Classification Ratemaking Using Decision Trees

Manual rating of specific risks begin with a base rate, which is then modified by appropriate relativity factors depending on characteristics of each risk. Classical methods of deriving indicated relativities, are described by McClenahan and Finger. A number of different modeling procedures are described in Brown's "minimum bias" paper and Venter's review of Brown's paper. These methods generally rely on the "multiplicative" or "additive" assumptions, which may not be reasonable for all types of risk. In this paper an alternative method of calculating indicated relativities is described, and demonstrated using a commercial Business Owners' Product (BOP) data set. Accident year 1997 to 2000 data is used to described the method. The results are then applied to claims with accident year 2001. The derived 2001 relativities are compared with observed relativities, thereby demonstrating the extent of suitability of this method. It should be stressed that the intent here is entirely demonstration of a procedure. For actual practical implementation, modification would be required.