An Introduction to Credibility

Credibility theory provides important tools to help the actuary deal with the randomness inherent in the data that he or she analyzes. Actuaries use past data to predict what can be expected in the future, but the data usually arises from a random process. In insurance, the loss process that generates claims is random. Both the number of claims and the size of individual claims can be expected to vary from one time period to another. If $1,500,000 in losses were paid by an insurer during the past year, one might estimate that $1,500,000 would likely be paid in the current year for the same group of policies. However, the expected accuracy of the estimate is a function of the variability in losses. Using credibility theory, the actuary estimates the randomness inherent in the data and then calculates a numeric weight to assign to the data.