A credibility-based Erlang mixture model for pricing crop reinsurance. Issue 2 (1st July 2014)

• Record Type: Journal Article
• Authors: Porth, Lysa; Zhu, Wenjun; Seng Tan, Ken
• Is Part Of: Agricultural finance review. Volume 74:Issue 2(2014)
• Page Start: 162
• Page End: 187
• Publication Date: 2014-07-01
• Subjects: Agriculture -- Finance -- Periodicals; Agriculture -- Finance -- Statistics -- Periodicals; Agricultural insurance -- Periodicals; Agriculture -- Taxation -- Periodicals; 332.71
• DOI: 10.1108/AFR-04-2014-0006
• Languages: English
• ISSNs: 0002-1466

Abstract

<abstract> <title> <x content-type="archive" xml:space="preserve">Abstract</x> </title> <sec> <title content-type="abstract-heading">Purpose</title> <p> – 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. </p> </sec> <sec> <title content-type="abstract-heading">Design/methodology/approach</title> <p> – 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. </p> </sec> <sec> <title content-type="abstract-heading">Findings</title> <p> – 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. </p> </sec> <sec> <title content-type="abstract-heading">Research limitations/implications</title> <p> – 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. </p> </sec> <sec> <title content-type="abstract-heading">Practical implications</title> <p> – The credibility-based Erlang mixture model proposed in this paper should be useful for crop insurers and reinsurers to enhance their ratemaking frameworks. </p> </sec> <sec> <title content-type="abstract-heading">Originality/value</title> <p> – 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.</p> </sec> </abstract>