Buhlmann credibility
Model computing the optimal weight to give an individual risk's own experience rather than the collective mean, as the ratio of between-risk variance to within-risk variance.
A garage has had zero claims in three years: should it be priced at zero. Obviously not, but then what weight should its experience carry. Buhlmann credibility answers with a formula rather than a convention. The premium is Z times individual experience plus one minus Z times the collective premium, where Z equals n over n plus k. Here n is the number of observations, and k the ratio of within-risk process variance to between-risk variance of the mean. The reading is intuitive and drives the whole rating. If risks closely resemble each other, between-risk variance is small, k is large, Z stays small and individual experience counts for little. If the book is very heterogeneous, k is small and individual experience quickly takes over. Buhlmann-Straub extends the model to unequal exposure volumes. That is the version used in practice, notably in reinsurance to weight treaty experience against market statistics.
Rating a 40 vehicle commercial fleet, 2026 policy year, five years of observation. Collective frequency 12%, observed fleet frequency 7%. Process variance estimated at 0.11, between-fleet variance at 0.0018, so k equals 61 in exposure units. With n equal to 200 vehicle-years, Z equals 200 over 261, that is 0.77. The retained frequency is 0.77 times 7% plus 0.23 times 12%, that is 8.2%.
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