CREDIBILITY CLAIMS RESERVING WITH STOCHASTIC DIAGONAL EFFECTS

Abstract

An interesting class of stochastic claims reserving methods is given by the models with conditionally independent loss increments (CILI), where the incremental losses are conditionally independent given a risk parameter Θ_i,j depending on both the accident year i and the development year j. The Bühlmann–Straub credibility reserving (BSCR) model is a particular case of a CILI model where the risk parameter is only depending on i. We consider CILI models with additive diagonal risk (ADR), where the risk parameter is given by the sum of two components, one depending on the accident year i and the other depending on the calendar year t = i + j. The model can be viewed as an extension of the BSCR model including random diagonal effects, which are often declared to be important in loss reserving but rarely are specifically modeled. We show that the ADR model is tractable in closed form, providing credibility formulae for the reserve and the mean square error of prediction (MSEP). We also derive unbiased estimators for the variance parameters which extend the classical Bühlmann–Straub estimators. The results are illustrated by a numerical example and the estimators are tested by simulation. We find that the inclusion of random diagonal effects can be significant for the reserve estimates and, especially, for the evaluation of the MSEP. The paper is written with the purpose of illustrating the role of stochastic diagonal effects. To isolate these effects, we assume that the development pattern is given. In particular, our MSEP values do not include the uncertainty due to the estimation of the development pattern.