BÜHLMANN CREDIBILITY

Rizky Reza Fauzi, D.Phil.Math.

Parahyangan Catholic University

Risk Theory
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 Bühlmann Credibility

Greatest Accuracy Credibility

Coming back to the topic of Mixed-Frequency Models in Loss Distribution
course, though we often consider the frequency N depends on a constant
parameter θ through all personals, actually each policy holder (or group of)
might has different value of θ due to their unique characteristics
In this setting, we may consider the difference of each θ as a random effect,
which is called the mixing distribution with pdf fΘ (or pmf pΘ ), while N|θ is
called the conditional frequency
Continuing this idea, let Ri |θ, i “ 1, 2, ..., n, be personal i.i.d. risk random
variables (frequency, severity, or aggregate loss) with similar characteristics
that depend on θ, then the actual pure premium (or hypothetical mean) of
this group of policy holders should be
µR pθq “ E pR|θq,
with process variance σR2 pθq “ VarpR|θq

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 Bühlmann Credibility

Greatest Accuracy Credibility

Since the manual premium µ was based on the past experience and usually
calculated regardless of each unique characteristics, then we can consider it
as the overall (or unconditional) mean

µ “ E pRq “ E rE pR|Θqs,

with total (or unconditional) variance

σ 2 “ VarpRq “ E rVarpR|Θqs ` VarrE pR|Θqs

Here, we call its variance within part as the expected process variances
(EPV) denoted by µPV , and its variance between component as the variance
2
of hypothetical means (VHM) denoted by σHM

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 Bühlmann Credibility

Greatest Accuracy Credibility

Now, by denoting R “ pR1 , R2 , ..., Rn qJ , our intention is to find the

credibility premium based on E pRn`1 |θq, i.e. the hypothetical mean of the
next claim, but unfortunately in practice the value of θ of someone is
sometimes unknown
However, we know that

E rE pRn`1 |Θqs “ E rE pRn`1 |Rqs,

which means we can calculate the credibility premium by estimating the next
claim based on previous sample, or mathematically, Rpn`1 “ E pRn`1 |Rq
In the Bühlmann (or greatest accuracy) Credibility Theory, we will utilize the
characteristics of each group of policy holders to adjust the credibility
premium Pc based on the known information

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 Bühlmann Credibility

Bühlmann Model
In the Bühlmann Model, regardless of θ we assume that there is a linear
relationship between the next claim and the previous ones, i.e.
Rn`1 “ β0 ` β1 X1 ` ¨ ¨ ¨ ` βn Xn ` ε,
where βi ’s are constants, also ε is independent to Θ and R with mean 0
Denoting W “ p1, RJ qJ , βR “ pβ1 , β2 , ..., βn qJ , and β “ pβ0 , βRJ qJ , then

Rpn`1 “ βp0 ` βp1 X1 ` ¨ ¨ ¨ ` βpn Xn

“ βp0 ` βpJ R
R
“ βpJ W

To achieve the greatest accuracy, we need to minimize

MSE pβq “ E rpRn`1 ´ βpJ Wq2 s

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 Bühlmann Credibility

Bühlmann Model
Back to Regression Analysis course and with matrix manipulation, we have
βpR “ rCovpRqs´1 CovpR, Rn`1 q and βp0 “ p1 ´ βpRJ 1qµ,
where 1 is an n ˆ 1 vector of ones, CovpRq is the variance-covariance matrix
of R and
CovpR, Rn`1 q “ pCovpR1 , Rn`1 q, CovpR2 , Rn`1 q, ..., CovpRn , Rn`1 qqJ
2
Because VarpRi q “ σHM ` µPV , also for i ‰ j we have
CovpRi , Rj q “ E rE pRi Rj |Θqs ´ E 2 rE pR|Θqs “ σHM
2
,
thus
˙´1
σ2 2
ˆ
2 2 σHM
βpR “ pµPV I ` σHM 11J q´1 σHM 1 “ HM I` 11J 1
µPV µPV

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 Bühlmann Credibility

Bühlmann Model

Defining

µPV E rVarpR|Θqs
k“ 2
“ ,
σHM VarrE pR|Θqs

it can be easily confirmed that

ˆ ˙´1
1 J 1
I ` 11 “I´ 11J ,
k n`k

which leads to
ˆ ˙
1 1 1
βpR “ I´ 11J 1 “ 1
k n`k n`k

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 Bühlmann Credibility

Bühlmann Model

Hence, the Bühlmann Premium is

ˆ ˙ ˆ ˙
1 J 1 J n s n
Rn`1 “ 1 ´
p 1 1 µ` 1 R“ R ` 1´ µ,
n`k n`k n`k n`k

which is the general formula of Pc with Z “ n{pn ` kq

Note that, assuming n is fixed, then we will consider the recent data to be
more credible when k « 0, meaning the variability within the same group is
less than the one between different groups, otherwise when there is almost
no difference among groups, we prefer to believe the manuals

