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A credibility‐based Erlang mixture model for pricing crop reinsurance

A credibility‐based Erlang mixture model for pricing crop reinsurance Purpose – The purpose of this paper is to address some of the fundamental issues surrounding crop insurance ratemaking, from the perspective of the reinsurer, through the development of a scientific pricing framework. Design/methodology/approach – The generating process of the historical loss cost ratio's (LCR's) are reviewed, and the Erlang mixture distribution is proposed. A modified credibility approach is developed based on the Erlang mixture distribution and the liability weighted LCR, and information from the observed data of the individual region/province is integrated with the collective experience of the entire crop reinsurance program in Canada. Findings – A comprehensive data set representing the entire crop insurance sector in Canada is used to show that the Erlang mixture distribution captures the tails of the data more accurately compared to conventional distributions. Further, the heterogeneous credibility premium based on the liability weighted LCR's is more conservative, and provides a more scientific approach to enhance the reinsurance pricing. Research limitations/implications – Credibility models are in the early stages of application in the area of agriculture insurance, therefore, the credibility models presented in this paper could be verified with data from other geographical regions. Practical implications – The credibility‐based Erlang mixture model proposed in this paper should be useful for crop insurers and reinsurers to enhance their ratemaking frameworks. Originality/value – This is the first paper to introduce the Erlang mixture model in the context of agricultural risk modeling. Two modified versions of the Bühlmann‐Straub credibility model are also presented based on the liability weighted LCR to enhance the reinsurance pricing framework. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Agricultural Finance Review Emerald Publishing

A credibility‐based Erlang mixture model for pricing crop reinsurance

Agricultural Finance Review , Volume 74 (2): 26 – Jul 1, 2014

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Publisher
Emerald Publishing
Copyright
Copyright © 2014 Emerald Group Publishing Limited. All rights reserved.
ISSN
0002-1466
DOI
10.1108/AFR-04-2014-0006
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to address some of the fundamental issues surrounding crop insurance ratemaking, from the perspective of the reinsurer, through the development of a scientific pricing framework. Design/methodology/approach – The generating process of the historical loss cost ratio's (LCR's) are reviewed, and the Erlang mixture distribution is proposed. A modified credibility approach is developed based on the Erlang mixture distribution and the liability weighted LCR, and information from the observed data of the individual region/province is integrated with the collective experience of the entire crop reinsurance program in Canada. Findings – A comprehensive data set representing the entire crop insurance sector in Canada is used to show that the Erlang mixture distribution captures the tails of the data more accurately compared to conventional distributions. Further, the heterogeneous credibility premium based on the liability weighted LCR's is more conservative, and provides a more scientific approach to enhance the reinsurance pricing. Research limitations/implications – Credibility models are in the early stages of application in the area of agriculture insurance, therefore, the credibility models presented in this paper could be verified with data from other geographical regions. Practical implications – The credibility‐based Erlang mixture model proposed in this paper should be useful for crop insurers and reinsurers to enhance their ratemaking frameworks. Originality/value – This is the first paper to introduce the Erlang mixture model in the context of agricultural risk modeling. Two modified versions of the Bühlmann‐Straub credibility model are also presented based on the liability weighted LCR to enhance the reinsurance pricing framework.

Journal

Agricultural Finance ReviewEmerald Publishing

Published: Jul 1, 2014

Keywords: Pricing; Crop insurance; Credibility theory; Erlang mixture distribution; Loss cost ratio; Ratemaking

References