Disadvantages of the Classical Credibility Approach

judyoh

what is meant by the second point under disadvantages? (doesnt consider quality of estimator ...) Thank you.

Graham

Sure, for classical credibility, the estimate you get for future loss experience is a weighted average between your prior estimate and the new data you've gathered.

However, the classical credibility approach doesn't give you a way to gauge how "good" your estimate is in relation to the most recent observation you have. For example, let's say your prior estimate was based on data from the last 5 years, but in the last year, there were some significant changes in behavior or regulations that made the most recent year very different. The classical approach would still weigh the new data and the old data without accounting for the relevance or quality of either.

That's why judgment is often required. You, or an actuary, would need to make a judgment call about whether the recent observations should perhaps be given more weight, or if they're even reliable indicators of future loss experience. This isn't automatically considered in the classical credibility approach, making it a notable disadvantage.