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 Bühlmann Credibility

Bühlmann Model
Example, based on past experience, suppose the manual of auto insurance is
devided based on driving ability as follows
Ability pΘq pΘ pθq Severity
good 0.5 Γp3, 2q
so so 0.125 Γp5, 2q
bad 0.375 Γp4, 3q
then the overall mean is µ “ 8.75, also
2
σHM “ p0.5qp36q ` p0.125qp100q ` p0.375qp144q ´ 8.752 “ 7.94,
µPV “ p0.5qp12q ` p0.125qp20q ` p0.375qp36q “ 22,
implying k “ 2.77
If there are 26 claims with total loss 312 from a new auto insurance product,
then we can update its next premium based on
ˆ ˙
26 312 26
Pc “ Xp27 “ ` 1´ 8.75 “ 11.69
26 ` 2.77 26 26 ` 2.77 Risk Theory
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 Bühlmann Credibility

Bühlmann-Straub Model
In some cases, instead of personal risk, the random variable R can represent
the risk per unit of exposure of a certain period of time
Let Xij (or Nij ) be the claim severity (or frequency) of j-th policy holder in
i-th month, where mi is the exposure of that month, thus if we define
m m
1 ÿi 1 ÿi
Ri “ Xij or Ri “ Nij ,
mi j“1 mi j“1

then Ri represents the severity (or frequency) per unit of exposure in i-th
month, with
σX2 pθq
E pRi |θq “ µX pθq and VarpRi |θq “ ;
mi
change the subscript X to N if Ri is for frequency
It is trivial that though Xij |θ’s (or Nij |θ’s) are identically distributed, Ri |θ’s
in general are not identical (but still independent), as the exposure of each
month might be different Risk Theory
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 Bühlmann Credibility

Bühlmann-Straub Model
In this setting, the Bühlmann Model cannot be applied as it requires the
risks being identically distributed, fortunately Straub modified it to become
the Bühlmann-Straub Model
This model still assumes that the relationship between Rn`1 and R is linear
as in the Bühlmann Model, also the overall mean still µ “ E pRi q, but, if we
denote µPV “ E rσX2 pΘqs and σHM
2
“ VarrµX pΘqs, then the total variance is
µPV
σi2 “ VarpRi q “ 2
` σHM
mi

By similar arguments, we have the same formula for βp0 on page 6, but
2
ˆ ˙
´1 σHM {µPV J 2 1
βR “ V ´
p
2
řn mm σHM 1“ řn m,
µPV ` σHM i“1 mi k ` i“1 mi

where V´1 “ µ´1

PV diagpm1 , m2 , ..., mn q and m “ pm1 , m2 , ..., mn q
J

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 Bühlmann Credibility

Bühlmann-Straub Model

Defining Rs as the weighted average of R, i.e.

řn
m i Ri 1
Rs “ ři“1n “ řn mJ R,
m
i“1 i m
i“1 i

hence, the Bühlmann-Straub Premium is

ˆ ˙
1 1
Rpn`1 “ 1´ řn mJ 1 µ ` řn mJ R
k ` i“1 mi k ` i“1 mi
řn ˆ řn ˙
mi s mi
“ řn i“1 R ` 1 ´ řn i“1 µ,
i“1 mi ` k i“1 mi ` k
řn řn
which is the general formula of Pc with Z “ i“1 mi {p i“1 mi ` kq

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 Bühlmann Credibility

Bühlmann-Straub Model
Continuing the example on page 9, suppose the new auto insurance has
been launched for more than 3 months with individual risks (in hundred of
dollars) data as follows
Month Number of insureds Total loss
1 100 7
2 200 13
3 250 18
4 280 ´
if we define Ri “ Si {mi , then Ri represents the monthly amount of claim per
policy holder
Hence, the predicted severity per policy holder should be
ˆ ˙ ˆ ˙
550 550
Pc “ Rp4 “ 0.07 ` 1 ´ 8.75 “ 0.11,
550 ` 2.77 550 ` 2.77
which means the predicted total loss is p280qp0.11q “ 30.8 hundred dollars
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 Closing

Homework

1 Solve [Klugman] no. 17.10

2 Solve [Klugman] no. 17.21(a)
3 Solve [Tse] no. 7.1
4 Solve [Tse] no. 7.4
5 Read Bayesian Credibility

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