Experience Rating with Credibility Adjustment of the Manual Premium

A common procedure for experience rating is to use Whitney's credibility formula with the manual premium per risk unit estimated by the observed average claim amount per risk unit. As pointed out by Whitney himself, this observed average also needs to be subjected to credibility adjustment. This suggestion is pursued in the paper and an experience rating procedure developed in which there are two stages: (i) revision of the prior expected manual premium in accordance with the observed average claim amount per risk unit; (ii) experience rating of the individual risk classes by the usual methods but using the manual premium obtained in stage (i). Both stages of this procedure involve credibility indices, for which formulae are developed. Conditions under which the “common procedure†referred to above is fairly reliable are found and it is seen, somewhat surprisingly, that the procedure is often more valid than one expects on intuitive grounds. Care is necessary, however, when there are wide differences in size between different risk classes.