Potential Enhancements to Ratemaking Techniques - Cont.

A third approach for improving MPCI ratemaking analysis is to extend the concept of credibility to consider the spatial and intertemporal correlation between territories, that is, to create a spatial credibility model. This model is still in the early development stage, and its development is deferred to the appendix.

The spatial credibility technique is similar to spatial smoothing in that the experience in nearby counties is given more weight than that of more distant counties. However, it may allow for greater local fluctuations than spatial smoothing would produce. Each county's loss cost is used to the extent it is credible, with the remainder of the credibility being assigned to nearby counties, based on the relevance of their information.

The spatial credibility technique permits the loss costs to be estimated even for counties with little or no experience by taking advantage of the redundant information in nearby territories. In comparison, the classical credibility technique is generally applied to the indicated price changes, which may reduce or eliminate the spatial correlation between territories. As a result, classical credibility produces price changes for small territories that are similar to the statewide price change. Consequently, if these territories had been previously misrated, the classical credibility approach may not correct the misrating.