Multiple Bonus–Malus Scale Models for Insureds of Different Sizes

Abstract

How to consider the a priori risks in experience-rating models has been questioned in the actuarial community for a long time. Classic past-claim-rating models, such as the Buhlmann–Straub credibility model, normalize the past experience of each insured before applying claim penalties. On the other hand, classic Bonus–Malus Scales (BMS) models generate the same surcharges and the same discounts for all insureds because the transition rules within the class system do not depend on the a priori risk. Despite the quality of prediction of the BMS models, this experience-rating model could appear unfair to many insureds and regulators because it does not recognize the initial risk of the insured. In this paper, we propose the creation of different BMSs for each type of insured using recursive partitioning methods. We apply this approach to real data for the farm insurance product of a major Canadian insurance company with widely varying sizes of insureds. Because the a priori risk can change over time, a study of the possible transitions between different BMS models is also performed.