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Frequency-severity experience rating based on latent Markovian risk profiles

Robert Matthijs Verschuren

Insurance: Mathematics and Economics, 2022, vol. 107, issue C, 379-392

Abstract: Bonus-Malus Systems traditionally consider a customer's number of claims irrespective of their sizes, even though these components are dependent in practice. We propose a novel joint experience rating approach based on latent Markovian risk profiles to allow for a positive or negative individual frequency-severity dependence. The latent profiles evolve over time in a Hidden Markov Model to capture updates in a customer's claims experience, making claim counts and sizes conditionally independent. We show that the resulting risk premia lead to a dynamic, claims experience-weighted mixture of standard credibility premia. The proposed approach is applied to a Dutch automobile insurance portfolio and identifies customer risk profiles with distinctive claiming behavior. These profiles, in turn, enable us to better distinguish between customer risks.

Keywords: Experience rating; Frequency-severity dependence; Dynamic latent risk profiles; Hidden Markov model; Automobile insurance (search for similar items in EconPapers)
JEL-codes: C32 C33 C53 G22 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:107:y:2022:i:c:p:379-392

DOI: 10.1016/j.insmatheco.2022.09.007

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