Spatial modelling of risk premiums for water damage insurance

Abstract

In this paper, we compare different spatial models for modelling the risk premium for water damage insurance on the level of the policyholder. We evaluate four models that take the spatial variability into account: (1) the Intrinsic Conditional Auto-Regressive (ICAR) model; (2) the Besag, York, Mollier (BYM) model; (3) the independent random effects model; and (4) a spatial spline model. The models are compared on a huge data set from the Norwegian insurance company Gjensidige containing seven million observations of policyholders during the period 2011–2018. While Bayesian methods are most frequently used for inference in Gaussian Markov Random Field models, we take a frequentist approach and estimate the model parameters using Laplace approximated restricted maximum likelihood. Using the R package mgcv, we compare the different models for claim frequency, claim size and combined in a risk premium model in a comprehensive cross-validation study. Practical measures such as the loss ratio lift, double lift and Gini index are used to compare performance. Finally, we also compare mgcv with INLA and show that for reasonable big data sets we get identical estimates at a much lower computational cost.