameters α∗ = α + n
β∗ = β + nx̄

51 Bühlmann Credibility: Basics

Expected hypothetical mean µ = E[E[X|θ]]
Variance of hypothetical mean (VHM) a = Var[E[X|θ]]
Expected value of process variance (EPV) v = E[Var[X|θ]]
Bühlmann’s k k = v/a
Bühlmann credibility factor Z = n/(n + k)
Bühlmann credibility premium PC = Z X̄ + (1 − Z)µ

52 Bühlmann Credibility: Discrete Prior

No additional formulas

53 Bühlmann Credibility: Continuous Prior

No additional formulas

54 Bühlmann-Straub Credibility
55 Exact Credibility
Bühlmann equals Bayesian credibility when the model distribution is a member
of the linear exponential family and the conjugate prior is used.

13
 Frequency/Severity Bühlmann’s k
Poisson/Gamma k = 1/θ = γ
Normal/Normal k = v/a
Binomial/Beta k =a+b

56 Bühlmann As Least Squares Estimate of Bayes

Var[X] = pi Xi2 − X̄ 2
P
Variance of observations
Bayesian estimates Yi P
Covariance Cov[X, Y ] = pi Xi Yi − X̄ Ȳ
Mean relationship E[X] = E[Y ] = E[Ŷ ]
Cov[X, Y ]
regression slope/Bühlmann cred- b=Z=
Var[X]
ibility estimate
regression intercept a = (1 − Z) E[X]
Bühlmann predictions Ŷi = a + bXi

57 Empirical Bayes Non-Parametric Methods

For uniform exposures,
Number of exposures/years data n
Number of classes/groups r
Observation of of group i, year j xij
r n
1 XX
Unbiased manual premium µ̂ = x̄ = xij
rn i=1 j=1
r n
1X 1 X
Unbiased EPV v̂ = (xij − x̄i )2
r i=1 n − 1 j=1
r
1 X v̂
Unbiased MHV â = (x̄i − x̄)2 −
r − 1 i=1 n
n
Bühlmann credibility factor Z=
n + k̂

58 Empirical Bayes Semi-Parametric Methods

When the model is Poisson, v = µ, and we have
EPV v̂ = µ
VHM â = Var[S] − v̂
X (xi − x̄)2
Sample variance Var[S] = σ 2 =
n−1

14
Part V
Simulation
59 Simulation—Inversion Method
Random number u ∈ [0, 1]
Inversion relationship Pr[F −1 (u) ≤ x] = Pr[F (u) ≤ F (x)] = F (x)
Method xi = F −1 (u)
Simply take the generated uniform random number u and compute the inverse
CDF of u to obtain the corresponding simulated xi .

15