Estimating property excess of loss risk premium: The Pareto model
An underwriter has two methods at his disposal for estimating the risk premium for reinsurance treaties: experience rating or exposure rating. As a rule, he will exploit all available means in order to compose a reliable estimate of the risk premium.
The Pareto model can be used in conjunction with both experience and exposure rating, depending on the origin of the losses used to calculate the model's parameters. If the underwriter uses only losses incurred in the portfolio to be reinsured, this is known as experience rating. Yet he will also have experience values for parameters of specific portfolios. If he considers the characteristics of the portfolio in order to adjust these experience values, then he uses the model for exposure rating.
The Pareto model is often used to estimate risk premiums for excess of loss treaties with high deductibles, where loss experience is insufficient and could therefore be misleading. This brochure goes beyond a mere collection of “recipes” and provides the reader with an insight into the basic assumptions that lead to a mathematical model for excess loss rating.
